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            Full Disclosure in
            Financial Reporting

            H    igh-Quality Financial Reporting—It’s a Necessity
            Here are excerpts from leading experts regarding the importance of high-

                                                                                                         After studying this chapter, you
            quality financial reporting:1                                                                should be able to:
                                                                                                             Review the full disclosure
            Warren E. Buffett, Chairman and Chief Executive Officer, Berkshire
                                                                                                             principle and describe
            Hathaway Inc.:                                                                                   problems of
                 Financial reporting for Berkshire Hathaway, and for me personally, is the begin-            implementation.
                 ning of every decision that we make around here in terms of capital. I’m punching           Explain the use of notes
                 out 10-Ks and 10-Qs every single day. We look at the numbers and try to evaluate            in financial statement
                 the quality of the financial reporting, and then we try to figure out what that means       preparation.
                 for the bonds and stocks that we’re looking at, and thinking of either buying or
                 selling.                                                                                    Describe the disclosure
                                                                                                             requirements for major
            Abby Joseph Cohen, Chair, Investment Policy Committee, Goldman, Sachs                            segments of a business.
            & Co.:                                                                                           Describe the accounting
                 High-quality financial reporting is perhaps the most important thing we can ex-             problems associated with
                 pect from companies. For investors to make good decisions—whether those in-                 interim reporting.
                 vestors are buying stocks or bonds or making private investments—they need to               Identify the major
                 know the truth. And we think that when information is as clear as possible and is           disclosures found in the
                 reported as frequently as makes sense, investors can do their jobs as best they can.        auditor’s report.
            Jeffrey E. Garton, Dean of the Yale School of Management and former Under                        Understand management’s
            Secretary of Commerce for International Trade:                                                   responsibilities for
                 . . . The integrity of the whole society is undermined if financial information is
                 misrepresented, or if it isn’t accurate or understandable. Because we live in a mar-        Identify issues related to
                 ket society—and increasingly, the world does—unless the markets can be trusted,             financial forecasts and
                 then you have widespread corruption . . . and a market economy that doesn’t                 projections.
                 function.                                                                                   Describe the profession’s
            Judy C. Lewent, Executive Vice President and Chief Financial Officer, Merck                      response to fraudulent
                                                                                                             financial reporting.
            & Co., Inc.:
                . . . Higher standards, when properly implemented, drive excellence. I can make
                 a parallel to the pharmaceutical industry. If you look around the world at where
                 innovations come from, economists have studied and seen that where regulatory
                 standards are the highest is where innovation is also the highest.
            Floyd Norris, Chief Financial Correspondent, the New York Times:
                 We are in a situation now in our society where the temptations to provide “bad”
                 financial reporting are probably greater than they used to be. The need to get the
                 stock price up, or to keep it up, is intense. So, the temptation to play games, the
                 temptation to manage earnings—some of which can be legitimate and some of
                 which cannot be—is probably greater than it used to be.
            In short, the comments of these respected individuals illustrate why high-quality
            financial reporting is important to companies, to investors, and to the capital
            markets. At the heart of high-quality financial reporting is full disclosure.
                  Excerpts taken from video entitled “Financially Correct with Ben Stein,” Financial
            Accounting Standards Board (Norwalk, Conn.: FASB, 2002). By permission.
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                            As indicated in the opening story, without transparent, complete, and truthful report-
                            ing of financial performance our markets will not function properly. That is why it is
                            so important that all aspects of financial reporting—the financial statements, the notes,
                            the president’s letter, and management’s discussion and analysis—be read and under-
                            stood. In this chapter, we cover the full disclosure principle in more detail and exam-
                            ine disclosures that must accompany financial statements so that they are not mis-
                            leading. The content and organization of this chapter are as follows.

                                                                     FULL DISCLOSURE IN FINANCIAL

                 Full Disclosure                                                                       Auditor’s and      Current Reporting
                                             Notes to Financial
                    Principle                                                Disclosure Issues         Management’s            Issues
               • Increase in reporting       • Accounting policies          • Special transactions   • Auditor’s report   • Reporting on
                 requirements                • Common notes                   or events              • Management’s         forecasts and
                                                                            • Post-balance-sheet       reports              projections
               • Differential
                 disclosure                                                   events                                      • Internet financial
                                                                            • Diversified                                   reporting
                                                                              companies                                   • Fraudulent financial
                                                                            • Interim reports                               reporting
                                                                                                                          • Criteria for
                                                                                                                            accounting and
                                                                                                                            reporting choices

                                             FULL DISCLOSURE PRINCIPLE
                                             FASB Concepts Statement No. 1 notes that some useful information is better provided in
                                             the financial statements, and some is better provided by means of financial reporting
                                             other than in financial statements. For example, earnings and cash flows are readily
                                             available in financial statements—but investors might do better to look at comparisons
                                             to other companies in the same industry, found in news articles or brokerage house
           OBJECTIVE                              Financial statements, notes to the financial statements, and supplementary infor-
           Review the full                   mation are areas directly affected by FASB standards. Other types of information found
           disclosure principle              in the annual report, such as management’s discussion and analysis, are not subject to
           and describe problems             FASB standards. Illustration 24-1 indicates the types of financial information presented.
           of implementation.                     As indicated in Chapter 2, the profession has adopted a full disclosure principle
                                             that calls for financial reporting of any financial facts significant enough to influence

                                             the judgment of an informed reader. In some situations, the benefits of disclosure may
                                             be apparent but the costs uncertain. In other instances, the costs may be certain but the
              Underlying                     benefits of disclosure not as apparent.
              Concepts                            For example, the SEC increased the amount of information financial institutions
        Here is a good example of the        must disclose about their foreign lending practices. With some foreign countries in eco-
        trade-off between the                nomic straits, the benefits of increased disclosure about the risk of uncollectibility are
        cost/benefit constraint and the      fairly obvious to the investing public. The exact costs of disclosure in these situations
        full disclosure principle.           cannot be quantified, though they would appear to be relatively small.

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                                                                                                                Full Disclosure Principle       •   1273

             ILLUSTRATION 24-1          Types of Financial Information

                                                All Information Useful for Investment, Credit, and Similar Decisions

                                                             Financial Reporting

                             Area Directly Affected by Existing FASB Standards

                              Basic Financial Statements

                                                  Notes to the                                        Other Means of
                         Financial                                         Supplementary                                         Other
                                                   Financial                                             Financial
                        Statements                                          Information                                       Information
                                                  Statements                                             Reporting

                    • Balance Sheet           Examples:                  Examples:                  Examples:             Examples:
                    • Statement of            • Accounting               • Changing Prices          • Management          • Discussion of
                      Income                    Policies                   Disclosures                Discussion and        Competition and
                                              • Contingencies            • Oil and Gas                Analysis              Order Backlog in
                    • Statement of                                                                                          SEC Forms
                      Cash Flows              • Inventory                  Reserves                 • Letters to
                                                Methods                    Information                Stockholders        • Analysts' Reports
                    • Statement of                                         (FASB
                                              • Number of                                                                 • Economic
                      Changes in                                           Statement                                        Statistics
                      Stockholders'             Shares of Stock            No. 69)
                                                Outstanding                                                               • News Articles
                                                                                                                            about Company
                                              • Alternative
                                                (market values
                                                of items carried
                                                at historical

                On the other hand, the cost of disclosure can be substantial in some cases and the
            benefits difficult to assess. For example, the Wall Street Journal reported that, at one
            time, if segment reporting were adopted, a company like Fruehauf would have had to                                       Underlying
            increase its accounting staff 50 percent, from 300 to 450 individuals. In this case, the                                 Concepts
            cost of disclosure is apparent, but the benefits are less well defined. Some would even                          The AICPA’s Special Committee
            argue that the reporting requirements are so detailed and substantial that users will                            on Financial Reporting notes
                                                                                                                             that business reporting is not
            have a difficult time absorbing the information. These critics charge the profession with
                                                                                                                             free, and improving it requires
            engaging in information overload.
                                                                                                                             considering the relative costs
                The difficulty of implementing the full disclosure principle is highlighted by such                          and benefits of information,
            financial disasters as Enron, PharMor, WorldCom, and Global Crossing. Why were                                   just as costs and benefits are
            investors not aware of potential problems—Was the information presented about these                              key to determining the features
            companies not comprehensible? Was it buried? Was it too technical? Was it properly                               included in any product. Undis-
            presented and fully disclosed as of the financial statement date, but the situation later                        ciplined expansion of man-
            deteriorated? Or was it simply not there?                                                                        dated reporting could result in
                                                                                                                             large and needless costs.

            Increase in Reporting Requirements
            Disclosure requirements have increased substantially. One survey showed that in a sam-
            ple of 25 large, well-known companies over a recent 10-year period, the average num-
            ber of pages of notes to the financial statements increased from 9 to 17 pages, and the
            average number of pages for management’s discussion and analysis grew from 7 to 12
            pages. This result is not surprising because as illustrated throughout this textbook, the
            FASB has issued many standards in the last 10 years that have substantial disclosure
            provisions.2 The reasons for this increase in disclosure requirements are varied. Some
            of them are:

                 Complexity of the Business Environment. The difficulty of distilling economic
                 events into summarized reports has been magnified by the increasing complexity

                  The survey results were taken from Ray J. Groves, “Financial Disclosure: When More Is
            Not Better,” Financial Executive (May/June 1994).
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        1274     •   Chapter 24 Full Disclosure in Financial Reporting

                                               of business operations in such areas as derivatives, leasing, business combinations,
                                               pensions, financing arrangements, revenue recognition, and deferred taxes. As a
                                               result, notes to the financial statements are used extensively to explain these trans-
                                               actions and their future effects.
                                               Necessity for Timely Information. Today, more than ever before, users are de-
                                               manding information that is current and predictive. For example, more complete
                                               interim data are required. And published financial forecasts, long avoided and even
                                               feared by management, are recommended by the SEC.
                                               Accounting as a Control and Monitoring Device. The government has recently
                                               sought more information and public disclosure of such phenomena as management
                                               compensation, off-balance-sheet financing arrangements, and related party trans-
                                               actions. An “Enronitis” concern is expressed in many of these newer disclosure
                                               requirements, and accountants and auditors have been selected as the agents to as-
                                               sist in controlling and monitoring these concerns.

                                               Supersize that, please!

                                               General Electric’s 2001 annual report is 93 pages and has 30 percent more financial
                                               information than the year before. Primarily GE provided more specific data about 26
                                               individual businesses, including its industrial units as well as GE Capital, compared
        What do the                            with just 12 business segments for 2000. Other companies such as International Busi-
        numbers mean?                          ness Machines and Sun Trust Banks have promised greater disclosure in reports, as
                                               investors seem now to want more corporate nitty-gritty, hoping it will protect them from
                                               Enron-like surprises. Williams Companies, a natural gas and energy trading company,
                                               may take the prize for having the largest annual report—it’s 1,234 pages, three times as
                                               large as the previous year!
                                               Source: Rachel Emma Silverman, “GE’s Annual Report Bulges With Data in Bid to Address Post-
                                               Enron Concerns,” Wall Street Journal (March 11, 2002).

                                           Differential Disclosure
                                           A trend toward differential disclosure is also occurring. For example, the SEC requires
              Underlying                   that certain substantive information be reported to it that is not found in annual re-
              Concepts                     ports to stockholders. And the FASB, recognizing that certain disclosure requirements
        The AICPA Special Committee        are costly and unnecessary for certain companies, has eliminated reporting require-
        on Financial Reporting indi-       ments for nonpublic enterprises in such areas as fair value of financial instruments and
        cated that users differ in their   segment reporting.3
        needs for information, and that        Some still complain that the FASB has not gone far enough. They note that certain
        not all companies should           types of companies (small or nonpublic) should not have to follow complex GAAP re-
        report all elements of informa-    quirements such as deferred income taxes, leases, or pensions. This issue, often referred
        tion. Rather, companies should     to as Big GAAP versus Little GAAP, continues to be controversial. The FASB takes
        report only information that       the position that one set of GAAP should be used, except in unusual situations.
        users and preparers agree is
        needed in the particular
                                           NOTES TO THE FINANCIAL STATEMENTS
                                           As you know from your study of this textbook, notes are an integral part of the finan-
           OBJECTIVE                       cial statements of a business enterprise. However, they are often overlooked because
           Explain the use of              they are highly technical and often appear in small print. Notes are the means of am-
           notes in financial
           statement preparation.              3
                                               The FASB has had a disclosure-effectiveness project. The revised pension and postretire-
                                           ment benefit disclosures discussed in Chapter 20 (FASB Statement No. 132) are one example of
                                           how disclosures can be streamlined and made more useful.
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                                                                                                      Notes to the Financial Statements         •   1275

            plifying or explaining the items presented in the main body of the statements. In-
            formation pertinent to specific financial statement items can be explained in qualita-
            tive terms, and supplementary data of a quantitative nature can be provided to expand
            the information in the financial statements. Restrictions imposed by financial arrange-
            ments or basic contractual agreements also can be explained in notes. Although notes
            may be technical and difficult to understand, they provide meaningful information for
            the user of the financial statements.

            Accounting Policies
            Accounting policies of a given entity are the specific accounting principles and meth-
            ods currently employed and considered most appropriate to present fairly the finan-
            cial statements of the enterprise. APB Opinion No. 22, “Disclosure of Accounting Poli-
            cies,” concluded that information about the accounting policies adopted and followed
            by a reporting entity is essential for financial statement users in making economic de-
            cisions. It recommended that a statement identifying the accounting policies adopted
            and followed by the reporting entity should also be presented as an integral part of
            the financial statements. The disclosure should be given as the initial note or in a sep-
            arate Summary of Significant Accounting Policies section preceding the notes to the
            financial statements. The Summary of Significant Accounting Policies answers such
            questions as: What method of depreciation is used on plant assets? What valuation
            method is employed on inventories? What amortization policy is followed in regard to
            intangible assets? How are marketing costs handled for financial reporting purposes?
                 Refer to Appendix 5B, pages 202–228, for an illustration of note disclosure of ac-
            counting policies (Note 1) and other notes accompanying the audited financial state-
            ments of 3M Company. An illustration from OshKosh B’Gosh, Inc. is provided in
            Illustration 24-2.

                                                                                                                                  ILLUSTRATION 24-2
                   OshKosh B’Gosh, Inc. and Subsidiaries                                                                          Note Disclosure of
                   (Dollars in thousands, except per share amounts)                                                               Accounting Policies
                 Note 1. Significant Accounting Policies
                 OshKosh B’Gosh, Inc. and its wholly-owned subsidiaries (the Company) are engaged primarily in the
                 design, sourcing, and marketing of apparel to wholesale customers and through Company-owned retail
                 Principles of consolidation
                 The consolidated financial statements include the accounts of all wholly-owned subsidiaries. All signifi-
                 cant intercompany accounts and transactions have been eliminated in consolidation.
                 Cash and cash equivalents
                 Cash equivalents consist of highly liquid debt instruments such as money market accounts and com-
                 mercial paper with original maturities of three months or less and other financial instruments that can be
                 readily liquidated. The Company’s policy is to invest cash in conservative instruments as part of its cash
                 management program and to evaluate the credit exposure of any investment. Cash equivalents are stated
                 at cost, which approximates market value.
                 Investments are classified as available-for-sale securities and are highly liquid debt instruments. These
                 investments are stated at cost, which approximates market value.
                 Financial instruments
                 The fair value of financial instruments, primarily accounts receivable and debt, do not materially differ
                 from their carrying value.
                 Inventories are stated at the lower of cost or market. Inventories stated on the last-in, first-out (LIFO) ba-
                 sis represent 99.4% of total 2001 and 99.6% of total 2000 inventories. Remaining inventories are valued
                 using the first-in, first-out (FIFO) method.
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        1276     •   Chapter 24 Full Disclosure in Financial Reporting

                                            Property, plant and equipment
                                            Property, plant and equipment are carried at cost or at management’s estimate of fair market value if
                                            considered impaired under the provisions of Statement of Financial Accounting Standards (SFAS) No.
                                            121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of,”
                                            less accumulated depreciation. Expenditures for improvements that increase asset values and extend
                                            usefulness are capitalized. Expenditures for maintenance and repairs are expensed as incurred.
                                            Depreciation and amortization for financial reporting purposes are calculated using the straight-line
                                            method based on the following useful lives:
                                                                           Land improvements                 10   to   15
                                                                           Buildings                         10   to   40
                                                                           Leasehold improvements             5   to   10
                                                                           Machinery and equipment            3   to   10
                                            Revenue recognition
                                            Revenue within wholesale operations is recognized at the time merchandise is shipped and title is trans-
                                            ferred to customers. Retail store revenues are recognized at the time of sale.
                                            Use of estimates
                                            The preparation of financial statements in conformity with accounting principles generally accepted in the
                                            United States requires management to make estimates and assumptions that affect the amounts reported
                                            in the financial statements and accompanying notes. Actual results could differ from those estimates.
                                            Advertising costs are expensed as incurred and totaled $14,896, $16,318 and $13,803 in 2001, 2000
                                            and 1999, respectively.
                                            Earnings per share
                                            The numerator for the calculation of basic and diluted earnings per share is net income. The denomina-
                                            tor is computed as follows (in thousands):
                                                                                                           2001             2000      1999
                                            Denominator for basic earnings per share—
                                              weighted average shares                                     12,191            12,321   16,112
                                            Employee stock options (treasury stock method)                   390               157      208
                                            Denominator for diluted earnings per share                    12,581            12,478   16,320

                                            The Company had 26,500, 639,450 and 361,000 employee stock options that were anti-dilutive in 2001,
                                            2000 and 1999, respectively, and, accordingly, are not included in the diluted earnings per share calcu-
                                            Fiscal year
                                            The Company’s fiscal year is a 52/53 week year ending on the Saturday closest to December 31. Fiscal
                                            2001 ended on December 29, 2001, fiscal 2000 ended on December 30, 2000 and fiscal 1999 ended

                                            on January 1, 2000, all of which were 52 week years. All references to years in this report refer to the
                                            fiscal years described above.
                                            Comprehensive income
              Underlying                    Comprehensive income equaled net income in 2001, 2000 and 1999.
              Concepts                      Reclassifications
        The AICPA’s Special Committee       Certain prior year amounts have been reclassified to conform with the current year presentation.
        on Financial Reporting states
        that to meet users’ changing
        needs, business reporting
        must: (1) Provide more for-
        ward-looking information about
        plans, opportunities, risks, and
        uncertainties. (2) Focus more          Analysts examine carefully the summary of accounting policies section to deter-
        on the factors that create
                                           mine whether the company is using conservative or liberal accounting practices. For
        longer-term value, including
                                           example, depreciating plant assets over an unusually long period of time is considered
        nonfinancial measures indicat-
        ing how key business               liberal. On the other hand, using LIFO inventory valuation in a period of inflation is
        processes are performing.          generally viewed as following a conservative practice.
        (3) Better align information           Companies that fail to adopt high-quality reporting policies are now being heav-
        reported externally with the       ily penalized by the market. For example, when IBM disclosed that it had used the
        information reported internally.   gain on sale of one of its businesses to lower reported expenses, its shares were slammed
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                                                                                    Notes to the Financial Statements   •   1277

            in the market. Investors felt that IBM was trying to look better than it really was. In
            short, its quality of earnings was viewed as low.

            Common Notes
            Many of the notes to the financial statements have been discussed throughout this
            textbook. Others will be discussed more fully in this chapter. The more common are as

                                               MAJOR DISCLOSURES

                 Inventory. The basis upon which inventory amounts are stated (lower of cost or
                 market) and the method used in determining cost (LIFO, FIFO, average cost, etc.)
                 should be reported. Manufacturers should report the inventory composition (fin-
                 ished goods, work in process, raw materials) either in the balance sheet or in a
                 separate schedule in the notes. Unusual or significant financing arrangements re-
                 lating to inventories that may require disclosure include transactions with related
                 parties, product financing arrangements, firm purchase commitments, involun-
                 tary liquidation of LIFO inventories, and pledging of inventories as collateral.
                 Chapter 9 (pages 441–442) illustrates these disclosures.
                 Property, Plant, and Equipment. The basis of valuation for property, plant, and
                 equipment should be stated. It is usually historical cost. Pledges, liens, and other
                 commitments related to these assets should be disclosed. In the presentation of
                 depreciation, the following disclosures should be made in the financial statements
                 or in the notes: (1) depreciation expense for the period; (2) balances of major
                 classes of depreciable assets, by nature and function, at the balance sheet date; (3)
                 accumulated depreciation, either by major classes of depreciable assets or in to-
                 tal, at the balance sheet date; and (4) a general description of the method or meth-
                 ods used in computing depreciation with respect to major classes of depreciable
                 assets. Any major impairments should be explained. Chapter 11 (pages 541–542)
                 illustrates these disclosures.
                 Credit Claims. An investor normally finds it extremely useful to determine the
                 nature and cost of creditorship claims. However, the liabilities section in the bal-
                 ance sheet can provide the major types of liabilities outstanding only in the ag-
                 gregate. Note schedules regarding such obligations provide additional informa-
                 tion about how the company is financing its operations, the costs that will have
                 to be borne in future periods, and the timing of future cash outflows. Financial
                 statements must disclose for each of the 5 years following the date of the finan-
                 cial statements the aggregate amount of maturities and sinking fund requirements
                 for all long-term borrowings. Chapter 14 (pages 691–692) illustrates these disclo-
                 Equity Holders’ Claims. Many companies present in the body of the balance sheet
                 the number of shares authorized, issued, and outstanding and the par value for
                 each type of equity security. Such data may also be presented in a note. Beyond
                 that, the most common type of equity note disclosure relates to contracts and sen-
                 ior securities outstanding that might affect the various claims of the residual eq-
                 uity holders—for example, the existence of outstanding stock options, outstand-
                 ing convertible debt, redeemable preferred stock, and convertible preferred stock.
                 In addition, it is necessary to disclose to equity claimants certain types of re-
                 strictions currently in force. Generally, these types of restrictions involve the
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        1278      •    Chapter 24 Full Disclosure in Financial Reporting

                                               amount of earnings available for dividend distribution. Examples of these types
                                               of disclosures are illustrated in Chapter 15 (pages 747–749) and Chapter 16 (pages

                                               Contingencies and Commitments. An enterprise may have gain or loss contingen-
                                               cies that are not disclosed in the body of the financial statements. These contin-
                Underlying                     gencies include litigation, debt and other guarantees, possible tax assessments,
                                               renegotiation of government contracts, sales of receivables with recourse, and so
         The AICPA Special Committee           on. In addition, commitments that relate to dividend restrictions, purchase agree-
         on Financial Reporting notes          ments (through-put and take-or-pay), hedge contracts, and employment contracts
         that standards setters should
                                               are also disclosed. Disclosures of items of this nature are illustrated in Chapter 7
         address disclosures and ac-
         counting requirements for off-
                                               (pages 337–338), Chapter 9 (pages 430–432), and Chapter 13 (pages 640–643).
         balance-sheet financial               Deferred Taxes, Pensions, and Leases. Extensive disclosure is required in these three
         arrangements to ensure that           areas. Chapter 19 (pages 980–983), Chapter 20 (pages 1043–1045), and Chapter 21
         business reporting faithfully re-     (pages 1114–1116) discuss each of these disclosures in detail. It should be empha-
         ports the risks, opportunities,
                                               sized that notes to the financial statements should be given a careful reading for
         resources, and obligations that
         result from those arrange-
                                               information about off-balance-sheet commitments, future financing needs, and the
         ments, consistent with users’         quality of a company’s earnings.
         needs for information.                Changes in Accounting Principles. The profession defines various types of ac-
                                               counting changes and establishes guides for reporting each type. Either in the
                                               summary of significant accounting policies or in the other notes, changes in ac-
                                               counting principles (as well as material changes in estimates and corrections of
                                               errors) are discussed. See Chapter 22 (pages 1154–1158 and 1162–1165).

                                             The disclosures listed above have been discussed in earlier chapters. Four additional dis-
           Additional Examples of            closures of significance—special transactions or events, subsequent events, segment re-
             Major Disclosures               porting, and interim reporting—are illustrated in the following sections of this chapter.

                                                 More pages, but better?
                                                 The biggest overall change in annual reports recently is that companies are now dis-
                                                 closing debt-rating triggers buried in their financing arrangements. These triggers can
                                                 require a company to pay off a loan immediately if the debt rating folds; they are one
        What do the                              of the reasons Enron crumbled so quickly. But few Enron stockholders knew about them
        numbers mean?                            until the gun had gone off. Companies are also telling more about their bank credit lines,
                                                 liquidity, and any special purpose entities, which were major villains in the Enron drama.
                                                 Source: Gretchen Morgenson, “Annual Reports: More Pages, But Better?” New York Times (March
                                                 17, 2002).

                                             DISCLOSURE ISSUES
                                             Disclosure of Special Transactions or Events
                                             Related party transactions, errors and irregularities, and illegal acts pose especially sen-
                                             sitive and difficult problems. The accountant/auditor who has responsibility for re-
                                             porting on these types of transactions has to be extremely careful that the rights of
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                                                                                                                     Disclosure Issues         •   1279

            the reporting company and the needs of users of the financial statements are properly
                 Related party transactions arise when a business enterprise engages in transac-
            tions in which one of the transacting parties has the ability to influence significantly
            the policies of the other, or in which a nontransacting party has the ability to influence
            the policies of the two transacting parties.4 Transactions involving related parties can-
            not be presumed to be carried out on an “arm’s-length” basis because the requisite con-
            ditions of competitive, free-market dealings may not exist. Transactions such as bor-                        International
            rowing or lending money at abnormally low or high interest rates, real estate sales at                       Insight
            amounts that differ significantly from appraised value, exchanges of nonmonetary as-                         In Switzerland there are no re-
            sets, and transactions involving enterprises that have no economic substance (“shell                         quirements to disclose related
            corporations”) suggest that related parties may be involved.                                                 party transactions. In Italy and
                 The economic substance rather than the legal form of these transactions should be                       Germany related parties do not
            reported in order to make adequate disclosures. FASB Statement No. 57 requires the fol-                      include a company’s directors.
            lowing disclosures of material related party transactions.
                   The nature of the relationship(s) involved.
                   A description of the transactions (including transactions to which no amounts or
                   nominal amounts were ascribed) for each of the periods for which income state-
                   ments are presented.
                   The dollar amounts of transactions for each of the periods for which income state-
                   ments are presented.
                   Amounts due from or to related parties as of the date of each balance sheet
                Illustration 24-3 is an example of the disclosure of related party transactions taken
            from the annual report of Tyler Technologies, Inc.

                                                                                                                         ILLUSTRATION 24-3
                       Tyler Technologies, Inc.                                                                          Disclosure of Related
                                                                                                                         Party Transactions
                 (4) (in part): Related Party Transactions
                 On September 29, 2000, the Company sold for cash certain net assets of Kofile and another subsidiary,
                 the Company’s interest in a certain intangible work product, and a building and related building im-
                 provements to investment entities beneficially owned by a principal shareholder of the Company, who
                 was also a director at the time (See Note 3).

                Errors are defined as unintentional mistakes, whereas irregularities are intentional
            distortions of financial statements.5 As indicated in this textbook, when errors are dis-
            covered, the financial statements should be corrected. The same treatment should be

                   Examples of related party transactions include transactions between (a) a parent company
            and its subsidiaries; (b) subsidiaries of a common parent; (c) an enterprise and trusts for the ben-
            efit of employees (controlled or managed by the enterprise); and (d) an enterprise and its prin-
            cipal owners, management, or members of immediate families, and affiliates. Two classic cases
            of related party transactions were Enron, with its misuse of special purpose entities, and Tyco
            International, with its forgiving of loans to its management team.
                 “The Auditor’s Responsibility to Detect and Report Errors and Irregularities,” Statement on
            Auditing Standards No. 53 (New York, AICPA, 1988).
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        1280     •   Chapter 24 Full Disclosure in Financial Reporting

                                      given irregularities. The discovery of irregularities, however, gives rise to a whole dif-
                                      ferent set of suspicions, procedures, and responsibilities on the part of the account-
                                           Illegal acts encompass such items as illegal political contributions, bribes, kick-
                                      backs, and other violations of laws and regulations.7 In these situations, the account-
                                      ant/auditor must evaluate the adequacy of disclosure in the financial statements. For
                                      example, if revenue is derived from an illegal act that is considered material in rela-
                                      tion to the financial statements, this information should be disclosed. To deter these il-
                                      legal acts, Congress recently enacted the Sarbanes-Oxley Act of 2002. This acts adds
                                      significant fines and longer jail time for those who improperly sign off on the correct-
                                      ness of financial statements that actually include willing and knowing misstatements.
                                           Many companies are involved in related party transactions; errors and irregulari-
                                      ties, and illegal acts, however, are the exception rather than the rule. Disclosure plays
                                      a very important role in these areas because the transaction or event is more qualita-
                                      tive than quantitative and involves more subjective than objective evaluation. The users
                                      of the financial statements must be provided with some indication of the existence and
                                      nature of these transactions where material, through disclosures, modifications in the
                                      auditor’s report, or reports of changes in auditors.

                                      Post-Balance-Sheet Events (Subsequent Events)
                                      Notes to the financial statements should explain any significant financial events that
                                      took place after the formal balance sheet date, but before it is finally issued. These
                                      events are referred to as post-balance-sheet events, events subsequent to the balance
                                      sheet date, or just plain subsequent events. The subsequent events period is time-
                                      diagrammed as shown in Illustration 24-4.

        ILLUSTRATION 24-4
        Time Periods for
        Subsequent Events                                                                    Balance                    Financial
                                                                                              Sheet                    Statements
                                                                                              Date                     Issue Date

                                                           Financial Statement Period              Subsequent Events Period

                                           Jan. 1,                                            Dec. 31,                    Mar. 3,
                                           2004                                               2004                        2005

                                          A period of several weeks, and sometimes months, may elapse after the end of the
                                      year before the financial statements are issued. Taking and pricing the inventory, rec-
                                      onciling subsidiary ledgers with controlling accounts, preparing necessary adjusting
                                      entries, ensuring that all transactions for the period have been entered, obtaining an
                                      audit of the financial statements by independent certified public accountants, and print-
                                      ing the annual report all take time. During the period between the balance sheet date
                                      and its distribution to stockholders and creditors, important transactions or other events
                                      may occur that materially affect the company’s financial position or operating situa-

                                           The profession became so concerned with certain management frauds that affect financial
                                      statements that it established a National Commission on Fraudulent Financial Reporting. The
                                      major purpose of this organization was to determine how fraudulent reporting practices can be
                                      constrained. Fraudulent financial reporting is discussed later in this chapter.
                                           “Illegal Acts by Clients,” Statement on Auditing Standards No. 54 (New York, AICPA, 1988).
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                                                                                                        Disclosure Issues          •   1281

                Many who read a recent balance sheet believe the balance sheet condition is con-
            stant and they project it into the future. However, readers must be told if the company
            has sold one of its plants, acquired a subsidiary, suffered extraordinary losses, settled
            significant litigation, or experienced any other important event in the post-balance-
            sheet period. Without an explanation in a note, the reader might be misled and draw

            inappropriate conclusions.
                Two types of events or transactions occurring after the balance sheet date may have
            a material effect on the financial statements or may need to be considered to interpret
            these statements accurately:                                                                            Underlying
                 Events that provide additional evidence about conditions that existed at the bal-
                 ance sheet date, affect the estimates used in preparing financial statements, and           The periodicity or time period
                                                                                                             assumption implies that eco-
                 therefore result in needed adjustments: All information available prior to the is-
                                                                                                             nomic activities of an enter-
                 suance of the financial statements is used to evaluate estimates previously made.
                                                                                                             prise can be divided into artifi-
                 To ignore these subsequent events is to pass up an opportunity to improve the ac-           cial time periods for purpose
                 curacy of the financial statements. This first type encompasses information that            of analysis.
                 would have been recorded in the accounts had it been known at the balance sheet
                      For example, if a loss on an account receivable results from a customer’s bank-
                 ruptcy subsequent to the balance sheet date, the financial statements are adjusted
                 before their issuance. The bankruptcy stems from the customer’s poor financial
                 health existing at the balance sheet date.
                      The same criterion applies to settlements of litigation. The financial state-
                 ments must be adjusted if the events that gave rise to the litigation, such as per-
                 sonal injury or patent infringement, took place prior to the balance sheet date. If
                 the event giving rise to the claim took place subsequent to the balance sheet date,
                 no adjustment is necessary, but disclosure is. To illustrate, a loss resulting from
                 a customer’s fire or flood after the balance sheet date is not indicative of condi-
                 tions existing at that date. Thus, adjustment of the financial statements is not nec-
                 Events that provide evidence about conditions that did not exist at the balance
                 sheet date but arise subsequent to that date and do not require adjustment of
                 the financial statements: Some of these events may have to be disclosed to keep
                 the financial statements from being misleading. These disclosures take the form of
                 notes, supplemental schedules, or even pro forma (“as if”) financial data prepared
                 as if the event had occurred on the balance sheet date. Below are examples of such
                 events that require disclosure (but do not result in adjustment):
                 (a) Sale of bonds or capital stock; stock splits or stock dividends.
                 (b) Business combination pending or effected.
                 (c) Settlement of litigation when the event giving rise to the claim took place sub-
                      sequent to the balance sheet date.
                 (d) Loss of plant or inventories from fire or flood.
                 (e) Losses on receivables resulting from conditions (such as customer’s major ca-
                      sualty) arising subsequent to the balance sheet date.
                 (f) Gains or losses on certain marketable securities.8
            An example of subsequent events disclosure, excerpted from the Annual Report of
            Krispy Kreme Doughnuts, Inc. is presented in Illustration 24-5.

                   “Subsequent Events,” Statement on Auditing Standards No. 1 (New York: AICPA, 1973),
            pp. 123–124. Accounting Trends and Techniques—2001 listed the following types of subsequent
            events and their frequency of occurrence among the 600 companies surveyed: debt incurred,
            reduced, or refinanced, 72; business combinations pending or effected, 63; discontinued opera-
            tions, 33; litigation, 31; and capital stock issued or repurchased, 16.
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        1282     •   Chapter 24 Full Disclosure in Financial Reporting

        ILLUSTRATION 24-5
        Disclosure of Subse-              Krispy Kreme Doughnuts, Inc.
        quent Events                   Note 21. Subsequent Events
                                       In February 2001, the Company completed a follow-on public offering of 5,200,000 shares of common
                                       stock at a price of $33.50 per share with the net proceeds totaling $31.83 per share after underwriters’
                                       commissions. The 5,200,000 shares included a 600,000 share over-allotment option exercised by the un-
                                       derwriters. Of the 5,200,000 shares, 4,656,650 were sold by selling shareholders and 543,350 were sold
                                       by the Company. Net proceeds to the Company were $17,295,000.
                                           On February 2, 2001, the Company acquired the assets of Digital Java, Inc., a Chicago-based cof-
                                       fee company for a purchase price of $389,500 plus an earn-out not to exceed $775,000. Digital Java,
                                       Inc. is a sourcer and micro-roaster of premium quality coffees and offers a broad line of coffee-based
                                       and non-coffee beverages.
                                           On February 5, 2001, the Company purchased a 104,000 square foot manufacturing facility in Winston-
                                       Salem for approximately $3.3 million. The Company will relocate its equipment manufacturing and training
                                       facilities from its current location in Winston-Salem to this new facility.

                                           Many subsequent events or developments are not likely to require either ad-
                                      justment of or disclosure in the financial statements. Typically, these are nonac-
                                      counting events or conditions that managements normally communicate by other
                                      means. These events include legislation, product changes, management changes,
                                      strikes, unionization, marketing agreements, and loss of important customers.

                                      Reporting for Diversified (Conglomerate) Companies
                                      In the last several decades business enterprises at times have had a tendency to diver-
           OBJECTIVE                  sify their operations. Take the case of conglomerate GenCorp. whose products at one
           Describe the               time had included tires, Penn tennis balls, parts for the MX missile, and linings for dis-
           disclosure                 posable diapers. Its RKO subsidiary owned radio and television stations, made movies,
           requirements for major     bottled soda pop, ran hotels, and held a big stake in an airline. As a result of such di-
           segments of a              versification efforts, investors and investment analysts have sought more information
           business.                  concerning the details behind conglomerate financial statements. Particularly, they want
                                      income statement, balance sheet, and cash flow information on the individual segments
                                      that compose the total business income figure.
                                           An illustration of segmented (disaggregated) financial information is presented in
                                      the following example of an office equipment and auto parts company.

        ILLUSTRATION 24-6
                                                               OFFICE EQUIPMENT AND AUTO PARTS COMPANY
        Segmented Income
                                                                          INCOME STATEMENT DATA
        Statement                                                              (IN MILLIONS)
                                                                                                                Office         Auto
                                                                                          Consolidated        Equipment        Parts
                                                Net sales                                    $78.8              $18.0         $60.8
                                                Manufacturing costs
                                                 Inventories, beginning                        12.3               4.0           8.3
                                                 Materials and services                        38.9              10.8          28.1
                                                 Wages                                         12.9               3.8           9.1
                                                 Inventories, ending                          (13.3)             (3.9)         (9.4)
                                                                                              50.8               14.7          36.1
                                                Selling and administrative expense            12.1                1.6          10.5
                                                  Total operating expenses                    62.9               16.3          46.6
                                                Income before taxes                           15.9                 1.7         14.2
                                                Income taxes                                  (9.3)               (1.0)        (8.3)
                                                Net income                                   $ 6.6              $ 0.7         $ 5.9
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                                                                                                    Disclosure Issues   •   1283

                 If only the consolidated figures are available to the analyst, much information re-
            garding the composition of these figures is hidden in aggregated totals. There is no
            way to tell from the consolidated data the extent to which the differing product lines
            contribute to the company’s profitability, risk, and growth potential. For example, in
            Illustration 24-6, if the office equipment segment is deemed a risky venture, then seg-
            mented reporting provides useful information for purposes of making an informed in-
            vestment decision regarding the whole company.
                 A classic situation that demonstrates the need for segmented data involved
            Caterpillar, Inc. Caterpillar was cited by the SEC because it failed to tell investors
            that nearly a quarter of its income in 1989 came from a Brazilian unit. This income
            was nonrecurring in nature. The company knew that different economic policies in
            the next year would probably greatly affect earnings of the Brazilian unit. But Cater-
            pillar presented its financial results on a consolidated basis, not disclosing the Brazil-
            ian’s operations. The SEC stated that Caterpillar’s failure to include information
            about Brazil left investors with an incomplete picture of the company’s financial re-
            sults and denied investors the opportunity to see the company “through the eyes of
                 Companies have always been somewhat hesitant to disclose segmented data for
            various reasons:
                 Without a thorough knowledge of the business and an understanding of such im-
                 portant factors as the competitive environment and capital investment require-
                 ments, the investor may find the segmented information meaningless or may even
                 draw improper conclusions about the reported earnings of the segments.
                 Additional disclosure may harm reporting firms because it may be helpful to com-
                 petitors, labor unions, suppliers, and certain government regulatory agencies.
                 Additional disclosure may discourage management from taking intelligent busi-
                 ness risks because segments reporting losses or unsatisfactory earnings may cause
                 stockholder dissatisfaction with management.
                 The wide variation among firms in the choice of segments, cost allocation, and
                 other accounting problems limits the usefulness of segmented information.
                 The investor is investing in the company as a whole and not in the particular seg-
                 ments, and it should not matter how any single segment is performing if the over-
                 all performance is satisfactory.
                 Certain technical problems, such as classification of segments and allocation of seg-
                 ment revenues and costs (especially “common costs”), are formidable.
            On the other hand, the advocates of segmented disclosures offer these reasons in sup-
            port of the practice:
                 Segmented information is needed by the investor to make an intelligent investment
                 decision regarding a diversified company.
                 (a) Sales and earnings of individual segments are needed to forecast consolidated
                     profits because of the differences between segments in growth rate, risk, and
                 (b) Segmented reports disclose the nature of a company’s businesses and the rel-
                     ative size of the components as an aid in evaluating the company’s investment

                 The absence of segmented reporting by a diversified company may put its un-
                 segmented, single product-line competitors at a competitive disadvantage
                 because the conglomerate may obscure information that its competitors must
                The advocates of segmented disclosures appear to have a much stronger case. Many
            users indicate that segmented data are the most useful financial information provided,
            aside from the basic financial statements. As a result, the FASB has issued extensive re-
            porting guidelines in this area.
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        1284     •   Chapter 24 Full Disclosure in Financial Reporting

                                      Objective of Reporting Segmented Information
                                      The objective of reporting segmented financial data is to provide information about the
                                      different types of business activities in which an enterprise engages and the differ-
                                      ent economic environments in which it operates, in order to help users of financial
                                      statements do the following.
                                      (a) Better understand the enterprise’s performance.
                                      (b) Better assess its prospects for future net cash flows.
                                      (c) Make more informed judgments about the enterprise as a whole.

                                      Basic Principles
                                      A company might meet the segmented reporting objective by providing complete sets
                                      of financial statements that are disaggregated in several ways. For example, financial
                                      statements can be disaggregated by products or services, by geography, by legal entity,
                                      or by type of customer. However, it is not feasible to provide all of that information in
                                      every set of financial statements. FASB Statement No. 131 requires that general purpose
                                      financial statements include selected information on a single basis of segmentation. The
                                      method chosen is referred to as the management approach.9 The management ap-
                                      proach is based on the way that management segments the company for making
                                      operating decisions. Consequently, the segments are evident from the company’s or-
                                      ganization structure. It focuses on information about components of the business that
                                      management uses to make decisions about operating matters. These components are
                                      called operating segments.

                                      Identifying Operating Segments
                                      An operating segment is a component of an enterprise:
                                      (a) That engages in business activities from which it earns revenues and incurs
                                      (b) Whose operating results are regularly reviewed by the company’s chief operating
                                          decision maker to assess segment performance and allocate resources to the
                                      (c) For which discrete financial information is available that is generated by or based
                                          on the internal financial reporting system.
                                         Information about two or more operating segments may be aggregated only if the
                                      segments have the same basic characteristics in each of the following areas.
                                      (a) The nature of the products and services provided.
                                      (b) The nature of the production process.
                                      (c) The type or class of customer.
                                      (d) The methods of product or service distribution.
                                      (e) If applicable, the nature of the regulatory environment.
                                          After the company decides on the segments for possible disclosure, a quantitative
                                      materiality test is made to determine whether the segment is significant enough to war-
                                      rant actual disclosure. An operating segment is regarded as significant and therefore
                                      identified as a reportable segment if it satisfies one or more of the following quantita-
                                      tive thresholds.
                                          Its revenue (including both sales to external customers and intersegment sales or
                                          transfers) is 10 percent or more of the combined revenue of all the enterprise’s op-
                                          erating segments.

                                            “Disclosures about Segments of an Enterprise and Related Information,” Statement of
                                      Financial Accounting Standards No. 131 (Norwalk, Conn.: FASB, 1997).
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                                                                                                     Disclosure Issues         •   1285

                 The absolute amount of its profit or loss is 10 percent or more of the greater, in ab-
                 solute amount, of
                 (a) the combined operating profit of all operating segments that did not incur a
                     loss, or
                 (b) the combined loss of all operating segments that did report a loss.

                 Its identifiable assets are 10 percent or more of the combined assets of all operat-
                 ing segments.
                In applying these tests, two additional factors must be considered. First, segment
            data must explain a significant portion of the company’s business. Specifically, the seg-
            mented results must equal or exceed 75 percent of the combined sales to unaffiliated
            customers for the entire enterprise. This test prevents a company from providing lim-
            ited information on only a few segments and lumping all the rest into one category.
                Second, the profession recognizes that reporting too many segments may over-
            whelm users with detailed information. The FASB decided that 10 is a reasonable up-
            per limit for the number of segments that a company should be required to disclose.
                To illustrate these requirements, assume a company has identified six possible re-
            porting segments (000 omitted):

                                                                                                          ILLUSTRATION 24-7
                                           Total Revenue      Operating      Identifiable
                                                                                                          Data for Different
                             Segments       (Unaffiliated)   Profit (Loss)     Assets
                                                                                                          Possible Reporting
                                 A            $ 100              $10            $ 60                      Segments
                                 B               50                2              30
                                 C              700               40             390
                                 D              300               20             160
                                 E              900               18             280
                                 F              100               (5)             50
                                              $2,150             $85            $970

            The respective tests may be applied as follows:

                 Revenue test: 10% $2,150 $215; C, D, and E meet this test.
                 Operating profit (loss) test: 10% $90 $9 (note that the $5 loss is ignored); A,
                 C, D, and E meet this test.                                                                    Underlying
                 Identifiable assets tests: 10% $970 $97; C, D, and E meet this test.                           Concepts
                                                                                                          The AICPA Special Committee
            The segments are therefore A, C, D, and E, assuming that these four segments have             on Financial Reporting notes
            enough sales to meet the 75 percent of combined sales test. The 75 percent test is com-       that multi-segment companies
                                                                                                          operate diverse businesses
            puted as follows.
                                                                                                          that are subject to different
                75% of combined sales test: 75% $2,150 $1,612.50. The sales of A, C, D, and               opportunities and risks. Many
                E total $2,000 ($100 $700 $300 $900); therefore, the 75% test is met.                     users view business segments
                                                                                                          as the engines that generate
            Measurement Principles                                                                        future earnings or cash flows
            The accounting principles to be used for segment disclosure need not be the same as           and thereby drive returns on
                                                                                                          investments. Segment informa-
            the principles used to prepare the consolidated statements. This flexibility may at first
                                                                                                          tion provides additional insight
            appear inconsistent. But, preparing segment information in accordance with generally
                                                                                                          about the opportunities and
            accepted accounting principles would be difficult because some principles are not ex-         risks of investments and
            pected to apply at a segment level. Examples are accounting for the cost of company-          sharpens predictions. Because
            wide employee benefit plans, accounting for income taxes in a company that files a            of its predictive value, improv-
            consolidated tax return, and accounting for inventory on a LIFO basis if the pool in-         ing segment reporting is of the
            cludes items in more than one segment.                                                        highest priority.
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        1286     •   Chapter 24 Full Disclosure in Financial Reporting

                                          Allocations of joint, common, or company-wide costs solely for external reporting
                                      purposes are not required. Common costs are those incurred for the benefit of more
                                      than one segment and whose interrelated nature prevents a completely objective divi-
                                      sion of costs among segments. For example, the company president’s salary is difficult
                                      to allocate to various segments. Allocations of common costs are inherently arbitrary
                                      and may not be meaningful if they are not used for internal management purposes.
                                      There is a presumption that allocations to segments are either directly attributable or
                                      reasonably allocable.

                                      Segmented Information Reported
                                      The FASB requires that an enterprise report the following.

                                          General information about its operating segments. This includes factors that man-
                                          agement considers most significant in determining the company’s operating seg-
                                          ments, and the types of products and services from which each operating segment
                                          derives its revenues.

                                          Segment profit and loss and related information. Specifically, the following infor-
                                          mation about each operating segment must be reported if the amounts are included
                                          in the determination of segment profit or loss.
                                          (a) Revenues from transactions with external customers.
                                          (b) Revenues from transactions with other operating segments of the same
                                          (c) Interest revenue.
                                          (d) Interest expense.
                                          (e) Depreciation, depletion, and amortization expense.
                                          (f) Unusual items.
                                          (g) Equity in the net income of investees accounted for by the equity method.
                                          (h) Income tax expense or benefit.
                                          (i) Extraordinary items.
                                          (j) Significant noncash items other than depreciation, depletion, and amortization

                                          Segment assets. An enterprise must report each operating segment’s total assets.

                                          Reconciliations. An enterprise must provide a reconciliation of the total of the seg-
                                          ments’ revenues to total revenues, a reconciliation of the total of the operating seg-
                                          ments’ profits and losses to its income before income taxes, and a reconciliation of
                                          the total of the operating segments’ assets to total assets.

                                          Information about products and services and geographic areas. For each operating
                                          segment that has not been determined based on geography, the enterprise must re-
                                          port (unless it is impracticable): (1) revenues from external customers, (2) long-lived
                                          assets, and (3) expenditures during the period for long-lived assets. This informa-
                                          tion, if material, must be reported (a) in the enterprise’s country of domicile and
                                          (b) in each other country.

                                          Major customers. If 10 percent or more of the revenues is derived from a single
                                          customer, the enterprise must disclose the total amount of revenues from each such
                                          customer by segment.

                                      Illustration of Disaggregated Information
                                      The segment disclosure for Johnson & Johnson is shown in Illustration 24-8.
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                                                                                                                         Disclosure Issues           •     1287

                                                                                                                             ILLUSTRATION 24-8
                                                                                                                             Segment Disclosure

                 Johnson & Johnson
                      (Notes excluded)
                   Segments of Business

                                                                                                                        Sales to Customers
                   (dollars in millions)                                                                       2001              2000             1999
                   Consumer—Domestic                                                                       $ 3,789           $ 3,760          $ 3,670
                            International                                                                    3,173             3,144            3,194
                   Total                                                                                        6,962             6,904            6,864
                   Pharmaceutical—Domestic                                                                     10,240             8,441            6,955
                                  International                                                                 4,611             4,220            4,275
                   Total                                                                                       14,851            12,661           11,230
                   Medical Devices & Diagnostics—Domestic                                                       6,175             5,506            5,296
                                                 International                                                  5,016             4,775            4,617
                   Total                                                                                       11,191            10,281            9,913
                   Worldwide total                                                                         $33,004           $29,846          $28,007

                                                                          Operating Profit                              Identifiable Assets
                   (dollars in millions)                        2001              2000            1999         2001              2000             1999
                   Consumer                                 $ 1,004           $     867       $     683    $ 4,209           $ 4,761          $ 4,901
                   Pharmaceutical                             4,928               4,394           3,735     11,568             9,209            8,797
                   Medical Devices & Diagnostics              2,001               1,696           1,632     13,645            12,745           12,458
                   Segments total                               7,933             6,957           6,050        29,422            26,715           26,156
                   Expenses not allocated to segments             (35)              (89)           (173)
                   General corporate                                                                            9,066             7,530            4,908
                   Worldwide total                          $ 7,898           $ 6,868         $ 5,877      $38,488           $34,245          $31,064

                                                                       Additions to Property,                            Depreciation and
                                                                        Plant & Equipment                                  Amortization
                   (dollars in millions)                        2001              2000            1999         2001              2000             1999
                   Consumer                                 $     230         $     336       $     412    $     263         $     275        $     277
                   Pharmaceutical                                 749               627             760          492               474              407
                   Medical Devices & Diagnostics                  621               665             576          801               801              786
                   Segments total                                1,600             1,628           1,748        1,556             1,550            1,470
                   General corporate                               131                61              74           49                42               40
                   Worldwide total                         $ 1,731            $ 1,689         $ 1,822      $ 1,605           $ 1,592          $ 1,510

                   Geographic Areas
                                                                         Sales to Customers                             Long-Lived Assets
                   (dollars in millions)                        2001              2000            1999         2001              2000             1999
                   United States                            $20,204           $17,707         $15,921      $11,922           $10,043          $10,033
                   Europe                                     6,853             6,365           6,711        3,632             3,551            3,698
                   Western Hemisphere excluding U.S.          2,142             2,084           2,023          640               653              550
                   Asia-Pacific, Africa                       3,805             3,690           3,352          433               427              439
                   Segments total                               33,004            29,846          28,007       16,627            14,674           14,720
                   General corporate                                                                              319               255              282
                   Other non long-lived assets                                                                 21,542            19,316           16,062
                   Worldwide total                          $33,004           $29,846         $28,007      $38,488           $34,245          $31,064

            Interim Reports
            One further source of information for the investor is interim reports. As noted earlier,
            interim reports are those reports that cover periods of less than one year. At one time,
            interim reports were referred to as the “forgotten reports”; this is no longer the case.
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        1288     •   Chapter 24 Full Disclosure in Financial Reporting

                                           The stock exchanges, the SEC, and the accounting profession have taken an active role
           OBJECTIVE                       in developing guidelines for the presentation of interim information.
           Describe the                        The SEC mandates that certain companies file a Form 10-Q, which requires a com-
           accounting problems             pany to disclose quarterly data similar to that disclosed in the annual report. It also re-
           associated with                 quires those companies to disclose selected quarterly information in notes to the an-
           interim reporting.              nual financial statements. Illustration 24-9 presents the disclosure of selected quarterly
                                           data for Tootsie Roll Industries, Inc. In addition to this requirement, the APB issued
                                           Opinion No. 28, which attempted to narrow the reporting alternatives related to interim

        ILLUSTRATION 24-9
        Disclosure of Selected                  Tootsie Roll Industries, Inc.
        Quarterly Data                          For the Year Ended December 31, 2001

                                                                                         (Thousands of dollars except per share data)
                                                                             First          Second          Third         Fourth         Total
                                              Net sales                     $82,621          $86,882         $158,781         $95,212   $423,496
                                              Gross margin                   42,958           43,517           76,304          44,060    206,839
                                              Net earnings                   12,385           13,902           27,010          12,390     65,687
                                              Net earnings per share           0.25             0.28             0.54            0.25       1.32

                                                                                          Stock Prices
                                                                                      High             Low        Dividends
                                                                       1st Qtr        $51.10       $43.31         $0.0680
                                                                       2nd Qtr         48.89        38.54          0.0700
                                                                       3rd Qtr         40.55        35.08          0.0700
                                                                       4th Qtr         39.44        36.35          0.0700

                                                Because of the short-term nature of the information in these reports, however, there
                                           is considerable controversy as to the general approach that should be employed. One
              Underlying                   group, which holds the discrete view, believes that each interim period should be
              Concepts                     treated as a separate accounting period; deferrals and accruals would therefore follow
        For information to be relevant,    the principles employed for annual reports. In this view, accounting transactions should
        it must be available to decision   be reported as they occur, and expense recognition should not change with the period
        makers before it loses its         of time covered. Another group, which holds the integral view, believes that the in-
        capacity to influence their
                                           terim report is an integral part of the annual report and that deferrals and accruals
        decisions (timeliness). Interim
                                           should take into consideration what will happen for the entire year. In this approach,
        reporting is an excellent
        example of this concept.           estimated expenses are assigned to parts of a year on the basis of sales volume or some
                                           other activity base. At present, many companies follow the discrete approach for cer-
                                           tain types of expenses and the integral approach for others, because the standards cur-
                                           rently employed in practice are vague and lead to differing interpretations.

                                           Interim Reporting Requirements
                                           Generally, the same accounting principles used for annual reports should be em-
                                           ployed for interim reports. Revenues should be recognized in interim periods on the
                                           same basis as they are for annual periods. For example, if the installment-sales method
                                           is used as the basis for recognizing revenue on an annual basis, then the installment
                                           basis should be applied to interim reports as well. Also, costs directly associated with
                                           revenues (product costs), such as materials, labor and related fringe benefits, and man-
                                           ufacturing overhead, should be treated in the same manner for interim reports as for
                                           annual reports.

                                                “Interim Financial Reporting,” Opinions of the Accounting Principles Board No. 28 (New York:
                                           AICPA, 1973).
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                                                                                                    Disclosure Issues   •   1289

                Companies should use the same inventory pricing methods (FIFO, LIFO, etc.) for
            interim reports that they use for annual reports. However, the following exceptions are
            appropriate at interim reporting periods.

                 Companies may use the gross profit method for interim inventory pricing, but
                 disclosure of the method and adjustments to reconcile with annual inventory are
                 When LIFO inventories are liquidated at an interim date and are expected to be re-
                 placed by year-end, cost of goods sold should include the expected cost of replac-
                 ing the liquidated LIFO base and not give effect to the interim liquidation.
                 Inventory market declines should not be deferred beyond the interim period un-
                 less they are temporary and no loss is expected for the fiscal year.
                 Planned variances under a standard cost system which are expected to be absorbed
                 by year-end ordinarily should be deferred.

                Costs and expenses other than product costs, often referred to as period costs, are
            often charged to the interim period as incurred. But they may be allocated among in-
            terim periods on the basis of an estimate of time expired, benefit received, or activity
            associated with the periods. Considerable latitude is exercised in accounting for these
            costs in interim periods, and many believe more definitive guidelines are needed.
                Regarding disclosure, the following interim data should be reported as a minimum.

                 Sales or gross revenues, provision for income taxes, extraordinary items, cumula-
                 tive effect of a change in accounting principles or practices, and net income.
                 Basic and diluted earnings per share where appropriate.
                 Seasonal revenue, cost, or expenses.
                 Significant changes in estimates or provisions for income taxes.
                 Disposal of a component of a business and extraordinary, unusual, or infrequently
                 occurring items.
                 Contingent items.
                 Changes in accounting principles or estimates.
                 Significant changes in financial position.

                Companies are encouraged but not required to publish a balance sheet and a state-
            ment of cash flows. When this information is not presented, significant changes in such
            items as liquid assets, net working capital, long-term liabilities, and stockholders’ eq-
            uity should be disclosed.

            Unique Problems of Interim Reporting
            In APB Opinion No. 28, the Board indicated that it favored the integral approach. How-
            ever, within this broad guideline, a number of unique reporting problems develop re-
            lated to the following items.

            Advertising and Similar Costs. The general guidelines are that costs such as advertis-
            ing should be deferred in an interim period if the benefits extend beyond that pe-
            riod; otherwise they should be expensed as incurred. But such a determination is dif-
            ficult, and even if they are deferred, how should they be allocated between quarters?
            Because of the vague guidelines in this area, accounting for advertising varies widely.
            At one time, some companies in the food industry, such as RJR Nabisco and Pills-
            bury, charged advertising costs as a percentage of sales and adjusted to actual at year-
            end, whereas General Foods and Kellogg expensed these costs as incurred.
                The same type of problem relates to such items as Social Security taxes, research
            and development costs, and major repairs. For example, should the company expense
            Social Security costs (payroll taxes) on highly paid personnel early in the year, or allo-
            cate and spread them to subsequent quarters? Should a major repair that occurs later
            in the year be anticipated and allocated proportionately to earlier periods?
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        1290     •   Chapter 24 Full Disclosure in Financial Reporting

                                      Expenses Subject to Year-End Adjustment. Bad debts, executive bonuses, pension costs,
                                      and inventory shrinkage are often not known with a great deal of certainty until year-
                                      end. These costs should be estimated and allocated in the best possible way to interim
                                      periods. Companies use a variety of allocation techniques to accomplish this objective.

                                      Income Taxes. Not every dollar of corporate taxable income is assessed at the same
                                      rate; the tax rate is progressive. This aspect of business income taxes poses a problem
                                      in preparing interim financial statements. Should the income to date be annualized
                                      and the proportionate income tax accrued for the period to date (annualized approach)?
                                      Or should the first amount of income earned be taxed at the lower rate of tax applica-
                                      ble to such income (marginal principle approach)? At one time, companies generally
                                      followed the latter approach and accrued the tax applicable to each additional dollar
                                      of income.
                                           The marginal principle was especially applicable to businesses having a seasonal
                                      or uneven income pattern, because the interim accrual of tax was based on the actual
                                      results to date. The profession now, however, uses the annualized approach requiring
                                      that “at the end of each interim period the company should make its best estimate of
                                      the effective tax rate expected to be applicable for the full fiscal year. The rate so de-
                                      termined should be used in providing for income taxes on income for the quarter.”11
                                           Because businesses did not uniformly apply this guideline in accounting for simi-
                                      lar situations, the FASB issued Interpretation No. 18. This interpretation requires that the
                                      estimated annual effective tax rate be applied to the year-to-date “ordinary” income
                                      at the end of each interim period to compute the year-to-date tax. Further, the interim
                                      period tax related to “ordinary” income shall be the difference between the amount so
                                      computed and the amounts reported for previous interim periods of the fiscal period.12

                                      Extraordinary Items. Extraordinary items consist of unusual and nonrecurring mate-
                                      rial gains and losses. In the past, they were handled in interim reports in one of three
                                      ways: (1) absorbed entirely in the quarter in which they occurred; (2) prorated over the
                                      four quarters; or (3) disclosed only by note. The required approach is to charge or
                                      credit the loss or gain in the quarter that it occurs instead of attempting some arbi-
                                      trary multiple-period allocation. This approach is consistent with the way in which
                                      extraordinary items are currently handled on an annual basis. No attempt is made to
                                      prorate the extraordinary items over several years.
                                           Some favor the omission of extraordinary items from the quarterly net income.
                                      They believe that inclusion of extraordinary items that may be large in proportion to
                                      interim results distorts the predictive value of interim reports. Many, however, consider
                                      such an omission inappropriate because it deviates from actual results.

                                      Changes in Accounting. What happens if a company decides to change an accounting
                                      principle in the third quarter of a fiscal year? Should the cumulative effect adjustment
                                      be charged or credited to that quarter? Presentation of a cumulative effect in the third
                                      quarter may be misleading because of the inherent subjectivity associated with the first
                                      two quarters’ reported income. In addition, a question arises as to whether such a
                                      change might not be used to manipulate a given quarter’s income.
                                          As a result, FASB Statement No. 3 was issued, indicating that if a cumulative effect
                                      change occurs in other than the first quarter, no cumulative effect should be recog-

                                              “Interim Financial Reporting,” Opinions of the Accounting Principles Board No. 28 (New York:
                                      AICPA, 1973), par. 19. The estimated annual effective tax rate should reflect anticipated tax cred-
                                      its, foreign tax rates, percentage depletion, capital gains rates, and other available tax planning
                                            “Accounting for Income Taxes in Interim Periods,” FASB Interpretation No. 18 (Stamford,
                                      Conn.: FASB, March 1977), par. 9. “Ordinary” income (or loss) refers to “income (or loss) from
                                      continuing operations before income taxes (or benefits)” excluding extraordinary items, discon-
                                      tinued operations, and cumulative effects of changes in accounting principles.
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                                                                                                                   Disclosure Issues   •   1291

            nized in those quarters.13 Rather, the cumulative effect at the beginning of the year
            should be computed and the first quarter restated. Subsequent quarters would not re-
            port a cumulative effect adjustment.

            Earnings per Share. Interim reporting of earnings per share has all the problems in-
            herent in computing and presenting annual earnings per share, and then some. If shares
            are issued in the third period, EPS for the first two periods will not be indicative of
            year-end EPS. If an extraordinary item is present in one period and new equity shares
            are sold in another period, the EPS figure for the extraordinary item will change for
            the year. On an annual basis only one EPS figure is associated with an extraordinary
            item and that figure does not change; the interim figure is subject to change. For pur-
            poses of computing earnings per share and making the required disclosure deter-
            minations, each interim period should stand alone. That is, all applicable tests should
            be made for that single period.

            Seasonality. Seasonality occurs when sales are compressed into one short period of
            the year while certain costs are fairly evenly spread throughout the year. For example,
            the natural gas industry has its heavy sales in the winter months. In contrast, the bev-
            erage industry has its heavy sales in the summer months.
                The problem of seasonality is related to the matching concept in accounting. Ex-
            penses should be matched against the revenues they create. In a seasonal business,
            wide fluctuations in profits occur because off-season sales do not absorb the company’s
            fixed costs (for example, manufacturing, selling, and administrative costs that tend to
            remain fairly constant regardless of sales or production).
                To illustrate why seasonality is a problem, assume the following information.

                                                                                                                      ILLUSTRATION 24-10
                 Selling price per unit                                     $1                                        Data for Seasonality
                 Annual sales for the period (projected and actual)
                   100,000 units @ $1                                       $100,000
                 Manufacturing costs
                   Variable                                                 10¢ per unit
                   Fixed                                                    20¢ per unit or $20,000 for the year
                 Nonmanufacturing costs
                   Variable                                                 10¢ per unit
                   Fixed                                                    30¢ per unit or $30,000 for the year

            Sales for four quarters and the year (projected and actual) were:

                                                                                                                      ILLUSTRATION 24-11
                                                                          Percent of Sales
                                                                                                                      Sales Data for Seasonality
                                       1st Quarter             $ 20,000          20%                                  Example
                                       2nd Quarter                5,000           5
                                       3rd Quarter               10,000          10
                                       4th Quarter               65,000          65
                                       Total for the year     $100,000           100%

               Under the present accounting framework, the income statements for the quarters
            might be shown as in Illustration 24-12.

                   “Reporting Accounting Changes in Interim Financial Statements,” Statement of the Finan-
            cial Accounting Standards Board No. 3 (Stamford, Conn.: FASB, 1974). This standard also provides
            guidance related to a LIFO change and accounting changes made in the fourth quarter of a fis-
            cal year in which interim data are not presented.
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        1292      •   Chapter 24 Full Disclosure in Financial Reporting

        ILLUSTRATION 24-12
                                                                                 1st Qtr          2nd Qtr           3rd Qtr           4th Qtr             Year
        Interim Net Income for
        Seasonal Business—                  Sales                              $20,000           $ 5,000           $10,000           $65,000           $100,000
        Discrete Approach                   Manufacturing costs
                                              Variable                           (2,000)             (500)           (1,000)          (6,500)            (10,000)
                                              Fixeda                             (4,000)           (1,000)           (2,000)         (13,000)            (20,000)
                                                                                 14,000             3,500             7,000           45,500              70,000
                                            Nonmanufacturing costs
                                              Variable                           (2,000)             (500)           (1,000)           (6,500)           (10,000)
                                              Fixedb                             (7,500)           (7,500)           (7,500)           (7,500)           (30,000)
                                            Net income                          $ 4,500          $(4,500)          $ (1,500)         $31,500           $ 30,000

                                             The fixed manufacturing costs are inventoried, so that equal amounts of fixed costs do not appear during each quarter.
                                             The fixed nonmanufacturing costs are not inventoried, so equal amounts of fixed costs appear during each quarter.

                                               An investor who uses the first quarter’s results can be misled. If the first quarter’s
                                           earnings are $4,500, should this figure be multiplied by four to predict annual earnings
                                           of $18,000? Or, as the analysis suggests, inasmuch as $20,000 in sales is 20 percent of
                                           the predicted sales for the year, net income for the year should be $22,500 ($4,500 5).
                                           Either figure is obviously wrong, and after the second quarter’s results occur, the in-
                                           vestor may become even more confused.
                                               The problem with the conventional approach is that the fixed nonmanufacturing
                                           costs are not charged in proportion to sales. Some enterprises have adopted a way of
                                           avoiding this problem by making all fixed nonmanufacturing costs follow the sales pat-
                                           tern, as shown in Illustration 24-13.

        ILLUSTRATION 24-13
                                                                                 1st Qtr         2nd Qtr            3rd Qtr           4th Qtr             Year
        Interim Net Income for
        Seasonal Business—                  Sales                              $20,000           $ 5,000           $10,000           $65,000           $100,000
        Integral Approach                   Manufacturing costs
                                              Variable                           (2,000)             (500)           (1,000)          (6,500)            (10,000)
                                              Fixed                              (4,000)           (1,000)           (2,000)         (13,000)            (20,000)
                                                                                 14,000             3,500             7,000           45,500              70,000
                                            Nonmanufacturing costs
                                              Variable                           (2,000)             (500)           (1,000)          (6,500)            (10,000)
                                              Fixed                              (6,000)           (1,500)           (3,000)         (19,500)            (30,000)
                                            Net income                         $ 6,000           $ 1,500           $ 3,000           $19,500           $ 30,000

                                                This approach solves some of the problems of interim reporting: Sales in the first
                                           quarter are 20 percent of total sales for the year, and net income in the first quarter is
                                           20 percent of total income. In this case, as in the previous example, the investor can-
                                           not rely on multiplying any given quarter by four, but can use comparative data or rely
                                           on some estimate of sales in relation to income for a given period.
        International                           The greater the degree of seasonality experienced by a company, the greater the
        Insight                            possibility of distortion. Because no definitive guidelines are available for handling
         IASB GAAP requires that interim   such items as the fixed nonmanufacturing costs, variability in income can be substan-
         financial statements use the      tial. To alleviate this problem, the profession recommends that companies subject to
         discrete method, except for the   material seasonal variations disclose the seasonal nature of their business and consider
         tax charge.                       supplementing their interim reports with information for 12-month periods ended at
                                           the interim date for the current and preceding years.
                                                The two illustrations above highlight the difference between the discrete and in-
                                           tegral viewpoints. The fixed nonmanufacturing expenses are expensed as incurred un-
                                           der the discrete viewpoint. They are charged to expense on the basis of some measure
                                           of activity under the integral method.
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                                                                                   Auditor’s and Management’s Reports               •   1293

            Continuing Controversy. The profession has developed some standards for interim re-
            porting, but much still has to be done. As yet, it is unclear whether the discrete, inte-
            gral, or some combination of these two methods will be settled on.                                        Underlying
                 Discussion also persists concerning the independent auditor’s involvement in in-                     Concepts
            terim reports. Many auditors are reluctant to express an opinion on interim financial               The AICPA Special Committee
            information, arguing that the data are too tentative and subjective. Conversely, an in-             on Financial Reporting indi-
                                                                                                                cates that users would benefit
            creasing number of individuals advocate some type of examination of interim reports.
                                                                                                                from separate fourth-
            A compromise may be a limited review of interim reports that provides some assurance
                                                                                                                quarter reporting, including
            that an examination has been conducted by an outside party and that the published in-               management’s analysis of
            formation appears to be in accord with generally accepted accounting principles.14                  fourth-quarter activities and
                 Analysts want financial information as soon as possible, before it’s old news. We              events. Also, quarterly segment
            may not be far from a continuous database system in which corporate financial records               reporting was demanded.
            can be accessed via the Internet. Investors might be able to access a company’s finan-              Under FASB Statement No.
            cial records whenever they wish and put the information in the format they need. Thus,              131, companies now provide
            they could learn about sales slippage, cost increases, or earnings changes as they hap-             quarterly segment data.
            pen, rather than waiting until after the quarter has ended.15
                 A steady stream of information from the company to the investor could be very
            positive because it might alleviate management’s continual concern with short-run in-
            terim numbers. Today many contend that U.S. management is too short-run oriented.
            The truth of this statement is echoed by the words of the president of a large company
            who decided to retire early: “I wanted to look forward to a year made up of four sea-
            sons rather than four quarters.”

                                                                                       I want it faster

                 The SEC has decided that timeliness of information is of extreme importance. First the
                 SEC has said that public companies will have only 60 days to complete their annual
                 reports, down from 90 days. And quarterly reports must be done within 35 days of the
                 close of the quarter, instead of 45. In addition, corporate executives and shareholders        What do the
                 with more than 10 percent of a company’s outstanding stock will have 2 days to dis-            numbers mean?
                 close their sale or purchase of stock.
                    Also, in a bid to encourage Internet disclosure, the SEC encourages companies to
                 post current, quarterly, and annual reports on their Web sites—or explain why they
                 don’t. The Internet postings would have to be made by the day the company submits
                 the information to the SEC, rather than within 24 hours as current rules allow.

            Auditor’s Report
            Another important source of information that is often overlooked is the auditor’s report.
            An auditor is an accounting professional who conducts an independent examination                       OBJECTIVE
            of the accounting data presented by a business enterprise. If the auditor is satisfied that            Identify the major
            the financial statements present the financial position, results of operations, and cash               disclosures found in
                                                                                                                   the auditor’s report.

                  The AICPA has been involved in developing guidelines for the review of interim reports.
            “Limited Review of Interim Financial Statements,” Statement on Auditing Standards No. 24 (New
            York: AICPA, 1979) sets standards for the review of interim reports.
                   A step in this direction is the SEC’s mandate for companies to file their financial state-
            ments electronically with the SEC. The system, called EDGAR (electronic data gathering and re-
            trieval) provides interested parties with computer access to financial information such as peri-
            odic filings, corporate prospectuses, and proxy materials.
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        1294     •   Chapter 24 Full Disclosure in Financial Reporting

                                          flows fairly in accordance with generally accepted accounting principles, an unquali-
                                          fied opinion is expressed, as shown in Illustration 24-14.16

        ILLUSTRATION 24-14
        Auditor’s Report                       Boeing Company
                                           Independent Auditors’ Report
                                           Board of Directors and Shareholders, The Boeing Company:
                                           We have audited the accompanying consolidated statements of financial position of The Boeing Com-
                                           pany and subsidiaries (the “Company”) as of December 31, 2001 and 2000, and the related consolidated
                                           statements of operations, shareholders’ equity, and cash flows for each of the three years in the period
                                           ended December 31, 2001. These financial statements are the responsibility of the Company’s man-
                                           agement. Our responsibility is to express an opinion on these financial statements based on our audits.
                                               We conducted our audits in accordance with auditing standards generally accepted in the United
                                           States of America. Those standards require that we plan and perform the audit to obtain reasonable as-
                                           surance about whether the financial statements are free of material misstatement. An audit includes
                                           examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements.
         In Germany, auditors’ opinions    An audit also includes assessing the accounting principles used and significant estimates made by man-
         address whether the state-        agement, as well as evaluating the overall financial statement presentation. We believe that our audits
                                           provide a reasonable basis for our opinion.
         ments have been prepared in
                                               In our opinion, the financial statements referred to above present fairly, in all material respects, the fi-
         accordance with German law—
                                           nancial position of The Boeing Company and subsidiaries as of December 31, 2001 and 2000, and the
         a statutory audit.                results of their operations and their cash flows for each of the three years in the period ended December
                                           31, 2001, in conformity with accounting principles generally accepted in the United States of America.
                                               As discussed in Note 23 to the consolidated financial statements, in 2001 the Company changed its
                                           method of accounting for derivative financial statements to confirm to Statement of Financial Accounting
                                           Standards No. 133, Accounting for Derivative Financial Instruments and Hedging Activities, as amended.

                                           Deloitte & Touche LLP
                                           Chicago, Illinois
                                           January 28, 2002

                                              In preparing this report, the auditor follows these reporting standards.
                                              The report shall state whether the financial statements are presented in accordance
                                              with generally accepted accounting principles.
                                              The report shall identify those circumstances in which such principles have not
                                              been consistently observed in the current period in relation to the preceding period.
                                              Informative disclosures in the financial statements are to be regarded as reasonably
                                              adequate unless otherwise stated in the report.
                                              The report shall contain either an expression of opinion regarding the financial
                                              statements taken as a whole or an assertion to the effect that an opinion cannot be
                                              expressed. When an overall opinion cannot be expressed, the reasons why should
                                              be stated. In all cases where an auditor’s name is associated with financial state-
                                              ments, the report should contain a clear-cut indication of the character of the au-
                                              ditor’s examination, if any, and the degree of responsibility being taken.
                                              In most cases, the auditor issues a standard unqualified or clean opinion. That is,
                                          the auditor expresses the opinion that the financial statements present fairly, in all
                                          material respects, the financial position, results of operations, and cash flows of the en-

                                                 This auditor’s report is in exact conformance with the specifications contained in “Reports
                                          on Audited Financial Statements,” Statement on Auditing Standards No. 58 (New York: AICPA,
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                                                                                Auditor’s and Management’s Reports   •   1295

            tity in conformity with generally accepted accounting principles. Certain circumstances,
            although they do not affect the auditor’s unqualified opinion, may require the auditor
            to add an explanatory paragraph to the audit report. Some of the more important
            circumstances are as follows.
                 Uncertainties. A matter involving an uncertainty is one that is expected to be re-
                 solved at a future date, at which time sufficient evidence concerning its outcome
                 is expected to become available. In deciding whether an explanatory paragraph is
                 needed, the auditor should consider the likelihood of a material loss resulting from
                 the contingency. If, for example, the possibility that a loss will be incurred is re-
                 mote, then an explanatory paragraph is not warranted. If the loss is probable but
                 not estimable, or is reasonably possible and material, then an explanatory para-
                 graph is warranted.
                 Lack of Consistency. If there has been a change in accounting principles or in the
                 method of their application that has a material effect on the comparability of the
                 company’s financial statements, the auditor should refer to the change in an ex-
                 planatory paragraph of the report. Such an explanatory paragraph should identify
                 the nature of the change and refer the reader to the note in the financial statements
                 that discusses the change in detail. The auditor’s concurrence with a change is im-
                 plicit unless exception to the change is taken in expressing the auditor’s opinion
                 as to fair presentation of the financial statements in conformity with generally ac-
                 cepted accounting principles.
                 Emphasis of a Matter. The auditor may wish to emphasize a matter regarding the
                 financial statements, but nevertheless intends to express an unqualified opinion.
                 For example, the auditor may wish to emphasize that the entity is a component of
                 a larger business enterprise or that it has had significant transactions with related
                 parties. Such explanatory information should be presented in a separate paragraph
                 of the auditor’s report.
                 In some situations, however, the auditor is required to (1) express a qualified
            opinion, (2) express an adverse opinion, or (3) disclaim an opinion. A qualified opin-
            ion contains an exception to the standard opinion. Ordinarily the exception is not of
            sufficient magnitude to invalidate the statements as a whole; if it were, an adverse
            opinion would be rendered. The usual circumstances in which the auditor may de-
            viate from the standard unqualified short-form report on financial statements are as
                 The scope of the examination is limited or affected by conditions or restrictions.
                 The statements do not fairly present financial position or results of operations be-
                 cause of:
                 (a) Lack of conformity with generally accepted accounting principles and stan-
                 (b) Inadequate disclosure.
            If the auditor is confronted with one of the situations noted above, the opinion must
            be qualified. A qualified opinion states that, except for the effects of the matter to which
            the qualification relates, the financial statements present fairly, in all material respects,
            the financial position, results of operations, and cash flows in conformity with gener-
            ally accepted accounting principles.
                 An adverse opinion is required in any report in which the exceptions to fair pres-
            entation are so material that in the independent auditor’s judgment a qualified opin-
            ion is not justified. In such a case, the financial statements taken as a whole are not pre-
            sented in accordance with generally accepted accounting principles. Adverse opinions
            are rare, because most enterprises change their accounting to conform with the audi-
            tor’s desires.
                 A disclaimer of an opinion is appropriate when the auditor has gathered so little
            information on the financial statements that no opinion can be expressed.
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        1296     •   Chapter 24 Full Disclosure in Financial Reporting

                                           An example of a report in which the opinion is qualified because of the use of an
                                      accounting principle at variance with generally accepted accounting principles is shown
                                      in Illustration 24-15 (assuming the effects are such that the auditor has concluded that
                                      an adverse opinion is not appropriate).

        ILLUSTRATION 24-15
        Qualified Auditor’s               Helio Company
                                       Independent Auditor’s Report
                                       (Same first paragraph as the standard report)
                                       Helio Company has excluded, from property and debt in the accompanying balance sheets, certain lease
                                       obligations that, in our opinion, should be capitalized in order to conform with generally accepted ac-
                                       counting principles. If these lease obligations were capitalized, property would be increased by $1,500,000
                                       and $1,300,000, long-term debt by $1,400,000 and $1,200,000, and retained earnings by $100,000 and
                                       $50,000 as of December 31, in the current and prior year, respectively. Additionally, net income would
                                       be decreased by $40,000 and $30,000 and earnings per share would be decreased by $.06 and $.04,
                                       respectively, for the years then ended.
                                       In our opinion, except for the effects of not capitalizing certain lease obligations as discussed in the pre-
                                       ceding paragraph, the financial statements referred to above present fairly, in all material respects, the
                                       financial position of Helio Company, and the results of its operations and its cash flows for the years then
                                       ended in conformity with generally accepted accounting principles.

                                           The profession also requires the auditor to evaluate whether there is substantial
                                      doubt about the entity’s ability to continue as a going concern for a reasonable period
                                      of time (not to exceed one year beyond the date of the financial statements). If the au-
                                      ditor concludes that substantial doubt exists, an explanatory note to the auditor’s re-
                                      port would be added describing the potential problem.17
                                           The audit report should provide useful information to the investor. One investment
                                      banker noted, “Probably the first item to check is the auditor’s opinion to see whether
                                      or not it is a clean one—‘in conformity with generally accepted accounting principles’—
                                      or is qualified in regard to differences between the auditor and company management
                                      in the accounting treatment of some major item, or in the outcome of some major liti-

                                      Management’s Reports
                                      Management’s Discussion and Analysis
                                      Management’s discussion and analysis (MD&A) section covers three financial aspects
                                      of an enterprise’s business—liquidity, capital resources, and results of operations. It re-
                                      quires management to highlight favorable or unfavorable trends and to identify sig-
                                      nificant events and uncertainties that affect these three factors. This approach obvi-
                                      ously involves a number of subjective estimates, opinions, and soft data. However, the
                                      SEC, which has mandated this disclosure, believes the relevance of this information ex-
                                      ceeds the potential lack of reliability.

                                              “The Auditor’s Consideration of an Entity’s Ability to Continue as a Going Concern,”
                                      Statement on Auditing Standards No. 59 (New York: AICPA, 1988).
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                                                                                            Auditor’s and Management’s Reports                 •    1297

                The MD&A section (2001 outlook only) of Eastman Kodak’s Annual Report is pre-
            sented in Illustration 24-16.

                                                                                                                          ILLUSTRATION 24-16
                 Eastman Kodak Company                                                                                    Management’s
                                                                                                                          Discussion and Analysis
             The Company expects 2002 to be another difficult economic year, with full year revenues level with 2001
             and some earnings improvement in the second half of 2002. We do not expect to see any real upturn in
             the economy until 2003, with a very gradual return to consumer spending habits and behavior that will
             positively affect our business growth. The Company will continue to take actions to minimize the finan-
             cial impact of this slowdown. These actions include efforts to better manage production and inventory
             levels and reduce capital spending, while at the same time reducing discretionary spending to further

             hold down costs. The Company will also complete the implementation of the restructuring programs an-
             nounced in 2001 to make its operations more cost competitive and improve margins, particularly in its
             health imaging and consumer digital camera businesses.
                 During 2000, the Company completed an ongoing program of real estate divestitures and portfolio
             rationalization that contributed to other income (charges) reaching an annual average of $100 million over         Underlying
             the past three years. Now that this program is largely complete, the other income (charges) category is            Concepts
             expected to run in the negative $50 million to negative $100 million range annually.                         FASB Concepts Statement
                 The Company expects its effective tax rate to approximate 29% in 2002. The lower rate is attributa-      No. 1 notes that management
             ble to favorable tax benefits from the elimination of goodwill amortization and expected increased earn-     knows more about the enter-
             ings from operations in certain lower-taxed jurisdictions outside the U.S.
                                                                                                                          prise than users and therefore
                 From a liquidity and capital resource perspective, the Company expects to generate $6 billion in cash
                                                                                                                          can increase the usefulness of
             flow after dividends during the next six years, with approximately $400 million of this being achieved in
             2002. This will enable the Company to maintain its dividend, pay down debt and make acquisitions that        financial information by identi-
             promote profitable growth. Cash flow is defined as net cash flows (after dividends), excluding the impacts   fying significant transactions
             from debt and transactions in the Company’s own equity, such as stock repurchases and proceeds from          that affect the enterprise and
             the exercise of stock options.                                                                               by explaining their financial

                 The MD&A section also must provide information concerning the effects of infla-
            tion and changing prices if material to financial statement trends. No specific numeri-
            cal computations are specified, and companies have provided little analysis on chang-
            ing prices.
                 How this section of the annual report can be made even more effective is the sub-                          Expanded Discussion of
            ject of continuing questions such as:                                                                               Accounting for
                                                                                                                               Changing Prices

                 Is sufficient forward-looking information being disclosed under current MD&A
                 Should MD&A disclosures be changed to become more of a risk analysis?
                 Should the MD&A be audited by independent auditors?

            Management’s Responsibilities for Financial Statements                                                           OBJECTIVE
            Some companies already present a report on management’s responsibilities, including                              Understand
            its responsibilities for, and assessment of, the internal control system. The Sarbanes-                          management’s
            Oxley Act requires the SEC to develop guidelines for providing this information for all                          responsibilities for
            publicly traded companies. An example of the type of disclosure that some companies                              financials.
            are now making is shown in Illustration 24-17.
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        1298     •   Chapter 24 Full Disclosure in Financial Reporting

        ILLUSTRATION 24-17
        Report on Manage-                  AMR Corporation
        ment’s Responsibilities
                                       Report of Management
                                       The management of AMR Corporation is responsible for the integrity and objectivity of the Company’s
                                       financial statements and related information. The financial statements have been prepared in conformity
                                       with accounting principles generally accepted in the United States and reflect certain estimates and judg-
                                       ments of management as to matters set forth therein.
                                           AMR maintains a system of internal controls designed to provide reasonable assurance, at reason-
                                       able cost, that its financial records can be relied upon in the preparation of financial statements and that
                                       its assets are safeguarded against loss or unauthorized use. An important element of the Company’s
                                       control systems is the ongoing program to promote control consciousness throughout the organization.
                                       Management’s commitment to the program is evidenced by organizational arrangements that provide for
                                       divisions of responsibility, effective communication of policies and procedures, selection of competent fi-
                                       nancial managers and development and maintenance of financial planning and reporting systems.
                                           Management continually monitors the system for compliance. AMR maintains a strong internal audit-
                                       ing program that independently assesses the effectiveness of the internal controls and recommends pos-
                                       sible improvements. Ernst & Young, independent auditors, is engaged to audit the Company’s financial
                                       statements. Ernst & Young obtains and maintains an understanding of the internal control structure and
                                       conducts such tests and other auditing procedures considered necessary in the circumstances to ren-
                                       der the opinion on the financial statements contained in their report.
                                           The Audit Committee of the Board of Directors, composed entirely of independent directors, meets
                                       regularly with the independent auditors, management and internal auditors to review their work and con-
                                       firm that they are properly discharging their responsibilities. In addition, the independent auditors and the
                                       internal auditors meet periodically with the Audit Committee, without the presence of management, to
                                       discuss the results of their work and other relevant matters.

                                       Donald J. Carty
                                       Chairman, President and Chief Executive Officer

                                       Thomas W. Horton
                                       Senior Vice President and Chief Financial Officer

                                      CURRENT REPORTING ISSUES
                                      Reporting on Financial Forecasts and Projections
                                      In recent years, the investing public’s demand for more and better information has
                                      focused on disclosure of corporate expectations for the future.18 These disclosures take
                                      one of two forms:19

                                             Some areas in which companies are using financial information about the future are equip-
                                      ment lease-versus-buy analysis, analysis of a company’s ability to successfully enter new mar-
                                      kets, and examining merger and acquisition opportunities. In addition, forecasts and projections
                                      are also prepared for use by third parties in public offering documents (requiring financial fore-
                                      casts), tax-oriented investments, and financial feasibility studies. Use of forward-looking data
                                      has been enhanced by the increased capability of the microcomputer to analyze, compare, and
                                      manipulate large quantities of data.
                                           “Guide for Prospective Financial Information,” Audit and Accounting Guide (New York:
                                      AICPA, May 1999), pars. 3.04 and 3.05.
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                                                                                                 Current Reporting Issues          •   1299

                 Financial Forecast. Prospective financial statements that present, to the best of the
                 responsible party’s knowledge and belief, an entity’s expected financial position,               OBJECTIVE
                 results of operations, and cash flows. A financial forecast is based on the responsi-            Identify issues related
                 ble party’s assumptions reflecting conditions it expects to exist and the course of              to financial forecasts
                 action it expects to take.                                                                       and projections.

                 Financial Projection. Prospective financial statements that present, to the best of
                 the responsible party’s knowledge and belief, given one or more hypothetical as-
                 sumptions, an entity’s expected financial position, results of operations, and cash
                 flows. A financial projection is based on the responsible party’s assumptions re-
                 flecting conditions it expects would exist and the course of action it expects would
                 be taken, given one or more hypothetical assumptions.

            The difference between a financial forecast and a financial projection is that a forecast
            attempts to provide information on what is expected to happen, whereas a projection
            may provide information on what is not necessarily expected to happen, but might
            take place.
                Financial forecasts are the subject of intensive discussion with journalists, corpo-
            rate executives, the SEC, financial analysts, accountants, and others. Predictably, there
            are strong arguments on either side. Listed below are some of the arguments.
            Arguments for requiring published forecasts:
                 Investment decisions are based on future expectations. Therefore information about
                 the future facilitates better decisions.
                 Forecasts are already circulated informally, but are uncontrolled, frequently mis-
                 leading, and not available equally to all investors. This confused situation should
                 be brought under control.
                 Circumstances now change so rapidly that historical information is no longer ad-
                 equate for prediction.
            Arguments against requiring published forecasts:
                 No one can foretell the future. Therefore forecasts, while conveying an impression
                 of precision about the future, will inevitably be wrong.

                 Organizations will strive only to meet their published forecasts, not to produce re-
                 sults that are in the stockholders’ best interest.
                 When forecasts are not proved to be accurate, there will be recriminations and prob-
                 ably legal actions.20                                                                               Underlying
                 Disclosure of forecasts will be detrimental to organizations, because forecasts will          The AICPA’s Special Committee
                 fully inform not only investors but also competitors (foreign and domestic).                  on Financial Reporting indi-
                The AICPA has issued a statement on standards for accountants’ services on                     cates that the current legal
                                                                                                               environment discourages com-
            prospective financial information. This statement establishes guidelines for the
                                                                                                               panies from disclosing
            preparation and presentation of financial forecasts and projections.21 It requires ac-
                                                                                                               forward-looking information.
            countants to provide (1) a summary of significant assumptions used in the forecast or              Companies should not have to
            projection and (2) guidelines for minimum presentation.                                            expand reporting of forward-
                To encourage management to disclose this type of information, the SEC has a safe               looking information until there
            harbor rule. This rule provides protection to an enterprise that presents an erroneous             are more effective deterrents
            forecast as long as the forecast is prepared on a reasonable basis and is disclosed in             to unwarranted litigation.

                   The issue is serious. Over a recent 3-year period, 8 percent of the companies on the NYSE
            were sued because of an alleged lack of financial disclosure. Companies complain that they are
            subject to lawsuits whenever the stock price drops. And as one executive noted, “You can even
            be sued if the stock price goes up—because you did not disclose the good news fast enough.”
                   “Guide for Prospective Financial Information,” op. cit., par. 1.02.
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        1300     •   Chapter 24 Full Disclosure in Financial Reporting

                                      good faith.22 However, many companies note that the safe harbor rule does not work
                                      in practice, since it does not cover oral statements, nor has it kept them out of court.

                                      Experience in Great Britain
                                      Great Britain has permitted financial forecasts for years, and the results have been fairly
                                      successful. Some significant differences exist between the English and the American
                                      business and legal environment,23 but probably none that could not be overcome if in-
                                      fluential interests in this country cooperated to produce an atmosphere conducive to
                                      quality forecasting. A typical British forecast adapted from a construction company’s
                                      report to support a public offering of stock is as follows.

        ILLUSTRATION 24-18
                                       Profits have grown substantially over the past 10 years and directors are confident of being able to con-
        Financial Forecast of a
                                       tinue this expansion. . . . While the rate of expansion will be dependent on the level of economic activity
        British Company                in Ireland and England, the group is well structured to avail itself of opportunities as they arise, particu-
                                       larly in the field of property development, which is expected to play an increasingly important role in the
                                       group’s future expansion.
                                           Profits before taxation for the half year ended 30th June 1999 were 402,000 pounds. On the basis of
                                       trading experiences since that date and the present level of sales and completions, the directors expect
                                       that in the absence of unforeseen circumstances, the group’s profits before taxation for the year to 31st
                                       December 1999 will be not less than 960,000 pounds.
                                           No dividends will be paid in respect of the year December 31, 1999. In a full financial year, on the
                                       basis of above forecasts (not including full year profits) it would be the intention of the board, assuming
                                       current rates of tax, to recommend dividends totaling 40% (of after-tax profits), of which 15% payable
                                       would be as an interest dividend in November 2000 and 25% as a final dividend in June 2001.

                                           A general narrative-type forecast issued by a U.S. corporation might appear as

        ILLUSTRATION 24-19
                                       On the basis of promotions planned by the company for the second half of fiscal 2002, net earnings for
        Financial Forecast for an
                                       that period are expected to be approximately the same as those for the first half of fiscal 2002, with net
        American Company               earnings for the third quarter expected to make the predominant contribution to net earnings for the sec-
                                       ond half of fiscal 2002.

                                      Questions of Liability
                                      What happens if a company does not meet its forecasts? Are the company and the au-
                                      ditor going to be sued? If a company, for example, projects an earnings increase of 15
                                      percent and achieves only 5 percent, should stockholders be permitted to have some
                                      judicial recourse against the company?
                                          One court case involving Monsanto Chemical Corporation has provided some
                                      guidelines. In this case, Monsanto predicted that sales would increase 8 to 9 percent
                                      and that earnings would rise 4 to 5 percent. In the last part of the year, the demand
                                      for Monsanto’s products dropped as a result of a business turndown. Therefore, in-
                                      stead of increasing, the company’s earnings declined. The company was sued be-
                                      cause the projected earnings figure was erroneous, but the judge dismissed the suit
                                      because the forecasts were the best estimates of qualified people whose intents were

                                            “Safe-Harbor Rule for Projections,” Release No. 5993 (Washington: SEC, 1979). The Private
                                      Securities Litigation Reform Act of 1995 recognizes that some information that is useful to in-
                                      vestors is inherently subject to less certainty or reliability than other information. By providing
                                      safe harbor for forward-looking statements, Congress has sought to facilitate access to this in-
                                      formation by investors.
                                            The British system, for example, does not permit litigation on forecasted information, and
                                      the solicitor (lawyer) is not permitted to work on a contingent fee basis. See “A Case for Fore-
                                      casting—The British Have Tried It and Find That It Works,” World (New York: Peat, Marwick,
                                      Mitchell & Co., Autumn 1978), pp. 10–13.
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                                                                                                  Current Reporting Issues      •   1301

                As indicated earlier, the SEC’s safe harbor rules are intended to protect enterprises
            that provide good-faith projections. However, much concern exists as to how the SEC
            and the courts will interpret such terms as “good faith” and “reasonable assumptions”
            when erroneous forecasts mislead users of this information.

            Internet Financial Reporting
            How can companies improve the usefulness of their financial reporting practices? Many
            companies are using the power and reach of the Internet to provide more useful
            information to financial statement readers. Recent surveys indicate that most large com-
            panies have Internet sites, and a large proportion of these companies’ Web sites contain
            links to their financial statements and other disclosures.24 The increased popularity of
            such reporting is not surprising, since the costs of printing and disseminating paper
            reports could be reduced with the use of Internet reporting.
                 How does Internet financial reporting improve the overall usefulness of a com-
            pany’s financial reports? First, dissemination of reports via the Web can allow firms to
            communicate with more users than is possible with traditional paper reports. In ad-
            dition, Internet reporting allows users to take advantage of tools such as search en-
            gines and hyperlinks to quickly find information about the firm and, sometimes, to
            download the information for analysis, perhaps in computer spreadsheets. Finally, Int-
            ernet reporting can help make financial reports more relevant by allowing compa-
            nies to report expanded disaggregated data and more timely data than is possible
            through paper-based reporting. For example, some companies voluntarily report
            weekly sales data and segment operating data on their Web sites.
                 Given these benefits and ever-improving Internet tools, will it be long before elec-
            tronic reporting replaces paper-based financial disclosure? The main obstacles to achiev-
            ing complete electronic reporting are related to equality of access to electronic financial
            reporting and the reliability of the information distributed via the Internet. Although
            companies may practice Internet financial reporting, they must still prepare traditional
            paper reports because some investors may not have access to the Internet. These in-
            vestors would receive differential (less) information relative to other “wired” investors
            if companies were to eliminate paper reports. In addition, at present, Internet financial
            reporting is a voluntary means of reporting. As a result, there are no standards as to the
            completeness of reports on the Internet, nor is there the requirement that these reports
            be audited. One concern in this regard is that computer “hackers” could invade a com-
            pany’s Web site and corrupt the financial information contained therein.
                 Thus, although Internet financial reporting is gaining in popularity, until issues re-
            lated to differential access to the Internet and the reliability of information disseminated
            via the Web are solved, we will continue to see traditional paper-based reporting.

            Fraudulent Financial Reporting
            Fraudulent financial reporting is defined as “intentional or reckless conduct,
            whether act or omission, that results in materially misleading financial statements.”               OBJECTIVE
            Fraudulent reporting can involve gross and deliberate distortion of corporate records               Describe the
            (such as inventory count tags), or misapplication of accounting principles (failure to              profession’s response
            disclose material transactions).25 Although frauds are unusual, recent events involv-               to fraudulent financial
            ing such well-known companies as Enron, WorldCom, Adelphia Communications,                          reporting.
            and Tyco International indicate that more must be done to address this issue.

                   The FASB has issued a report on electronic dissemination of financial reports. This report
            summarizes current practice and research conducted on Internet financial reporting. See Busi-
            ness Reporting Research Project, “Electronic Distribution of Business Reporting Information”
            (Norwalk, Conn.: FASB, 2000).
                  “Report of the National Commission on Fraudulent Financial Reporting” (Washington,
            D.C., 1987), page 2. Unintentional errors as well as corporate improprieties (such as tax fraud,
            employee embezzlements, and so on) which do not cause the financial statements to be mis-
            leading are excluded from the definition of fraudulent financial reporting.
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        1302     •   Chapter 24 Full Disclosure in Financial Reporting

                                          Here’s a fraud

                                          The case of ESM Government Securities, Inc. (ESM) exemplifies the seriousness of
                                          these frauds. ESM was a Fort Lauderdale securities dealer entrusted with monies to in-
                                          vest by municipalities from Toledo, Ohio to Beaumont, Texas. The cities provided the
        What do the                       cash to ESM which they thought was collateralized with government securities. Exam-
        numbers mean?                     ination of ESM’s balance sheet indicated that the company owed about as much as it
                                          expected to collect. Unfortunately, the amount it expected to collect was from insolvent
                                          affiliates which, in effect, meant that ESM was bankrupt. In fact, ESM had been bank-
                                          rupt for more than 6 years, and the fraud was discovered only because a customer ques-
                                          tioned a note to the balance sheet! More than $300 million of losses had been disguised.
                                          Source: For an expanded discussion of this case, see Robert J. Sack and Robert Tangreti, “ESM: Im-
                                          plications for the Profession,” Journal of Accountancy (April 1987).

                                      Causes of Fraudulent Financial Reporting
                                      Fraudulent financial reporting usually occurs because of conditions in the internal or
                                      external environment.26 Influences in the internal environment relate to poor systems
                                      of internal control, management’s poor attitude toward ethics, or perhaps a company’s
                                      liquidity or profitability. Those in the external environment may relate to industry con-
                                      ditions, overall business environment, or legal and regulatory considerations.
                                           General incentives for fraudulent financial reporting are the desire to obtain a
                                      higher stock price or debt offering, to avoid default on a loan covenant, or to make a
                                      personal gain of some type (additional compensation, promotion). Situational pressures
                                      on the company or an individual manager also may lead to fraudulent financial re-
                                      porting. Examples of these situational pressures include:
                                          Sudden decreases in revenue or market share. A single company or an entire in-
                                          dustry can experience these decreases.
                                          Unrealistic budget pressures, particularly for short-term results. These pressures
                                          may occur when headquarters arbitrarily determines profit objectives and budgets
                                          without taking actual conditions into account.
                                          Financial pressure resulting from bonus plans that depend on short-term economic
                                          performance. This pressure is particularly acute when the bonus is a significant
                                          component of the individual’s total compensation.
                                           Opportunities for fraudulent financial reporting are present in circumstances when
                                      the fraud is easy to commit and when detection is difficult. Frequently these opportu-
                                      nities arise from:
                                          The absence of a board of directors or audit committee that vigilantly oversees the
                                          financial reporting process.
                                          Weak or nonexistent internal accounting controls. This situation can occur, for
                                          example, when a company’s revenue system is overloaded as a result of a rapid
                                          expansion of sales, an acquisition of a new division, or the entry into a new,
                                          unfamiliar line of business.
                                          Unusual or complex transactions such as the consolidation of two companies, the
                                          divestiture or closing of a specific operation, and agreements to buy or sell gov-
                                          ernment securities under a repurchase agreement.
                                          Accounting estimates, requiring significant subjective judgment by company man-
                                          agement, such as reserves for loan losses and the yearly provision for warranty

                                             The discussion in this section is based on the Report of the National Commission on Fraud-
                                      ulent Financial Reporting, pp. 23–24.
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                                                                                        Summary of Learning Objectives               •   1303

                 Ineffective internal audit staffs resulting from inadequate staff size and severely
                 limited audit scope.
                A weak corporate ethical climate contributes to these situations. Opportunities for
            fraudulent financial reporting also increase dramatically when the accounting princi-
            ples followed in reporting transactions are nonexistent, evolving, or subject to varying
                The Auditing Standards Board of the AICPA has issued numerous auditing stan-
            dards in response to concerns expressed by the accounting profession, by the media,
            and by the public.27 For example, the Board issued a new standard that “raises the bar”
            on the performance of financial statement audits by explicitly requiring auditors to as-
            sess the risk of material financial misstatement due to fraud.28 As indicated earlier, the
            Sarbanes-Oxley Act of 2002 now raises the penalty substantially for executives who are
            involved in fraudulent financial reporting.

            Criteria for Making Accounting and Reporting Choices

            Throughout this textbook, we have stressed the need to provide information that is
            useful to predict the amounts, timing, and uncertainty of future cash flows. To achieve
            this objective, judicious choices between alternative accounting concepts, methods, and                   Underlying
            means of disclosure must be made. You are probably surprised by the large number of
                                                                                                                The FASB concept statements
            choices that exist among acceptable alternatives.
                                                                                                                on objectives of financial
                 You should recognize, however, as indicated in Chapter 1, that accounting is greatly
                                                                                                                reporting, elements of financial
            influenced by its environment. Because it does not exist in a vacuum, it seems unreal-              statements, qualitative charac-
            istic to assume that alternative presentations of certain transactions and events will be           teristics of accounting informa-
            eliminated entirely. Nevertheless, we are hopeful that the profession, through the de-              tion, and recognition and
            velopment of a conceptual framework, will be able to focus on the needs of financial                measurement are important
            statement users and eliminate diversity where appropriate. The profession must con-                 steps in the right direction.
            tinue its efforts to develop a sound foundation upon which financial standards and
            practice can be built. As Aristotle said: “The correct beginning is more than half the


                  Review the full disclosure principle and describe problems of implementation. The             KEY TERMS
             full disclosure principle calls for financial reporting of any financial facts significant         accounting policies, 1275
             enough to influence the judgment of an informed reader. Implementing the full dis-                 adverse opinion, 1295
             closure principle is difficult, because the cost of disclosure can be substantial and the
                                                                                                                auditor, 1293
             benefits difficult to assess. Disclosure requirements have increased because of (1) the
                                                                                                                auditor’s report, 1293
             growing complexity of the business environment, (2) the necessity for timely infor-
                                                                                                                common costs, 1286
             mation, and (3) the use of accounting as a control and monitoring device.
                  Explain the use of notes in financial statement preparation. Notes are the accoun-               disclosure, 1274
             tant’s means of amplifying or explaining the items presented in the main body of the               disclaimer of an
             statements. Information pertinent to specific financial statement items can be ex-                    opinion, 1295
             plained in qualitative terms, and supplementary data of a quantitative nature can be               discrete view, 1288

                  Because the profession believes that the role of the auditor is not well understood outside
            the profession, much attention has been focused on the expectation gap. The expectation gap is
            the gap between (1) the expectation of financial statement users concerning the level of assur-
            ance they believe the independent auditor provides and (2) the assurance that the independent
            auditor actually does provide under generally accepted auditing standards.
                  “Consideration of Fraud in a Financial Statement Audit,” Statement on Auditing Standards
            No. 99 (New York: AICPA, 2002).
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        1304     •   Chapter 24 Full Disclosure in Financial Reporting

        errors, 1279                  provided to expand the information in the financial statements. Common note
        financial forecast, 1299      disclosures relate to such items as the following: accounting policies; inventories; prop-
        financial projection, 1299    erty, plant, and equipment; credit claims; contingencies and commitments; and
        fraudulent financial          subsequent events.
            reporting, 1301
        full disclosure                    Describe the disclosure requirements for major segments of a business. If only the
            principle, 1272           consolidated figures are available to the analyst, much information regarding the com-
        illegal acts, 1280            position of these figures is hidden in aggregated figures. There is no way to tell from
        integral view, 1288           the consolidated data the extent to which the differing product lines contribute to the
        interim reports, 1287         company’s profitability, risk, and growth potential. As a result, segment information
        irregularities, 1279          is required by the profession in certain situations.
            approach, 1284                 Describe the accounting problems associated with interim reporting. Interim reports
        management’s discussion       cover periods of less than one year. Two viewpoints exist regarding interim reports.
            and analysis              One view (discrete view) holds that each interim period should be treated as a sepa-
            (MD&A), 1296              rate accounting period. Another view (integral view) is that the interim report is an
        notes to financial            integral part of the annual report and that deferrals and accruals should take into con-
            statements, 1277          sideration what will happen for the entire year.
        operating segment, 1284           The same accounting principles used for annual reports should be employed for
        post-balance-sheet            interim reports. A number of unique reporting problems develop related to the fol-
            events, 1280              lowing items: (1) advertising and similar costs, (2) expenses subject to year-end
        qualified opinion, 1295       adjustment, (3) income taxes, (4) extraordinary items, (5) changes in accounting, (6)
        related party                 earnings per share, and (7) seasonality.
            transactions, 1279
        safe harbor rule, 1299             Identify the major disclosures found in the auditor’s report. If the auditor is satisfied
        seasonality, 1291             that the financial statements present the financial position, results of operations, and
        subsequent events, 1280       cash flows fairly in accordance with generally accepted accounting principles, an un-
        unqualified or clean          qualified opinion is expressed. A qualified opinion contains an exception to the stan-
            opinion, 1294             dard opinion; ordinarily the exception is not of sufficient magnitude to invalidate the
                                      statements as a whole.
                                          An adverse opinion is required in any report in which the exceptions to fair pre-
                                      sentation are so material that a qualified opinion is not justified. A disclaimer of an
                                      opinion is appropriate when the auditor has gathered so little information on the
                                      financial statements that no opinion can be expressed.

                                            Understand management’s responsibilities for financials. Management’s discussion
                                      and analysis section covers three financial aspects of an enterprise’s business: liquid-
                                      ity, capital resources, and results of operations. Management has primary responsi-
                                      bility for the financial statements, and this responsibility is often indicated in a letter
                                      to stockholders in the annual report.

                                           Identify issues related to financial forecasts and projections. The SEC has indicated
                                      that companies are permitted (not required) to include profit forecasts in reports filed
                                      with that agency. To encourage management to disclose this type of information, the
                                      SEC has issued a “safe harbor” rule. The safe harbor rule provides protection to an
                                      enterprise that presents an erroneous forecast as long as the projection was prepared
                                      on a reasonable basis and was disclosed in good faith. However, the safe harbor rule
                                      has not worked well in practice.

                                           Describe the profession’s response to fraudulent financial reporting. Fraudulent
                                      financial reporting is intentional or reckless conduct, whether act or omission, that
                                      results in materially misleading financial statements. Fraudulent financial reporting
                                      usually occurs because of poor internal control, management’s poor attitude toward
                                      ethics, and so on. The recently enacted Sarbanes-Oxley Act has numerous provisions
                                      intended to help prevent fraudulent financial reporting.
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                                                                       Perspective on Financial Statement Analysis               •   1305

            Basic Financial
            Statement Analysis

            What would be important to you in studying a company’s financial statements? The
            answer depends on your particular interest—whether you are a creditor, stockholder,
            potential investor, manager, government agency, or labor leader. For example, short-
            term creditors such as banks are primarily interested in the ability of the firm to pay
            its currently maturing obligations. In that case, you would examine the current assets
            and their relation to short-term liabilities to evaluate the short-run solvency of the firm.
            Bondholders, on the other hand, look more to long-term indicators, such as the enter-
            prise’s capital structure, past and projected earnings, and changes in financial position.
            Stockholders, present or prospective, also are interested in many of the features con-
            sidered by a long-term creditor. As a stockholder, you would focus on the earnings pic-
            ture, because changes in it greatly affect the market price of your investment. You also
            would be concerned with the financial position of the firm, because it affects indirectly
            the stability of earnings.
                 The management of a company is concerned about the composition of its capital
            structure and about the changes and trends in earnings. This financial information has
            a direct influence on the type, amount, and cost of external financing that the company
            can obtain. In addition, the company finds financial information useful on a day-to-
            day operating basis in such areas as capital budgeting, breakeven analysis, variance
            analysis, gross margin analysis, and for internal control purposes.

            Information from financial statements can be gathered by examining relationships
            between items on the statements and identifying trends in these relationships. The                OBJECTIVE
                                                                                                              Understand the
            relationships are expressed numerically in ratios and percentages, and trends are iden-
                                                                                                              approach to financial
            tified through comparative analysis.
                                                                                                              statement analysis.
                 A problem with learning how to analyze statements is that the means may become
            an end in itself. There are thousands of possible relationships that could be calculated

            and trends that could be identified. If one knows only how to calculate ratios and trends
            without understanding how such information can be used, little is accomplished. There-
            fore, a logical approach to financial statement analysis is necessary. Such an approach
            may consist of the following steps.                                                                  Concepts
                 Know the questions for which you want to find answers. As indicated at the be-            Because financial statements
                 ginning of this chapter, various groups have different types of interest in a com-        report on the past, they em-
                 pany.                                                                                     phasize the qualitative charac-
                                                                                                           teristic of feedback value. This
                 Know the questions that particular ratios and comparisons are able to help an-
                                                                                                           feedback value is useful be-
                 swer. These will be discussed in this appendix.                                           cause it can be used to better
                 Match 1 and 2 above. By such a matching, the statement analysis will have a log-          achieve the qualitative charac-
                 ical direction and purpose.                                                               teristic of predictive value.
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        1306      •   Chapter 24 Full Disclosure in Financial Reporting

                                                   Several caveats must be mentioned. Financial statements report on the past. As
                                              such, analysis of these data is an examination of the past. Whenever such information
                                              is incorporated into a decision-making (future-oriented) process, a critical assumption
                                              is that the past is a reasonable basis for predicting the future. This is usually a reason-
                                              able approach, but the limitations associated with it should be recognized. Also, ratio
        Insight                               and trend analyses will help identify present strengths and weaknesses of a company.
                                              They may serve as “red flags” indicating problem areas. In many cases, however, such
         Some companies outside the           analyses will not reveal why things are as they are. Finding answers about “why” usu-
         U.S. provide “convenience” fi-       ally requires an in-depth analysis and an awareness of many factors about a company
         nancial statements for U.S. read-    that are not reported in the financial statements—for instance, the impact of inflation,
         ers. These financial statements
                                              actions of competitors, technological developments, a strike at a major supplier’s or
         have been translated into Eng-
         lish, and they may also translate
                                              buyer’s operations, and so on.
         the currency units into U.S. dol-         Another caveat is that a single ratio by itself is not likely to be very useful. For
         lars. However, the statements        example, a current ratio of 2 to 1 (current assets are twice current liabilities) may be
         are not restated using U.S. ac-      viewed as satisfactory. However, if the industry average is 3 to 1, such a conclusion
         counting principles, and financial   may be questioned. Even given this industry average, one may conclude that the par-
         statement analysis needs to take     ticular company is doing well if one knows the previous year‘s ratio was 1.5 to 1. Con-
         this fact into account.              sequently, to derive meaning from ratios, some standard against which to compare
                                              them is needed. Such a standard may come from industry averages, past years’
                                              amounts, a particular competitor, or planned levels.
                                                   Finally, awareness of the limitations of accounting numbers used in an analysis
                                              is important. We will discuss some of these limitations and their consequences later in
                                              this appendix.

                                              RATIO ANALYSIS
                                              Various devices are used in the analysis of financial statement data to bring out the
            OBJECTIVE         µ               comparative and relative significance of the financial information presented. These de-
            Identify major analytic           vices include ratio analysis, comparative analysis, percentage analysis, and examina-
            ratios and describe               tion of related data. No one device is more useful than another. Every situation faced
            their calculation.                by the investment analyst is different, and the answers needed are often obtained only
                                              upon close examination of the interrelationships among all the data provided. Ratio
                                              analysis is the starting point in developing the information desired by the analyst.
                                                  Ratios can be classified as follows.

                                                                                 MAJOR TYPES OF RATIOS

                                                 LIQUIDITY RATIOS. Measures of the enterprise’s short-run ability to pay its
                                                 maturing obligations.
                                                 ACTIVITY RATIOS.           Measures of how effectively the enterprise is using the as-
                                                 sets employed.
                                                 PROFITABILITY RATIOS. Measures of the degree of success or failure of a
                                                 given enterprise or division for a given period of time.
                                                 COVERAGE RATIOS.             Measures of the degree of protection for long-term cred-
                                                 itors and investors.1

                                                    Other terms may be used to categorize these ratios. For example, liquidity ratios are some-
                                              times referred to as solvency ratios; activity ratios as turnover or efficiency ratios; and coverage
                                              ratios as leverage or capital structure ratios.
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                                                                                                               Ratio Analysis     •   1307

                 Discussions and illustrations about the computation and use of these financial ra-
            tios have been integrated throughout this book. Illustration 24A-1 summarizes all of
            the ratios presented in the book and identifies the specific chapters in which ratio cov-
            erage has been presented.

                                                                                                                ILLUSTRATION 24A-1
                                        SUMMARY OF RATIOS PRESENTED IN EARLIER CHAPTERS
                                                                                                                Summary of Financial
                             Ratio                       Formula for Computation              Reference         Ratios
                 I. Liquidity
                                                              Current assets
                    1. Current ratio                                                      Chapter 13, p. 643
                                                             Current liabilities
                    2. Quick or acid-test            Cash, marketable securities, and
                       ratio                                net receivables
                                                                                          Chapter 13, p. 644
                                                            Current liabilities
                    3. Current cash debt                  Net cash provided by
                       ratio                                operating activities
                                                                                          Chapter 5, p. 196
                                                         Average current liabilities
                 II. Activity
                                                                 Net sales
                    4. Receivables turnover                                               Chapter 7, p. 338
                                                      Average trade receivables (net)
                                                            Cost of goods sold
                    5. Inventory turnover                                                 Chapter 9, p. 442
                                                            Average inventory
                                                                Net sales
                    6. Asset turnover                                                     Chapter 11, p. 543
                                                           Average total assets
                 III. Profitability

                    7. Profit margin                            Net income                Chapter 11, p. 543
                       on sales                                  Net sales

                    8. Rate of return                          Net income                 Chapter 11, p. 543
                       on assets                           Average total assets
                    9. Rate of return on
                                                   Net income minus preferred dividends
                       common stock
                                                   Average common stockholders’ equity    Chapter 15, p. 749
                                                   Net income minus preferred dividends
                  10. Earnings per share                                                  Chapter 16, p. 801
                                                       Weighted shares outstanding
                                                              Cash dividends
                  11. Payout ratio                                                        Chapter 15, p. 750
                                                               Net income
                 IV. Coverage

                  12. Debt to total                                Debt                   Chapter 14, p. 692
                      assets ratio                        Total assets or equities

                                                      Income before interest charges
                  13. Times interest
                                                                and taxes
                                                            Interest charges              Chapter 14, p. 693
                                                          Net cash provided by
                  14. Cash debt coverage
                                                           operating activities
                                                          Average total liabilities       Chapter 5, p. 197

                  15. Book value                       Common stockholders’ equity        Chapter 15, p. 750
                      per share                           Outstanding shares

                Supplemental coverage of these ratios, accompanied with assignment material, is
            contained on the Take Action! CD. This supplemental coverage takes the form of a com-                Financial Analysis Primer
            prehensive case adapted from the annual report of a large international chemical com-
            pany that we have disguised under the name of Anetek Chemical Corporation.
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        1308     •   Chapter 24 Full Disclosure in Financial Reporting

                                          Limitations of Ratio Analysis
                                          The reader of financial statements must understand the basic limitations associated
           OBJECTIVE       ¸              with ratio analysis. As analytical tools, ratios are attractive because they are simple and
           Explain the limitations        convenient. But too frequently, decisions are based on only these simple computations.
           of ratio analysis.             The ratios are only as good as the data upon which they are based and the informa-
                                          tion with which they are compared.
                                               One important limitation of ratios is that they generally are based on historical
                                          cost, which can lead to distortions in measuring performance. By failing to incorpo-
                                          rate changing price information, many believe that inaccurate assessments of the en-
                                          terprise’s financial condition and performance result.
                                               Also, investors must remember that where estimated items (such as depreciation
                                          and amortization) are significant, income ratios lose some of their credibility. Income
                                          recognized before the termination of the life of the business is an approximation. In
                                          analyzing the income statement, the user should be aware of the uncertainty
                                          surrounding the computation of net income. As one writer aptly noted, “The physicist
                                          has long since conceded that the location of an electron is best expressed by a proba-
                                          bility curve. Surely an abstraction like earnings per share is even more subject to the

                                          rules of probability and risk.”2
                                               Probably the greatest criticism of ratio analysis is the difficult problem of achiev-
                                          ing comparability among firms in a given industry. Achieving comparability among
              Underlying                  firms requires that the analyst (1) identify basic differences existing in their accounting
              Concepts                    principles and procedures and (2) adjust the balances to achieve comparability.
        Consistency and comparability          Basic differences in accounting usually involve one of the following areas.
        are important concepts when
        financial statement analysis is       Inventory valuation (FIFO, LIFO, average cost).
        performed. If the principles          Depreciation methods, particularly the use of straight-line versus accelerated
        and assumptions used to               depreciation.
        prepare the financial state-
                                              Capitalization versus expense of certain costs.
        ments are continually chang-
        ing, it becomes difficult to          Pooling versus purchase in accounting for business combinations.
        make accurate assessments of          Capitalization of leases versus noncapitalization.
        a company’s progress.                 Investments in common stock carried at equity versus fair value.
                                              Differing treatments of postretirement benefit costs.
                                              Questionable practices of defining discontinued operations, impairments, and ex-
                                              traordinary items.
                                               The use of these different alternatives can make quite a significant difference in the
                                          ratios computed. For example, in the brewing industry, at one time Anheuser-Busch
                                          noted that if it had used average cost for inventory valuation instead of LIFO, inven-
                                          tories would have increased approximately $33,000,000. Such an increase would have
                                          a substantive impact on the current ratio. Several studies have analyzed the impact of
                                          different accounting methods on financial statement analysis. The differences in income
                                          that can develop are staggering in some cases. The average investor may find it diffi-
                                          cult to grasp all these differences, but investors must be aware of the potential pitfalls
                                          if they are to be able to make the proper adjustments.
                                               Finally, it must be recognized that a substantial amount of important information
                                          is not included in a company’s financial statements. Events involving such things as
                                          industry changes, management changes, competitors’ actions, technological develop-
                                          ments, government actions, and union activities are often critical to a company’s suc-
                                          cessful operation. These events occur continuously, and information about them must
                                          come from careful analysis of financial reports in the media and other sources. Indeed
                                          many argue, under what is known as the efficient market hypothesis, that financial
                                          statements contain “no surprises” to those engaged in market activities. They contend
                                          that the effect of these events is known in the marketplace—and the price of the com-
                                          pany’s stock adjusts accordingly—well before the issuance of such reports.

                                                Richard E. Cheney, “How Dependable Is the Bottom Line?” The Financial Executive (Janu-
                                          ary 1971), p. 12.
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                                                                                                                Comparative Analysis        •     1309

            In comparative analysis the same information is presented for two or more different
            dates or periods so that like items may be compared. Ratio analysis provides only a                              OBJECTIVE     ¹
                                                                                                                             Describe techniques of
            single snapshot, the analysis being for one given point or period in time. In a com-
                                                                                                                             comparative analysis.
            parative analysis, an investment analyst can concentrate on a given item and determine
            whether it appears to be growing or diminishing year by year and the proportion of
            such change to related items. Generally, companies present comparative financial
                In addition, many companies include in their annual reports 5- or 10-year sum-
            maries of pertinent data that permit the reader to examine and analyze trends. ARB
            No. 43 concluded that “the presentation of comparative financial statements in annual
            and other reports enhances the usefulness of such reports and brings out more clearly
            the nature and trends of current changes affecting the enterprise.” An illustration of a
            5-year condensed statement with additional supporting data as presented by Anetek
            Chemical Corporation is presented in Illustration 24A-2.
                                                                                                                           ILLUSTRATION 24A-2
                                                                                                                           Condensed Comparative
                                                                                                                           Financial Information

                                                                          ANETEK CHEMICAL CORPORATION
                                                                          CONDENSED COMPARATIVE STATEMENTS
                                                                                  (000,000 OMITTED)
                                                                                                                             10 Years     20 Years
                                                                                                                               Ago          Ago
                                                              2004             2003        2002        2001      2000         1994         1984
                 Sales and other revenue:
                 Net sales                                  $1,600.0          $1,350.0    $1,309.7   $1,176.2   $1,077.5      $636.2      $170.7
                 Other revenue                                  75.0              50.0        39.4       34.1       24.6         9.0         3.7
                         Total                               1,675.0           1,400.0     1,349.1    1,210.3    1,102.1       645.2        174.4
                 Costs and other charges:
                 Cost of sales                               1,000.0            850.0       827.4       737.6     684.2        386.8        111.0
                 Depreciation and amortization                 150.0            150.0       122.6       115.6      98.7         82.4         14.2
                 Selling and administrative
                    expenses                                      225.0         150.0       144.2       133.7     126.7         66.7            10.7
                 Interest expense                                  50.0          25.0        28.5        20.7       9.4          8.9             1.8
                 Taxes on income                                  100.0          75.0        79.5        73.5      68.3         42.4            12.4
                         Total                               1,525.0           1,250.0     1,202.2    1,081.1     987.3        587.2        150.1
                 Net income for the year                   $ 150.0            $ 150.0     $ 146.9    $ 129.2    $ 114.8       $ 58.0      $ 24.3

                 Other Statistics
                 Earnings per share on common
                   stock (in dollars)a                        $ 5.00            $ 5.00      $ 4.90     $ 3.58     $ 3.11      $ 1.66       $ 1.06
                 Cash dividends per share on
                   common stock (in dollars)a                      2.25          2.15        1.95        1.79      1.71         1.11            0.25
                 Cash dividends declared on
                   common stock                                   67.5          64.5        58.5        64.6      63.1         38.8             5.7
                 Stock dividend at approximate
                   market value                                                                         46.8                   27.3
                 Taxes (major)                                144.5            125.9       116.5       105.6      97.8         59.8         17.0
                 Wages paid                                   389.3            325.6       302.1       279.6     263.2        183.2         48.6
                 Cost of employee benefits                     50.8             36.2        32.9        28.7      27.2         18.4          4.4
                 Number of employees at year
                   end (thousands)                             47.4             36.4        35.0        33.8      33.2         26.6         14.6
                 Additions to property                        306.3            192.3       241.5       248.3     166.1        185.0         49.0
                 Adjusted for stock splits and stock dividends.

                 All 600 companies surveyed in Accounting Trends and Techniques—2001 presented compar-
            ative 2000 amounts in their 2001 balance sheets and presented comparative 1999 and 2000
            amounts in their 2001 income statements.
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        1310     •   Chapter 24 Full Disclosure in Financial Reporting

                                      PERCENTAGE (COMMON-SIZE) ANALYSIS
                                      Analysts also use percentage analysis to help them evaluate and compare companies.
           OBJECTIVE                  Percentage analysis consists of reducing a series of related amounts to a series of per-
           Describe techniques of     centages of a given base. All items in an income statement are frequently expressed as
           percentage analysis.       a percentage of sales or sometimes as a percentage of cost of goods sold. A balance
                                      sheet may be analyzed on the basis of total assets. This analysis facilitates comparison
                                      and is helpful in evaluating the relative size of items or the relative change in items. A
                                      conversion of absolute dollar amounts to percentages may also facilitate comparison
                                      between companies of different size.
                                           To illustrate, here is a comparative analysis of the expense section of Anetek for the
                                      last 2 years.

        ILLUSTRATION 24A-3
                                                                      ANETEK CHEMICAL CORPORATION
        Horizontal Percentage
                                                                       HORIZONTAL COMPARATIVE ANALYSIS
        Analysis                                                              (000,000 OMITTED)
                                                                                                                        % Change
                                                                                  2004       2003        Difference     Inc. (Dec.)
                                         Cost of sales                           $1,000.0   $850.0        $150.0          17.6%
                                         Depreciation and amortization              150.0    150.0             0             0
                                         Selling and administrative expenses        225.0    150.0          75.0          50.0
                                         Interest expense                            50.0     25.0          25.0         100.0
                                         Taxes                                      100.0     75.0          25.0          33.3

                                          This approach, normally called horizontal analysis, indicates the proportionate
                                      change over a period of time. It is especially useful in evaluating a trend situation, be-
                                      cause absolute changes are often deceiving.
                                          Another approach, called vertical analysis, is the proportional expression of each
                                      item on a financial statement in a given period to a base figure. For example, Anetek
                                      Chemical’s income statement using this approach appears below.

        ILLUSTRATION 24A-4
                                                                      ANETEK CHEMICAL CORPORATION
        Vertical Percentage
                                                                             INCOME STATEMENT
        Analysis                                                             (000,000 OMITTED)
                                                                                                                      Percentage of
                                                                                            Amount                    Total Revenue
                                         Net sales                                          $1,600.0                      96%
                                         Other revenue                                          75.0                       4
                                             Total revenue                                   1,675.0                     100

                                           Cost of goods sold                                1,000.0                       60
                                           Depreciation and amortization                       150.0                        9
                                           Selling and administrative expenses                 225.0                       13
                                           Interest expense                                     50.0                        3
                                           Income tax                                          100.0                        6
                                             Total expenses                                  1,525.0                       91
                                         Net income                                         $ 150.0                         9%

                                           Reducing all the dollar amounts to a percentage of a base amount is frequently
                                      called common-size analysis because all of the statements and all of the years are re-
                                      duced to a common size. That is, all of the elements within each statement are expressed
                                      in percentages of some common number and always add up to 100 percent. Common-
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                                                                Summary of Learning Objectives for Appendix 24A              •   1311

            size (percentage) analysis is the analysis of the composition of each of the financial
                 In the analysis of the balance sheet, common-size analysis answers such questions
            as: What is the distribution of equities between current liabilities, long-term debt, and
            owners’ equity? What is the mix of assets (percentage-wise) with which the enterprise
            has chosen to conduct its business? What percentage of current assets are in inventory,
            receivables, and so forth?
                 The income statement lends itself to common-size analysis because each item in it
            is related to a common amount, usually sales. It is instructive to know what propor-
            tion of each sales dollar is absorbed by various costs and expenses incurred by the en-
                 Common-size statements may be used for comparing one company’s statements
            from different years to detect trends not evident from the comparison of absolute
            amounts. Also, common-size statements provide intercompany comparisons regardless
            of size because the financial statements can be recast into a comparable common-size

                                                                                                            KEY TERMS
                   Understand the approach to financial statement analysis. Basic financial statement       acid-test ratio, 1307
             analysis involves examining relationships between items on the statements (ratio and           activity ratios, 1306
             percentage analysis) and identifying trends in these relationships (comparative analy-         asset turnover, 1307
             sis). Analysis is used to predict the future, but ratio analysis is limited because the        book value per
             data are from the past. Also, ratio analysis identifies present strengths and weaknesses          share, 1307
             of a company, but it may not reveal why they are as they are. Although single ratios           cash debt coverage
             are helpful, they are not conclusive; they must be compared with industry averages,               ratio, 1307
             past years, planned amounts, and the like for maximum usefulness.                              common-size
                                                                                                               analysis, 1310
             µ Identify major analytic ratios and describe their calculation. Ratios are classified as      comparative
             liquidity ratios, activity ratios, profitability ratios, and coverage ratios: (1) Liquidity       analysis, 1309
             ratio analysis measures the short-run ability of the enterprise to pay its currently ma-       coverage ratios, 1306
             turing obligations. (2) Activity ratio analysis measures how effectively the enterprise is     current cash debt
             using its assets. (3) Profitability ratio analysis measures the degree of success or failure      ratio, 1307
             of an enterprise to generate revenues adequate to cover its costs of operation and pro-        current ratio, 1307
             vide a return to the owners. (4) Coverage ratio analysis measures the degree of protec-
                                                                                                            debt to total assets
             tion afforded long-term creditors and investors.                                                  ratio, 1307
             ¸ Explain the limitations of ratio analysis. One important limitation of ratios is that        earnings per share, 1307
             they are based on historical cost, which can lead to distortions in measuring per-             horizontal analysis, 1310
             formance. Also, where estimated items (such as depreciation and amortization) are              inventory turnover, 1307
             significant, income ratios lose some of their credibility. In addition, difficult problems     liquidity ratios, 1306
             of comparability exist because firms use different accounting principles and proce-            payout ratio, 1307
             dures. Finally, it must be recognized that a substantial amount of important informa-          percentage analysis, 1310
             tion is not included in a company’s financial statements.                                      profit margin on
                                                                                                               sales, 1307
             ¹ Describe techniques of comparative analysis. Companies present comparative data,             profitability ratios, 1306
             which generally includes 2 years of balance sheet information and 3 years of income
                                                                                                            quick ratio, 1307
             statement information. In addition, many companies include in their annual reports
             5- to 10-year summaries of pertinent data that permit the reader to examine and an-            rate of return on
                                                                                                               assets, 1307
             alyze trends.
                                                                                                            rate of return on common
                  Describe techniques of percentage analysis. Percentage analysis consists of reduc-           stock equity, 1307
             ing a series of related amounts to a series of percentages of a given base. Two                receivables turnover, 1307
             approaches are often used: Horizontal analysis indicates the proportionate change in           times interest
             financial statement items over a period of time; such analysis is most helpful in eval-           earned, 1307
             uating trends. Vertical analysis (common-size analysis) is a proportional expression of        vertical analysis, 1310
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        1312     •   Chapter 24 Full Disclosure in Financial Reporting

                                       each item on the financial statements in a given period to a base amount. It analyzes
                                       the composition of each of the financial statements from different years (a) to detect
                                       trends not evident from the comparison of absolute amounts and (b) to make inter-
                                       company comparisons of different sized enterprises.

                                      Note: All asterisked Questions, Brief Exercises, Exercises, Problems, and Conceptual Cases re-
                                      late to materials contained in the appendix to the chapter.

         1. What are the major advantages of notes to the financial          how each of the following “subsequent events” would
            statements? What types of items are usually reported in          be reported.
            notes?                                                           (a) Collection of a note written off in a prior period.
         2. What is the full disclosure principle in accounting? Why         (b) Issuance of a large preferred stock offering.
            has disclosure increased substantially in the last 10
                                                                             (c) Acquisition of a company in a different industry.
                                                                             (d) Destruction of a major plant in a flood.
         3. The FASB requires a reconciliation between the effective
            tax rate and the federal government’s statutory rate. Of         (e) Death of the company’s chief executive officer (CEO).
            what benefit is such a disclosure requirement?                   (f) Additional wage costs associated with settlement of
         4. At the beginning of 2004, Beausoleil Inc. entered into an            a four-week strike.
            8-year nonrenewable lease agreement. Provisions in the           (g) Settlement of a federal income tax case at consider-
            lease require the client to make substantial recondition-            ably more tax than anticipated at year-end.
            ing and restoration expenditures at the end of the lease.        (h) Change in the product mix from consumer goods to
            What type of disclosure do you believe is necessary for              industrial goods.
            this type of situation?
                                                                          8. What are diversified companies? What accounting prob-
         5. What type of disclosure or accounting do you believe is          lems are related to diversified companies?
            necessary for the following items?
                                                                          9. What quantitative materiality test is applied to deter-
            (a) Because of a general increase in the number of labor         mine whether a segment is significant enough to war-
                disputes and strikes, both within and outside the in-        rant separate disclosure?
                dustry, there is an increased likelihood that a com-
                pany will suffer a costly strike in the near future.     10. Identify the segment information that is required to be
                                                                             disclosed by FASB Statement No. 131.
            (b) A company reports an extraordinary item (net of tax)
                correctly on the income statement. No other mention      11. What is an operating segment, and when can informa-
                is made of this item in the annual report.                   tion about two operating segments be aggregated?

            (c) A company expects to recover a substantial amount        12. The controller for Chang Lee Inc. recently commented,
                in connection with a pending refund claim for a prior        “If I have to disclose our segments individually, the only
                year’s taxes. Although the claim is being contested,         people who will gain are our competitors and the only
                counsel for the company has confirmed the client’s           people that will lose are our present stockholders.” Eval-
                expectation of recovery.                                     uate this comment.

         6. The following information was described in a note of         13. An article in the financial press entitled “Important In-
            Cebar Packing Co.                                                formation in Annual Reports This Year” noted that an-
               “During August, A. Belew Products Corporation pur-            nual reports include a management discussion and
            chased 311,003 shares of the Company’s common stock              analysis section. What would this section contain?
            which constitutes approximately 35% of the stock out-        14. “The financial statements of a company are manage-
            standing. A. Belew has since obtained representation on          ment’s, not the accountant’s.” Discuss the implications
            the Board of Directors.”                                         of this statement.
               “An affiliate of A. Belew Products Corporation acts as    15. Olga Conrad, a financial writer, noted recently, “There
            a food broker for the Company in the greater New York            are substantial arguments for including earnings pro-
            City marketing area. The commissions for such services           jections in annual reports and the like. The most com-
            after August amounted to approximately $20,000.”                 pelling is that it would give anyone interested some-
            Why is this information disclosed?                               thing now available to only a relatively select few—like
         7. What are the major types of subsequent events? Indicate          large stockholders, creditors, and attentive bartenders.”
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                                                                                                                    Brief Exercises       •   1313

                 Identify some arguments against providing earnings                    how does it differ from an embezzlement of company
                 projections.                                                          funds?
            16. The following comment appeared in the financial press:            *23. “The significance of financial statement data is not in the
                “Inadequate financial disclosure, particularly with re-                amount alone.” Discuss the meaning of this statement.
                spect to how management views the future and its role             *24. A close friend of yours, who is a history major and who
                in the marketplace, has always been a stone in the shoe.               has not had any college courses or any experience in
                After all, if you don’t know how a company views the                   business, is receiving the financial statements from com-
                future, how can you judge the worth of its corporate                   panies in which he has minor investments (acquired for
                strategy?” What are some arguments for reporting earn-                 him by his now-deceased father). He asks you what he
                ings forecasts?                                                        needs to know to interpret and to evaluate the financial
            17. What are interim reports? Why are balance sheets often                 statement data that he is receiving. What would you tell
                not provided with interim data?                                        him?
            18. What are the accounting problems related to the pres-             *25. Distinguish between ratio analysis and percentage
                entation of interim data?                                              analysis relative to the interpretation of financial state-
            19. Mysteries Inc., a closely held corporation, has decided to             ments. What is the value of these two types of analysis?
                go public. The controller, C. Keene, is concerned with            *26. In calculating inventory turnover, why is cost of goods
                presenting interim data when a LIFO inventory valua-                   sold used as the numerator? As the inventory turnover
                tion is used. What problems are encountered with LIFO                  increases, what increasing risk does the business
                inventories when quarterly data are presented?                         assume?
            20. What approaches have been suggested to overcome the               *27. What is the relationship of the asset turnover ratio to the
                seasonality problem related to interim reporting?                      rate of return on assets?
            21. What is the difference between a CPA’s unqualified opin-          *28. Explain the meaning of the following terms: (a) common-
                ion or “clean” opinion and a qualified one?                            size analysis, (b) vertical analysis, (c) horizontal analy-
            22. Mary Beidler and Lee Pannebecker are discussing the                    sis, (d) percentage analysis.
                recent fraud that occurred at LowRental Leasing, Inc. The         *29. Presently, the profession requires that earnings per share
                fraud involved the improper reporting of revenue to en-                be disclosed on the face of the income statement. What
                sure that the company would have income in excess of                   are some disadvantages of reporting ratios on the finan-
                $1 million. What is fraudulent financial reporting, and                cial statements?

                                                                  BRIEF EXERCISES
                      BE24-1 An annual report of D. Robillard Industries states, “The company and its subsidiaries have long-
                      term leases expiring on various dates after December 31, 2004. Amounts payable under such commit-
                      ments, without reduction for related rental income, are expected to average approximately $5,711,000 an-
                      nually for the next 3 years. Related rental income from certain subleases to others is estimated to average
                      $3,094,000 annually for the next 3 years.” What information is provided by this note?
                      BE24-2 An annual report of Ford Motor Corporation states, “Net income a share is computed based
                      upon the average number of shares of capital stock of all classes outstanding. Additional shares of com-
                      mon stock may be issued or delivered in the future on conversion of outstanding convertible debentures,
                      exercise of outstanding employee stock options, and for payment of defined supplemental compensation.
                      Had such additional shares been outstanding, net income a share would have been reduced by 10¢ in the
                      current year and 3¢ in the previous year. . . . As a result of capital stock transactions by the company dur-
                      ing the current year (primarily the purchase of Class A Stock from Ford Foundation), net income a share
                      was increased by 6¢.” What information is provided by this note?
                      BE24-3 Linden Corporation is preparing its December 31, 2003, financial statements. Two events that oc-
                      curred between December 31, 2003, and March 10, 2004, when the statements were issued, are described
                           1.   A liability, estimated at $150,000 at December 31, 2003, was settled on February 26, 2004, at $170,000.
                           2.   A flood loss of $80,000 occurred on March 1, 2004.
                      What effect do these subsequent events have on 2003 net income?
                      BE24-4 Bess Marvin, a student of intermediate accounting, was heard to remark after a class discussion
                      on diversified reporting, “All this is very confusing to me. First we are told that there is merit in pre-
                      senting the consolidated results, and now we are told that it is better to show segmental results. I wish
                      they would make up their minds.” Evaluate this comment.
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        1314   •    Chapter 24 Full Disclosure in Financial Reporting

                    BE24-5   Roder Corporation has seven industry segments with total revenues as follows.
                                                   Genso           $600       Sergei       $ 225
                                                   Konami           650       Takuhi         200
                                                   RPG              250       Nippon         700
                                                   Red Moon         375
                    Based only on the revenues test, which industry segments are reportable?
                    BE24-6   Operating profits and losses for the seven industry segments of Roder Corporation are:
                                                   Genso           $ 90       Sergei       $ (20)
                                                   Konami            (40)     Takuhi          34
                                                   RPG                25      Nippon        100
                                                   Red Moon           50
                    Based only on the operating profit (loss) test, which industry segments are reportable?
                    BE24-7   Identifiable assets for the seven industry segments of Roder Corporation are:
                                                   Genso           $500       Sergei       $ 200
                                                   Konami           550       Takuhi         150
                                                   RPG              400       Nippon         475
                                                   Red Moon         400
                    Based only on the identifiable assets test, which industry segments are reportable?
                   *BE24-8   Answer each of the questions in the following unrelated situations.
                       (a) The current ratio of a company is 5:1 and its acid-test ratio is 1:1. If the inventories and prepaid
                           items amount to $600,000, what is the amount of current liabilities?
                       (b) A company had an average inventory last year of $200,000 and its inventory turnover was 5. If
                           sales volume and unit cost remain the same this year as last and inventory turnover is 8 this year,
                           what will average inventory have to be during the current year?
                       (c) A company has current assets of $90,000 (of which $40,000 is inventory and prepaid items) and
                           current liabilities of $30,000. What is the current ratio? What is the acid-test ratio? If the company
                           borrows $15,000 cash from a bank on a 120-day loan, what will its current ratio be? What will the
                           acid-test ratio be?
                       (d) A company has current assets of $600,000 and current liabilities of $240,000. The board of direc-
                           tors declares a cash dividend of $180,000. What is the current ratio after the declaration but be-
                           fore payment? What is the current ratio after the payment of the dividend?
                   *BE24-9 Aston Martin Company’s budgeted sales and budgeted cost of goods sold for the coming year
                    are $144,000,000 and $90,000,000 respectively. Short-term interest rates are expected to average 10%. If As-
                    ton Martin can increase inventory turnover from its present level of 9 times a year to a level of 12 times
                    per year, compute its expected cost savings for the coming year.
                   *BE24-10 Ferrari Company’s net accounts receivable were $1,000,000 at December 31, 2003, and $1,200,000
                    at December 31, 2004. Net cash sales for 2004 were $400,000. The accounts receivable turnover for 2004
                    was 5.0. Determine Ferrari’s total net sales for 2004.

                    E24-1 (Post-Balance-Sheet Events) Madrasah Corporation issued its financial statements for the year
                    ended December 31, 2005, on March 10, 2006. The following events took place early in 2006.
                       (a) On January 10, 10,000 shares of $5 par value common stock were issued at $66 per share.
                       (b) On March 1, Madrasah determined after negotiations with the Internal Revenue Service that
                           income taxes payable for 2005 should be $1,270,000. At December 31, 2005, income taxes payable
                           were recorded at $1,100,000.

                    Discuss how the preceding post-balance sheet events should be reflected in the 2005 financial statements.
                    E24-2 (Post-Balance-Sheet Events) For each of the following subsequent (post-balance-sheet) events,
                    indicate whether a company should (a) adjust the financial statements, (b) disclose in notes to the finan-
                    cial statements, or (c) neither adjust nor disclose.
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                                                                                                                               Exercises   •   1315

                            ______ 1. Settlement of federal tax case at a cost considerably in excess of the amount expected at
                            ______ 2. Introduction of a new product line.
                            ______ 3. Loss of assembly plant due to fire.
                            ______ 4. Sale of a significant portion of the company’s assets.
                            ______ 5. Retirement of the company president.
                            ______ 6. Prolonged employee strike.
                            ______ 7. Loss of a significant customer.
                            ______ 8. Issuance of a significant number of shares of common stock.
                            ______ 9. Material loss on a year-end receivable because of a customer’s bankruptcy.
                            ______ 10. Hiring of a new president.
                            ______ 11. Settlement of prior year’s litigation against the company.
                            ______ 12. Merger with another company of comparable size.
                      E24-3 (Segmented Reporting) Carlton Company is involved in four separate industries. The follow-
                      ing information is available for each of the four industries.

                                   Operating Segment          Total Revenue         Operating Profit (Loss)   Identifiable Assets
                                           W                    $ 60,000                    $15,000               $167,000
                                           X                      10,000                      3,000                 83,000
                                           Y                      23,000                     (2,000)                21,000
                                           Z                       9,000                      1,000                 19,000
                                                                $102,000                    $17,000               $290,000

                      Determine which of the operating segments are reportable based on the:
                            (a) Revenue test.
                            (b) Operating profit (loss) test.
                            (c) Identifiable assets test.
                     *E24-4 (Ratio Computation and Analysis; Liquidity) As loan analyst for Utrillo Bank, you have been
                      presented the following information.

                                                                                              Toulouse Co.    Lautrec Co.
                                            Cash                                               $ 120,000      $ 320,000
                                            Receivables                                          220,000        302,000
                                            Inventories                                          570,000        518,000
                                              Total current assets                                910,000       1,140,000
                                            Other assets                                          500,000         612,000
                                               Total assets                                    $1,410,000     $1,752,000

                                            Liabilities and Stockholders’ Equity
                                            Current liabilities                                $ 305,000      $ 350,000
                                            Long-term liabilities                                400,000        500,000
                                            Capital stock and retained earnings                  705,000        902,000
                                               Total liabilities and stockholders’ equity      $1,410,000     $1,752,000
                                            Annual sales                                       $ 930,000      $1,500,000
                                            Rate of gross profit on sales                           30%             40%

                        Each of these companies has requested a loan of $50,000 for 6 months with no collateral offered. Inas-
                      much as your bank has reached its quota for loans of this type, only one of these requests is to be granted.

                      Which of the two companies, as judged by the information given above, would you recommend as the
                      better risk and why? Assume that the ending account balances are representative of the entire year.
                     *E24-5 (Analysis of Given Ratios) Picasso Company is a wholesale distributor of professional equip-
                      ment and supplies. The company’s sales have averaged about $900,000 annually for the 3-year period
                      2003–2005. The firm’s total assets at the end of 2005 amounted to $850,000.
                         The president of Picasso Company has asked the controller to prepare a report that summarizes the
                      financial aspects of the company’s operations for the past 3 years. This report will be presented to the
                      board of directors at their next meeting.
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        1316      •    Chapter 24 Full Disclosure in Financial Reporting

                          In addition to comparative financial statements, the controller has decided to present a number of rel-
                       evant financial ratios which can assist in the identification and interpretation of trends. At the request of
                       the controller, the accounting staff has calculated the following ratios for the 3-year period 2003–2005.

                                                                                               2003           2004           2005
                                         Current ratio                                          1.80           1.89           1.96
                                         Acid-test (quick) ratio                                1.04           0.99           0.87
                                         Accounts receivable turnover                           8.75           7.71           6.42
                                         Inventory turnover                                     4.91           4.32           3.42
                                         Percent of total debt to total assets                 51             46             41
                                         Percent of long-term debt to total assets             31             27             24
                                         Sales to fixed assets (fixed asset turnover)           1.58           1.69           1.79
                                         Sales as a percent of 2003 sales                       1.00           1.03           1.07
                                         Gross margin percentage                               36.0           35.1           34.6
                                         Net income to sales                                    6.9%           7.0%           7.2%
                                         Return on total assets                                 7.7%           7.7%           7.8%
                                         Return on stockholders’ equity                        13.6%          13.1%          12.7%

                          In preparation of the report, the controller has decided first to examine the financial ratios independ-
                       ent of any other data to determine if the ratios themselves reveal any significant trends over the 3-year

                          (a) The current ratio is increasing while the acid-test (quick) ratio is decreasing. Using the ratios pro-
                              vided, identify and explain the contributing factor(s) for this apparently divergent trend.
                          (b) In terms of the ratios provided, what conclusion(s) can be drawn regarding the company’s use of
                              financial leverage during the 2003–2005 period?
                          (c) Using the ratios provided, what conclusion(s) can be drawn regarding the company’s net invest-
                              ment in plant and equipment?
                      *E24-6 (Ratio Analysis) Edna Millay Inc. is a manufacturer of electronic components and accessories
                       with total assets of $20,000,000. Selected financial ratios for Millay and the industry averages for firms of
                       similar size are presented below.
                                                                                  Edna Millay                    Industry
                                                                          2002          2003          2004       Average
                          Current ratio                                   2.09          2.27           2.51           2.24
                          Quick ratio                                     1.15          1.12           1.19           1.22
                          Inventory turnover                              2.40          2.18           2.02           3.50
                          Net sales to stockholders’ equity               2.71          2.80           2.99           2.85
                          Net income to stockholders’ equity              0.14          0.15           0.17           0.11
                          Total liabilities to stockholders’ equity       1.41          1.37           1.44           0.95

                          Millay is being reviewed by several entities whose interests vary, and the company’s financial ratios
                       are a part of the data being considered. Each of the parties listed below must recommend an action based
                       on its evaluation of Millay’s financial position.
                          Archibald MacLeish Bank. The bank is processing Millay’s application for a new 5-year term note.
                          Archibald MacLeish has been Millay’s banker for several years but must reevaluate the company’s
                          financial position for each major transaction.
                          Robert Lowell Company. Lowell is a new supplier to Millay and must decide on the appropriate credit
                          terms to extend to the company.
                          Robert Penn Warren. A brokerage firm specializing in the stock of electronics firms that are sold over-
                          the-counter, Robert Penn Warren must decide if it will include Millay in a new fund being established
                          for sale to Robert Penn Warren’s clients.
                          Working Capital Management Committee. This is a committee of Millay’s management personnel chaired
                          by the chief operating officer. The committee is charged with the responsibility of periodically reviewing
                          the company’s working capital position, comparing actual data against budgets, and recommending
                          changes in strategy as needed.

                          (a) Describe the analytical use of each of the six ratios presented above.
                          (b) For each of the four entities described above, identify two financial ratios, from those ratios pre-
                              sented in Illustration 24A-1 (on page 1307), that would be most valuable as a basis for its deci-
                              sion regarding Millay.
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                                                                                                                            Problems    •   1317

                           (c)     Discuss what the financial ratios presented in the question reveal about Millay. Support your
                                   answer by citing specific ratio levels and trends as well as the interrelationships between these
                                                                                                                     (CMA adapted)

                      P24-1 (Subsequent Events) Your firm has been engaged to examine the financial statements of Sa-
                      brina Corporation for the year 2005. The bookkeeper who maintains the financial records has prepared
                      all the unaudited financial statements for the corporation since its organization on January 2, 1999. The
                      client provides you with the information below.

                                                                      SABRINA CORPORATION
                                                                          BALANCE SHEET
                                                                      AS OF DECEMBER 31, 2005
                                                  Assets                                                     Liabilities
                           Current assets                          $1,881,100        Current liabilities                   $ 962,400
                           Other assets                             5,171,400        Long-term liabilities                  1,439,500
                                                                                     Capital                                4,650,600
                                                                   $7,052,500                                              $7,052,500

                           An analysis of current assets discloses the following.
                                Cash (restricted in the amount of $400,000 for plant expansion)                            $ 571,000
                                Investments in land                                                                          185,000
                                Accounts receivable less allowance of $30,000                                                480,000
                                Inventories (LIFO flow assumption)                                                           645,100

                           Other assets include:
                                Prepaid expenses                                                                           $ 47,400
                                Plant and equipment less accumulated depreciation of $1,430,000                             4,130,000
                                Cash surrender value of life insurance policy                                                  84,000
                                Unamortized bond discount                                                                      49,500
                                Notes receivable (short-term)                                                                 162,300
                                Goodwill                                                                                      252,000
                                Land                                                                                          446,200

                           Current liabilities include:
                                Accounts payable                                                                           $ 510,000
                                Notes payable (due 2007)                                                                     157,400
                                Estimated income taxes payable                                                               145,000
                                Premium on common stock                                                                      150,000
                                                                                                                           $ 962,400

                           Long-term liabilities include:
                                Unearned revenue                                                                           $ 489,500
                                Dividends payable (cash)                                                                     200,000
                                8% bonds payable (due May 1, 2010)                                                           750,000

                           Capital includes:
                                Retained earnings                                                                          $2,810,600
                                Capital stock, par value $10; authorized 200,000 shares, 184,000 shares issued              1,840,000

                      The supplementary information below is also provided.
                           1.     On May 1, 2005, the corporation issued at 93.4, $750,000 of bonds to finance plant expansion. The
                                  long-term bond agreement provided for the annual payment of interest every May 1. The existing
                                  plant was pledged as security for the loan. Use straight-line method for discount amortization.
                           2.     The bookkeeper made the following mistakes.
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        1318     •    Chapter 24 Full Disclosure in Financial Reporting

                              (a)  In 2003, the ending inventory was overstated by $183,000. The ending inventories for 2004
                                   and 2005 were correctly computed.
                              (b) In 2005, accrued wages in the amount of $275,000 were omitted from the balance sheet and
                                   these expenses were not charged on the income statement.
                              (c) In 2005, a gain of $175,000 (net of tax) on the sale of certain plant assets was credited directly
                                   to retained earnings.
                         3.   A major competitor has introduced a line of products that will compete directly with Sabrina’s pri-
                              mary line, now being produced in a specially designed new plant. Because of manufacturing in-
                              novations, the competitor’s line will be of comparable quality but priced 50% below Sabrina’s line.
                              The competitor announced its new line on January 14, 2006. Sabrina indicates that the company
                              will meet the lower prices that are high enough to cover variable manufacturing and selling ex-
                              penses, but permit recovery of only a portion of fixed costs.
                         4.   You learned on January 28, 2006, prior to completion of the audit, of heavy damage because of a
                              recent fire to one of Sabrina’s two plants; the loss will not be reimbursed by insurance. The news-
                              papers described the event in detail.

                      Analyze the above information to prepare a corrected balance sheet for Sabrina in accordance with proper
                      accounting and reporting principles. Prepare a description of any notes that might need to be prepared.
                      The books are closed and adjustments to income are to be made through retained earnings.
                      P24-2 (Segmented Reporting) Friendly Corporation is a diversified company that operates in five dif-
                      ferent industries: A, B, C, D, and E. The following information relating to each segment is available for
                                                                A               B              C            D             E
                               Sales                         $40,000        $ 80,000    $580,000        $35,000         $55,000
                               Cost of goods sold             19,000          50,000        270,000      19,000          30,000
                               Operating expenses             10,000          40,000        235,000      12,000          18,000
                                    Total expenses            29,000          90,000        505,000      31,000          48,000
                               Operating profit (loss)       $11,000        $(10,000)   $ 75,000        $ 4,000         $ 7,000
                               Identifiable assets           $35,000        $ 60,000    $500,000        $65,000         $50,000

                      Sales of segments B and C included intersegment sales of $20,000 and $100,000, respectively.

                         (a) Determine which of the segments are reportable based on the:
                             (1) Revenue test.
                             (2) Operating profit (loss) test.
                             (3) Identifiable assets test.
                         (b) Prepare the necessary disclosures required by FASB No. 131.
                     *P24-3 (Ratio Computations and Additional Analysis) Carl Sandburg Corporation was formed 5 years
                      ago through a public subscription of common stock. Robert Frost, who owns 15% of the common stock,
                      was one of the organizers of Sandburg and is its current president. The company has been successful, but
                      it currently is experiencing a shortage of funds. On June 10, Robert Frost approached the Spokane Na-
                      tional Bank, asking for a 24-month extension on two $35,000 notes, which are due on June 30, 2004, and
                      September 30, 2004. Another note of $6,000 is due on December 31, 2005, but he expects no difficulty in
                      paying this note on its due date. Frost explained that Sandburg’s cash flow problems are due primarily
                      to the company’s desire to finance a $300,000 plant expansion over the next 2 fiscal years through inter-
                      nally generated funds.
                          The Commercial Loan Officer of Spokane National Bank requested financial reports for the last 2 fis-
                      cal years. These reports are reproduced below.

                                                               CARL SANDBURG CORPORATION
                                                                STATEMENT OF FINANCIAL POSITION
                                                                          MARCH 31
                                           Assets                                            2004            2003
                                           Cash                                         $      18,200   $      12,500
                                           Notes receivable                                   148,000         132,000
                                           Accounts receivable (net)                          131,800         125,500
                                           Inventories (at cost)                               95,000          50,000
                                           Plant & equipment (net of depreciation)          1,449,000       1,420,500
                                              Total assets                              $1,842,000      $1,740,500
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                                                                                                                                    Problems   •   1319

                                       Liabilities and Owners’ Equity
                                       Accounts payable                                        $      69,000        $      91,000
                                       Notes payable                                                  76,000               61,500
                                       Accrued liabilities                                             9,000                6,000
                                       Common stock (130,000 shares, $10 par)                      1,300,000            1,300,000
                                       Retained earningsa                                            388,000              282,000
                                           Total liabilities and owners’ equity                $1,842,000           $1,740,500
                                        Cash dividends were paid at the rate of $1 per share in fiscal year 2003 and $2 per share
                                       in fiscal year 2004.

                                                             CARL SANDBURG CORPORATION
                                                                      INCOME STATEMENT
                                                            FOR THE FISCAL YEARS ENDED MARCH 31
                                                                                           2004                2003
                                               Sales                                   $3,000,000           $2,700,000
                                               Cost of goods solda                      1,530,000            1,425,000
                                               Gross margin                            $1,470,000           $1,275,000
                                               Operating expenses                         860,000              780,000
                                               Income before income taxes              $ 610,000            $ 495,000
                                               Income taxes (40%)                        244,000              198,000
                                               Net income                              $ 366,000            $ 297,000
                                                Depreciation charges on the plant and equipment of $100,000 and
                                               $102,500 for fiscal years ended March 31, 2003 and 2004, respectively,
                                               are included in cost of goods sold.

                         (a) Compute the following items for Carl Sandburg Corporation.
                             (1) Current ratio for fiscal years 2003 and 2004.
                             (2) Acid-test (quick) ratio for fiscal years 2003 and 2004.
                             (3) Inventory turnover for fiscal year 2004.
                             (4) Return on assets for fiscal years 2003 and 2004. (Assume total assets were $1,688,500 at
                             (5) Percentage change in sales, cost of goods sold, gross margin, and net income after taxes from
                                  fiscal year 2003 to 2004.
                         (b) Identify and explain what other financial reports and/or financial analyses might be helpful to
                             the commercial loan officer of Spokane National Bank in evaluating Robert Frost’s request for a
                             time extension on Sandburg’s notes.
                         (c) Assume that the percentage changes experienced in fiscal year 2004 as compared with fiscal year
                             2003 for sales and cost of goods sold will be repeated in each of the next 2 years. Is Sandburg’s
                             desire to finance the plant expansion from internally generated funds realistic? Discuss.
                         (d) Should Spokane National Bank grant the extension on Sandburg’s notes considering Robert Frost’s
                             statement about financing the plant expansion through internally generated funds? Discuss.
                     *P24-4 (Horizontal and Vertical Analysis) Presented below are comparative balance sheets for the Eola
                      Yevette Company.

                                                                  EOLA YEVETTE COMPANY
                                                                  COMPARATIVE BALANCE SHEET
                                                                  DECEMBER 31, 2004 AND 2003
                                                                                                     December 31
                                                                                              2004                 2003
                                           Cash                                           $ 180,000            $ 275,000
                                           Accounts receivable (net)                         220,000              155,000
                                           Short-term investments                            270,000              150,000
                                           Inventories                                       960,000              980,000
                                           Prepaid expense                                    25,000               25,000
                                           Fixed assets                                    2,685,000            1,950,000
                                           Accumulated depreciation                       (1,000,000)            (750,000)
                                                                                          $3,340,000           $2,785,000
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        1320   •    Chapter 24 Full Disclosure in Financial Reporting

                                        Liabilities and Stockholders’ Equity
                                        Accounts payable                              $      50,000         $      75,000
                                        Accrued expenses                                    170,000               200,000
                                        Bonds payable                                       500,000               190,000
                                        Capital stock                                     2,100,000             1,770,000
                                        Retained earnings                                   520,000               550,000
                                                                                      $3,340,000            $2,785,000

                       (a) Prepare a comparative balance sheet of Yevette Company showing the percent each item is of the
                           total assets or total liabilities and stockholders’ equity.
                       (b) Prepare a comparative balance sheet of Yevette Company showing the dollar change and the per-
                           cent change for each item.
                       (c) Of what value is the additional information provided in part (a)?
                       (d) Of what value is the additional information provided in part (b)?
                   *P24-5 (Dividend Policy Analysis) Dawna Remmers Inc. went public 3 years ago. The board of direc-
                    tors will be meeting shortly after the end of the year to decide on a dividend policy. In the past, growth
                    has been financed primarily through the retention of earnings. A stock or a cash dividend has never been
                    declared. Presented below is a brief financial summary of Dawna Remmers Inc. operations.

                                                                                           ($000 omitted)
                                                             2004              2003              2002             2001       2000
                              Sales                         $20,000       $16,000              $14,000           $6,000      $4,000
                              Net income                      2,900         1,600                  800              900         250
                              Average total assets           22,000        19,000               11,500            4,200       3,000
                              Current assets                  8,000         6,000                3,000            1,200       1,000
                              Working capital                 3,600         3,200                1,200              500         400
                              Common shares:
                                Number of shares
                                  outstanding (000)           2,000            2,000             2,000              20          20
                                Average market price          $9               $6                $4                —           —

                       (a) Suggest factors to be considered by the board of directors in establishing a dividend policy.
                       (b) Compute the rate of return on assets, profit margin on sales, earnings per share, price-earnings
                           ratio, and current ratio for each of the 5 years for Dawna Remmers Inc.
                       (c) Comment on the appropriateness of declaring a cash dividend at this time, using the ratios com-
                           puted in part (b) as a major factor in your analysis.

                                                            CONCEPTUAL CASES
                    C24-1 (General Disclosures, Inventories, Property, Plant, and Equipment) Dan D. Lion Corporation
                    is in the process of preparing its annual financial statements for the fiscal year ended April 30, 2004.
                    Because all of Lion’s shares are traded intrastate, the company does not have to file any reports with the
                    Securities and Exchange Commission. The company manufactures plastic, glass, and paper containers for
                    sale to food and drink manufacturers and distributors.
                        Lion Corporation maintains separate control accounts for its raw materials, work-in-process, and fin-
                    ished goods inventories for each of the three types of containers. The inventories are valued at the lower
                    of cost or market.
                        The company’s property, plant, and equipment are classified in the following major categories: land,
                    office buildings, furniture and fixtures, manufacturing facilities, manufacturing equipment, and leasehold
                    improvements. All fixed assets are carried at cost. The depreciation methods employed depend upon the
                    type of asset (its classification) and when it was acquired.
                        Lion Corporation plans to present the inventory and fixed asset amounts in its April 30, 2004, balance
                    sheet as shown below.
                                           Inventories                                                          $4,814,200
                                           Property, plant, and equipment (net of depreciation)                  6,310,000
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                                                                                                              Conceptual Cases         •   1321

                      What information regarding inventories and property, plant, and equipment must be disclosed by Dan
                      D. Lion Corporation in the audited financial statements issued to stockholders, either in the body or the
                      notes, for the 2003–2004 fiscal year?
                                                                                                                (CMA adapted)

                      C24-2 (Disclosures Required in Various Situations) Rem Inc. produces electronic components for sale
                      to manufacturers of radios, television sets, and digital sound systems. In connection with her examina-
                      tion of Rem’s financial statements for the year ended December 31, 2004, Maggie Zeen, CPA, completed
                      field work 2 weeks ago. Ms. Zeen now is evaluating the significance of the following items prior to prepar-
                      ing her auditor’s report. Except as noted, none of these items have been disclosed in the financial state-
                      ments or notes.
                      Item 1
                      A 10-year loan agreement, which the company entered into 3 years ago, provides that dividend payments
                      may not exceed net income earned after taxes subsequent to the date of the agreement. The balance of re-
                      tained earnings at the date of the loan agreement was $420,000. From that date through December 31,
                      2004, net income after taxes has totaled $570,000 and cash dividends have totaled $320,000. On the basis
                      of these data, the staff auditor assigned to this review concluded that there was no retained earnings re-
                      striction at December 31, 2004.
                      Item 2
                      Recently Rem interrupted its policy of paying cash dividends quarterly to its stockholders. Dividends
                      were paid regularly through 2003, discontinued for all of 2004 to finance purchase of equipment for the
                      company’s new plant, and resumed in the first quarter of 2005. In the annual report dividend policy is
                      to be discussed in the president’s letter to stockholders.
                      Item 3
                      A major electronics firm has introduced a line of products that will compete directly with Rem’s primary
                      line, now being produced in the specially designed new plant. Because of manufacturing innovations, the
                      competitor’s line will be of comparable quality but priced 50% below Rem’s line. The competitor an-
                      nounced its new line during the week following completion of field work. Ms. Zeen read the announce-
                      ment in the newspaper and discussed the situation by telephone with Rem executives. Rem will meet the
                      lower prices that are high enough to cover variable manufacturing and selling expenses but will permit
                      recovery of only a portion of fixed costs.
                      Item 4
                      The company’s new manufacturing plant building, which cost $2,400,000 and has an estimated life of
                      25 years, is leased from Ancient National Bank at an annual rental of $600,000. The company is obligated
                      to pay property taxes, insurance, and maintenance. At the conclusion of its 10-year noncancellable lease,
                      the company has the option of purchasing the property for $1. In Rem’s income statement the rental pay-
                      ment is reported on a separate line.

                      For each of the items above discuss any additional disclosures in the financial statements and notes that
                      the auditor should recommend to her client. (The cumulative effect of the four items should not be con-

                      C24-3 (Disclosures Required in Various Situations) You have completed your audit of Keesha Inc.
                      and its consolidated subsidiaries for the year ended December 31, 2004, and were satisfied with the re-
                      sults of your examination. You have examined the financial statements of Keesha for the past 3 years. The
                      corporation is now preparing its annual report to stockholders. The report will include the consolidated
                      financial statements of Keesha and its subsidiaries and your short-form auditor’s report. During your au-
                      dit the following matters came to your attention.
                           1.   A vice president who is also a stockholder resigned on December 31, 2004, after an argument with
                                the president. The vice president is soliciting proxies from stockholders and expects to obtain suf-
                                ficient proxies to gain control of the board of directors so that a new president will be appointed.
                                The president plans to have a note prepared that would include information of the pending proxy
                                fight, management’s accomplishments over the years, and an appeal by management for the sup-
                                port of stockholders.
                           2.   The corporation decides in 2004 to adopt the straight-line method of depreciation for plant equip-
                                ment. The straight-line method will be used for new acquisitions as well as for previously acquired
                                plant equipment for which depreciation had been provided on an accelerated basis.
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        1322     •   Chapter 24 Full Disclosure in Financial Reporting

                        3.   The Internal Revenue Service is currently examining the corporation’s 2001 federal income tax re-
                             turn and is questioning the amount of a deduction claimed by the corporation’s domestic subsidiary
                             for a loss sustained in 2001. The examination is still in process, and any additional tax liability is
                             indeterminable at this time. The corporation’s tax counsel believes that there will be no substan-
                             tial additional tax liability.

                        (a) Prepare the notes, if any, that you would suggest for the items listed above.
                        (b) State your reasons for not making disclosure by note for each of the listed items for which you
                            did not prepare a note.
                                                                                                           (AICPA adapted)

                     C24-4 (Disclosures, Conditional and Contingent Liabilities) Presented below are three independent
                     Situation 1
                     A company offers a one-year warranty for the product that it manufactures. A history of warranty claims
                     has been compiled, and the probable amounts of claims related to sales for a given period can be deter-
                     Situation 2
                     Subsequent to the date of a set of financial statements, but prior to the issuance of the financial state-
                     ments, a company enters into a contract that will probably result in a significant loss to the company. The
                     amount of the loss can be reasonably estimated.
                     Situation 3
                     A company has adopted a policy of recording self-insurance for any possible losses resulting from injury
                     to others by the company’s vehicles. The premium for an insurance policy for the same risk from an in-
                     dependent insurance company would have an annual cost of $4,000. During the period covered by the
                     financial statements, there were no accidents involving the company’s vehicles that resulted in injury to

                     Discuss the accrual or type of disclosure necessary (if any) and the reason(s) why such disclosure is ap-
                     propriate for each of the three independent sets of facts above.
                                                                                                            (AICPA adapted)

                     C24-5 (Post-Balance Sheet Events) At December 31, 2004, Joni Brandt Corp. has assets of $10,000,000,
                     liabilities of $6,000,000, common stock of $2,000,000 (representing 2,000,000 shares of $1 par common
                     stock), and retained earnings of $2,000,000. Net sales for the year 2004 were $18,000,000, and net income
                     was $800,000. As auditors of this company, you are making a review of subsequent events on February
                     13, 2005, and you find the following.
                        1.   On February 3, 2005, one of Brandt’s customers declared bankruptcy. At December 31, 2004, this
                             company owed Brandt $300,000, of which $40,000 was paid in January, 2005.
                        2.   On January 18, 2005, one of the three major plants of the client burned.
                        3.   On January 23, 2005, a strike was called at one of Brandt’s largest plants, which halted 30% of its
                             production. As of today (February 13) the strike has not been settled.
                        4.   A major electronics enterprise has introduced a line of products that would compete directly with
                             Brandt’s primary line, now being produced in a specially designed new plant. Because of manu-
                             facturing innovations, the competitor has been able to achieve quality similar to that of Brandt’s
                             products, but at a price 50% lower. Brandt officials say they will meet the lower prices, which are
                             high enough to cover variable manufacturing and selling costs but which permit recovery of only
                             a portion of fixed costs.
                        5.   Merchandise traded in the open market is recorded in the company’s records at $1.40 per unit
                             on December 31, 2004. This price had prevailed for 2 weeks, after release of an official market
                             report that predicted vastly enlarged supplies; however, no purchases were made at $1.40. The
                             price throughout the preceding year had been about $2, which was the level experienced over
                             several years. On January 18, 2005, the price returned to $2, after public disclosure of an error
                             in the official calculations of the prior December, correction of which destroyed the expecta-
                             tions of excessive supplies. Inventory at December 31, 2004, was on a lower of cost or market
                        6.   On February 1, 2005, the board of directors adopted a resolution accepting the offer of an invest-
                             ment banker to guarantee the marketing of $1,200,000 of preferred stock.
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                                                                                                                             Conceptual Cases              •   1323

                      State in each case how the 2004 financial statements would be affected, if at all.
                      C24-6 (Segment Reporting) You are compiling the consolidated financial statements for Vender Cor-
                      poration International. The corporation’s accountant, Vincent Price, has provided you with the following
                      segment information.

                      Note 7: Major Segments of Business
                      VCI conducts funeral service and cemetery operations in the United States and Canada. Substantially all revenues of
                      VCI’s major segments of business are from unaffiliated customers. Segment information for fiscal 2004, 2003, and
                      2002 follows.

                                    Funeral          Floral        Cemetery         Corporate     Dried Whey             Limousine       Consolidated
                        2004        $302,000        $10,000        $ 83,000         $   —              $7,000            $14,000           $416,000
                        2003         245,000          6,000          61,000             —               4,000              8,000            324,000
                        2002         208,000          3,000          42,000             —               1,000              6,000            260,000
                      Operating Income
                       2004         79,000             1,500          18,000         (36,000)               500             2,000             65,000
                       2003         64,000               200          12,000         (28,000)               200               400             48,800
                       2002         54,000               150           6,000         (21,000)               100               350             39,600
                      Capital Expendituresa
                        2004        26,000             1,000           9,000              400               300             1,000             37,700
                        2003        28,000             2,000          60,000            1,500               100               700             92,300
                        2002        14,000                25           8,000              600                25                50             22,700
                      Depreciation and Amortization
                        2004        13,000          100                2,400            1,400               100               200             17,200
                        2003        10,000           50                1,400              700                50               100             12,300
                        2002         8,000           25                1,000              600                25                50              9,700
                      Identifiable Assets
                        2004         334,000           1,500        162,000         114,000                  500            8,000           620,000
                        2003         322,000           1,000        144,000          52,000                1,000            6,000           526,000
                        2002         223,000             500         78,000          34,000                  500            3,500           339,500
                       Includes $4,520,000, $111,480,000, and $1,294,000 for the years ended April 30, 2004, 2003, and 2002, respectively, for purchases
                      of businesses.

                      Determine which of the above segments must be reported separately and which can be combined under
                      the category “Other.” Then, write a one-page memo to the company’s accountant, Vincent Price, explaining
                      the following.
                           (a) What segments must be reported separately and what segments can be combined.
                           (b) What criteria you used to determine reportable segments.
                           (c) What major items for each must be disclosed.
                      C24-7 (Segment Reporting—Theory)                   Presented below is an excerpt from the financial statements of
                      H. J. Heinz Company.

                                                                    Segment and Geographic Data
                          The company is engaged principally in one line of business—processed food products—which represents over
                      90% of consolidated sales. Information about the business of the company by geographic area is presented in the
                      table below.
                          There were no material amounts of sales or transfers between geographic areas or between affiliates, and no
                      material amounts of United States export sales.
                      (in thousands of                             United                       Western
                      U.S. dollars)                Domestic       Kingdom        Canada         Europe         Other          Total         Worldwide
                      Sales                      $2,381,054       $547,527      $216,726        $383,784      $209,354     $1,357,391      $3,738,445
                      Operating income              246,780         61,282        34,146          29,146        25,111        149,685         396,465
                      Identifiable assets         1,362,152        265,218       112,620         294,732       143,971        816,541       2,178,693
                      Capital expenditures           72,712         12,262        13,790           8,253         4,368         38,673         111,385
                      Depreciation expense           42,279          8,364         3,592           6,355         3,606         21,917          64,196
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        1324   •   Chapter 24 Full Disclosure in Financial Reporting

                      (a) Why does H. J. Heinz not prepare segment information on its products or services?
                      (b) What are export sales, and when should they be disclosed?
                      (c) Why are sales by geographical area important to disclose?

                   C24-8 (Segment Reporting—Theory)           The following article appeared in the Wall Street Journal.
                      WASHINGTON—The Securities and Exchange Commission staff issued guidelines for companies grap-
                      pling with the problem of dividing up their business into industry segments for their annual reports.
                          An industry segment is defined by the Financial Accounting Standards Board as a part of an en-
                      terprise engaged in providing a product or service or a group of related products or services prima-
                      rily to unaffiliated customers for a profit.
                          Although conceding that the process is a “subjective task” that “to a considerable extent, depends on
                      the judgment of management,” the SEC staff said companies should consider . . . various factors . . . to
                      determine whether products and services should be grouped together or reported as segments.

                      (a) What does financial reporting for segments of a business enterprise involve?
                      (b) Identify the reasons for requiring financial data to be reported by segments.
                      (c) Identify the possible disadvantages of requiring financial data to be reported by segments.
                      (d) Identify the accounting difficulties inherent in segment reporting.

                   C24-9 (Interim Reporting) J. J. Kersee Corporation, a publicly traded company, is preparing the in-
                   terim financial data which it will issue to its stockholders and the Securities and Exchange Commission
                   (SEC) at the end of the first quarter of the 2003–2004 fiscal year. Kersee’s financial accounting department
                   has compiled the following summarized revenue and expense data for the first quarter of the year.
                                                    Sales                         $60,000,000
                                                    Cost of goods sold             36,000,000
                                                    Variable selling expenses       2,000,000
                                                    Fixed selling expenses          3,000,000
                   Included in the fixed selling expenses was the single lump sum payment of $2,000,000 for television ad-
                   vertisements for the entire year.

                      (a) J. J. Kersee Corporation must issue its quarterly financial statements in accordance with generally
                          accepted accounting principles regarding interim financial reporting.
                          (1) Explain whether Kersee should report its operating results for the quarter as if the quarter
                                 were a separate reporting period in and of itself or as if the quarter were an integral part of
                                 the annual reporting period.
                          (2) State how the sales, cost of goods sold, and fixed selling expenses would be reflected in
                                 Kersee Corporation’s quarterly report prepared for the first quarter of the 2003–2004 fiscal
                                 year. Briefly justify your presentation.
                      (b) What financial information, as a minimum, must Kersee Corporation disclose to its stockholders
                          in its quarterly reports?
                                                                                                               (CMA adapted)

                   C24-10 (Treatment of Various Interim Reporting Situations) The following statement is an excerpt
                   from Paragraphs 9 and 10 of Accounting Principles Board (APB) Opinion No. 28, “Interim Financial Re-
                      Interim financial information is essential to provide investors and others with timely information as
                      to the progress of the enterprise. The usefulness of such information rests on the relationship that it
                      has to the annual results of operations. Accordingly, the Board has concluded that each interim period
                      should be viewed primarily as an integral part of an annual period.
                         In general, the results for each interim period should be based on the accounting principles and
                      practices used by an enterprise in the preparation of its latest annual financial statements unless a
                      change in an accounting practice or policy has been adopted in the current year. The Board has con-
                      cluded, however, that certain accounting principles and practices followed for annual reporting pur-
                      poses may require modification at interim reporting dates so that the reported results for the interim
                      period may better relate to the results of operations for the annual period.
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                                                                                                             Conceptual Cases         •   1325

                      Listed below are six independent cases on how accounting facts might be reported on an individual com-
                      pany’s interim financial reports. For each of these cases, state whether the method proposed to be used
                      for interim reporting would be acceptable under generally accepted accounting principles applicable to
                      interim financial data. Support each answer with a brief explanation.
                           (a) B. J. King Company takes a physical inventory at year-end for annual financial statement pur-
                               poses. Inventory and cost of sales reported in the interim quarterly statements are based on esti-
                               mated gross profit rates, because a physical inventory would result in a cessation of operations.
                               King Company does have reliable perpetual inventory records.
                           (b) Florence Chadwick Company is planning to report one-fourth of its pension expense each quarter.
                           (c) N. Lopez Company wrote inventory down to reflect lower of cost or market in the first quar-
                               ter. At year-end the market exceeds the original acquisition cost of this inventory. Conse-
                               quently, management plans to write the inventory back up to its original cost as a year-end
                           (d) K. Witt Company realized a large gain on the sale of investments at the beginning of the second
                               quarter. The company wants to report one-third of the gain in each of the remaining quarters.
                           (e) Alice Marble Company has estimated its annual audit fee. They plan to prorate this expense
                               equally over all four quarters.
                           (f) Lori McNeil Company was reasonably certain it would have an employee strike in the third quar-
                               ter. As a result, it shipped heavily during the second quarter but plans to defer the recognition of
                               the sales in excess of the normal sales volume. The deferred sales will be recognized as sales in
                               the third quarter when the strike is in progress. McNeil Company management thinks this is more
                               nearly representative of normal second- and third-quarter operations.
                      C24-11 (Financial Forecasts) An article in Barron’s noted the following.
                           Okay. Last fall, someone with a long memory and an even longer arm reached into that bureau
                           drawer and came out with a moldy cheese sandwich and the equally moldy notion of corporate fore-
                           casts. We tried to find out what happened to the cheese sandwich—but, rats!, even recourse to the
                           Freedom of Information Act didn’t help. However, the forecast proposal was dusted off, polished
                           up and found quite serviceable. The SEC, indeed, lost no time in running it up the old flagpole—
                           but no one was very eager to salute. Even after some of the more objectionable features—compul-
                           sory corrections and detailed explanations of why the estimates went awry—were peeled off the
                           original proposal.
                              Seemingly, despite the Commission’s smiles and sweet talk, those craven corporations were still
                           afraid that an honest mistake would lead them down the primrose path to consent decrees and class
                           action suits. To lay to rest such qualms, the Commission last week approved a “Safe Harbor” rule
                           that, providing the forecasts were made on a reasonable basis and in good faith, protected corpo-
                           rations from litigation should the projections prove wide of the mark (as only about 99% are apt
                           to do).

                         (a) What are the arguments for preparing profit forecasts?
                         (b) What is the purpose of the “safe harbor” rule?
                         (c) Why are corporations concerned about presenting profit forecasts?
                      C24-12 (Disclosure of Estimates—Ethics) Patty Gamble, the financial vice-president, and Victoria
                      Maher, the controller, of Castle Manufacturing Company are reviewing the financial ratios of the com-
                      pany for the years 2003 and 2004. The financial vice president notes that the profit margin on sales ratio
                      has increased from 6% to 12%, a hefty gain for the 2-year period. Gamble is in the process of issuing a
                      media release that emphasizes the efficiency of Castle Manufacturing in controlling cost. Victoria Maher
                      knows that the difference in ratios is due primarily to an earlier company decision to reduce the estimates
                      of warranty and bad debt expense for 2004. The controller, not sure of her supervisor’s motives, hesitates
                      to suggest to Gamble that the company’s improvement is unrelated to efficiency in controlling cost. To
                      complicate matters, the media release is scheduled in a few days.

                         (a) What, if any, is the ethical dilemma in this situation?
                         (b) Should Maher, the controller, remain silent? Give reasons.
                         (c) What stakeholders might be affected by Gamble’s media release?
                         (d) Give your opinion on the following statement and cite reasons: “Because Gamble, the vice pres-
                             ident, is most directly responsible for the media release, Maher has no real responsibility in this
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        1326     •    Chapter 24 Full Disclosure in Financial Reporting

                      C24-13 (Reporting of Subsequent Event—Ethics) In June 2004, the board of directors for Holtzman
                      Enterprises Inc. authorized the sale of $10,000,000 of corporate bonds. Michelle Collins, treasurer for Holtz-
                      man Enterprises Inc., is concerned about the date when the bonds are issued. The company really needs
                      the cash, but she is worried that if the bonds are issued before the company’s year-end (December 31,
                      2004) the additional liability will have an adverse effect on a number of important ratios. In July, she
                      explains to company president Kenneth Holtzman that if they delay issuing the bonds until after
                      December 31 the bonds will not affect the ratios until December 31, 2005. They will have to report the
                      issuance as a subsequent event which requires only footnote disclosure. Collins expects that with expected
                      improved financial performance in 2005 ratios should be better.

                         (a) What are the ethical issues involved?
                         (b) Should Holtzman agree to the delay?

                     *C24-14 (Effect of Transactions on Financial Statements and Ratios) The transactions listed below re-
                      late to Botticelli Inc. You are to assume that on the date on which each of the transactions occurred the
                      corporation’s accounts showed only common stock ($100 par) outstanding, a current ratio of 2.7:1, and a
                      substantial net income for the year to date (before giving effect to the transaction concerned). On that date
                      the book value per share of stock was $151.53.
                         Each numbered transaction is to be considered completely independent of the others, and its related
                      answer should be based on the effect(s) of that transaction alone. Assume that all numbered transactions
                      occurred during 2004 and that the amount involved in each case is sufficiently material to distort reported
                      net income if improperly included in the determination of net income. Assume further that each trans-
                      action was recorded in accordance with generally accepted accounting principles and, where applicable,
                      in conformity with the all-inclusive concept of the income statement.
                         For each of the numbered transactions you are to decide whether it:
                         a.   Increased the corporation’s 2004 net income.
                         b.   Decreased the corporation’s 2004 net income.
                         c.   Increased the corporation’s total retained earnings directly (i.e., not via net income).
                         d.   Decreased the corporation’s total retained earnings directly.
                         e.   Increased the corporation’s current ratio.
                         f.   Decreased the corporation’s current ratio.
                         g.   Increased each stockholder’s proportionate share of total owner’s equity.
                         h.   Decreased each stockholder’s proportionate share of total owner’s equity.
                         i.   Increased each stockholder’s equity per share of stock (book value).
                         j.   Decreased each stockholder’s equity per share of stock (book value).
                         k.   Had none of the foregoing effects.

                      List the numbers 1 through 10. Select as many letters as you deem appropriate to reflect the effect(s) of
                      each transaction as of the date of the transaction by printing beside the transaction number the letter(s)
                      that identifies that transaction’s effect(s).

                         ____ 1.   Treasury stock originally repurchased and carried at $127 per share was sold for cash at $153
                                   per share.
                         ____ 2.   The corporation sold at a profit land and a building that had been idle for some time. Under
                                   the terms of the sale, the corporation received a portion of the sales price in cash immedi-
                                   ately, the balance maturing at 6 month intervals.
                         ____ 3.   In January the board directed the writeoff of certain patent rights that had suddenly and un-
                                   expectedly become worthless.
                         ____ 4.   The corporation wrote off all of the unamortized discount and issue expense applicable to
                                   bonds that it refinanced in 2004.
                         ____ 5.   The board of directors authorized the writeup of certain fixed assets to values established in
                                   a competent appraisal.
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                                                                                                            Using Your Judgment           •   1327

                           ____ 6.    The corporation called in all its outstanding shares of stock and exchanged them for new
                                      shares on a 2-for-1 basis, reducing the par value at the same time to $50 per share.
                           ____ 7.    The corporation paid a cash dividend that had been recorded in the accounts at time of dec-
                           ____ 8.    Litigation involving Botticelli Inc. as defendant was settled in the corporation’s favor, with
                                      the plaintiff paying all court costs and legal fees. In 2001 the corporation had appropriately
                                      established a special contingency for this court action. (Indicate the effect of reversing the
                                      contingency only.)
                           ____ 9.    The corporation received a check for the proceeds of an insurance policy from the company
                                      with which it is insured against theft of trucks. No entries concerning the theft had been made
                                      previously, and the proceeds reduce but do not cover completely the loss.
                           ____ 10.   Treasury stock, which had been repurchased at and carried at $127 per share, was issued as
                                      a stock dividend. In connection with this distribution, the board of directors of Botticelli Inc.
                                      had authorized a transfer from retained earnings to permanent capital of an amount equal
                                      to the aggregate market value ($153 per share) of the shares issued. No entries relating to this
                                      dividend had been made previously.
                                                                                                                     (AICPA adapted)

                      3M Company
                      In response to the investing public’s demand for greater disclosure of corporate expectations for the
                      future, safe-harbor rules and legislation have been passed to encourage and protect corporations that
                      issue financial forecasts and projections. Review 3M’s Analysis of Financial Condition and Results of
                      Operations—Future Outlook and Forward-Looking Statements sections in Appendix 5B or on the Take
                      Action! CD.

                      Refer to 3M’s financial statements and the accompanying notes to answer the following questions.
                      (a) What initiatives has 3M launched in 2001 that will help meet its economic challenges?
                      (b) What does 3M estimate its earnings per share will be for 2002?
                      (c) What caveats or other statements that temper its forecasts does 3M make?
                      (d) What is the difference between a financial forecast and a financial projection?

                      Twin Ricky Inc. (TRI) manufactures a variety of consumer products. The company’s founders have run
                      the company for 30 years and are now interested in retiring. Consequently, they are seeking a purchaser
                      who will continue its operations, and a group of investors, Donna Inc., is looking into the acquisition of
                      TRI. To evaluate its financial stability and operating efficiency, TRI was requested to provide the latest fi-
                      nancial statements and selected financial ratios. Summary information provided by TRI is presented on
                      the next page.
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          1328     •   Chapter 24 Full Disclosure in Financial Reporting

                                                                      INCOME STATEMENT
                                                            FOR THE YEAR ENDED NOVEMBER 30, 2004
                                                                        (IN THOUSANDS)
Additional Financial                    Sales (net)                                                  $30,500
Statement Analysis                      Interest income                                                  500
     Problems                                Total revenue                                               31,000
                                        Costs and expenses
                                          Cost of goods sold                                             17,600
                                          Selling and administrative expense                              3,550
                                          Depreciation and amortization expense                           1,890
                                          Interest expense                                                  900
                                             Total costs and expenses                                    23,940
                                          Income before taxes                                             7,060
                                            Income taxes                                                  2,900
                                          Net income                                                 $ 4,160

                                                               STATEMENT OF FINANCIAL POSITION
                                                                     AS OF NOVEMBER 30
                                                                       (IN THOUSANDS)
                                                                                             2004        2003
                                        Cash                                             $     400   $      500
                                        Marketable securities (at cost)                        500          200
                                        Accounts receivable (net)                            3,200        2,900
                                        Inventory                                            5,800        5,400
                                          Total current assets                               9,900        9,000
                                        Property, plant, & equipment (net)                   7,100        7,000
                                          Total assets                                   $17,000     $16,000

                                        Accounts payable                                 $ 3,700     $ 3,400
                                        Income taxes payable                                 900         800
                                        Accrued expenses                                   1,700       1,400
                                          Total current liabilities                          6,300        5,600
                                        Long-term debt                                       2,000        1,800
                                        Total liabilities                                    8,300        7,400
                                        Common stock ($1 par value)                          2,700        2,700
                                        Paid-in capital in excess of par                     1,000        1,000
                                        Retained earnings                                    5,000        4,900
                                          Total shareholders’ equity                         8,700        8,600
                                          Total liabilities and shareholders’ equity     $17,000     $16,000
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                                                                                                       Using Your Judgment        •   1329

                                                                 Selected Financial Ratios
                                                                                   TRI           Industry
                                                                           2003          2002    Average
                                              Current ratio                 1.61          1.62    1.63
                                              Acid-test ratio                .64           .63     .68
                                              Times interest earned         8.55          8.50    8.45
                                              Profit margin on sales       13.2%         12.1%   13.0%
                                              Total debt to net worth        .86          1.02    1.03
                                              Asset turnover                1.84          1.83    1.84
                                              Inventory turnover            3.17          3.21    3.18

                      (a) Calculate a new set of ratios for the fiscal year 2004 for TRI based on the financial statements pre-
                      (b) Explain the analytical use of each of the seven ratios presented, describing what the investors can
                          learn about TRI’s financial stability and operating efficiency.
                      (c) Identify two limitations of ratio analysis.
                                                                                                                (CMA adapted)

                      COMPARATIVE ANALYSIS CASE
                      The Coca-Cola Company versus PepsiCo, Inc.
                      Go to the Take Action! CD and use information found there to answer the following questions related to
                      The Coca-Cola Company and PepsiCo, Inc.
                      (a) (1) What specific items does Coca-Cola discuss in its Note 1—Accounting Policies? (Prepare a list of
                              the headings only.)
                          (2) What specific items does PepsiCo discuss in its Note 1—Summary of Significant Accounting
                              Policies? (Prepare a list of the headings only.)
                          (3) Note the similarities and differences between Coca-Cola’s and PepsiCo’s lists.
                      (b) For what lines of business or segments do Coca-Cola and PepsiCo present segmented information?
                      (c) Note and comment on the similarities and differences between the auditors’ reports submitted by the
                          independent auditors of Coca-Cola and PepsiCo for the year 2001.
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        1330     •   Chapter 24 Full Disclosure in Financial Reporting

                     RESEARCH CASES
                     Case 1
                     Read the article entitled “FASB Is Criticized for Inaction on Off-Balance-Sheet Debt Issue,” by Steve
                     Liesman, Jonathan Weil, and Scott Paltrow in the January 18, 2002, Wall Street Journal. (Subscribers to
                     Business Extra can access the article at that site.)

                     Answer the following questions.
                     (a) Why has the FASB not set better rules for when a firm should be allowed to keep debt off its balance
                     (b) Who is helped (in the short term and the long term) by a firm‘s being able to keep debt off its bal-
                         ance sheet? Who is hurt (short term and long term)?
                     (c) According to the article, when the FASB proposes new rules that would hurt them, “corporate Amer-
                         ica and its allies invoke portents of doom as to why we shouldn‘t have honest accounting treatment”
                         of what’s being proposed. How does this affect the usefulness of financial reporting for investors and
                     (d) Who has Congress favored in the past in similar situations? Why has Congress favored them?
                     (e) One of the groups criticizing the FASB for moving too slowly is the Financial Executives International
                         (FEI), which opposed requiring firms to consolidate the results of all their entities. The FEI also op-
                         posed the FASB’s proposal to require firms to expense executive stock options. Based on this, would
                         you consider FEI “part of the solution” or “part of the problem”? Justify your answer.

                     Case 2
                     Companies registered with the Securities and Exchange Commission are required to file a quarterly re-
                     port on Form 10-Q within 45 days of the end of the first three fiscal quarters.

                     Use EDGAR or some other source to examine the most recent 10-Q for the company of your choice and
                     answer the following questions.
                     (a) What financial information is included in Part I?
                     (b) Read the notes to the financial statements and identify any departures from the “integral approach.”
                     (c) Does the 10-Q include any information under Part II? Describe the nature of the information.
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                                                                                                                                   Using Your Judgment   •   1331

                    *PROFESSIONAL SIMULATION

                                                                          Financial Statement Analysis

                                              Directions      Situation       Analysis       Explanation    Research   Resources


                          In this simulation, you will be asked to evaluate a company’s solvency and going-concern potential. You
                          will be asked to analyze a set of ratios and indicate possible limitations of ratio analysis.
                          Prepare responses to all parts.

                            As the CPA for Packard Clipper, Inc., you have been requested to develop some key ratios from the
                            comparative financial statements. This information is to be used to convince creditors that Packard
                            Clipper, Inc. is solvent and to support the use of going-concern valuation procedures in the financial
                               The data requested and the computations developed from the financial statements follow:

                                                                                                           2004                2003
                                          Current ratio                                                2.6 times             2.1 times
                                          Acid-test ratio                                               .8 times             1.3 times
                                          Property, plant, and equipment to
                                            stockholders’ equity                                       2.5 times             2.2 times
                                          Sales to stockholders’ equity                                2.4 times             2.7 times
                                          Net income                                                   Up 32%                Down 9%
                                          Earnings per share                                           $3.30                 $2.50
                                          Book value per share                                         Up 6%                 Up 9%


                            Packard Clipper asks you to prepare a list of brief comments stating how each of these items
                            supports the solvency and going-concern potential of the business. The company wishes to use
                            these comments to support its presentation of data to its creditors. You are to prepare the comments
                            as requested, giving the implications and the limitations of each item separately, and then the collective
                            inference that may be drawn from them about Packard Clipper’s solvency and going-concern potential.


                              Having done as the client requested in the Analysis section above, prepare a brief listing of additional
                              ratio-analysis-type data for this client which you think its creditors are going to ask for to supplement
                              the analytical data you provided. Explain why you think the additional data will be helpful to these
                              creditors in evaluating the client’s solvency. What warnings should you offer these creditors about
                              the limitations of ratio analysis for the purposes stated here?

                                                                                          /col ge/

                                                                             w.w ey.c



                                                             Remember to check the Take Action! CD
                                                                and the book’s companion Web site
                                                           to find additional resources for this chapter.
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        1332     •   Accounting and the Time Value of Money

                                      The following time value of money tables are also presented at the end of Chapter 6,
                                      “Accounting and the Time Value of Money,” in Volume I (pages 302–311). They are pre-
                                      sented here to facilitate your use of Volume II.

                                      TABLE 6-1 FUTURE VALUE OF 1 (FUTURE VALUE OF A SINGLE SUM)
                                                                         FVFn,i   (1   i)n
                                      Periods       2%          21/2%         3%               4%        5%          6%
                                         1        1.02000      1.02500      1.03000          1.04000   1.05000     1.06000
                                         2        1.04040      1.05063      1.06090          1.08160   1.10250     1.12360
                                         3        1.06121      1.07689      1.09273          1.12486   1.15763     1.19102
                                         4        1.08243      1.10381      1.12551          1.16986   1.21551     1.26248
                                         5        1.10408      1.13141      1.15927          1.21665   1.27628     1.33823

                                         6        1.12616      1.15969      1.19405          1.26532   1.34010     1.41852
                                         7        1.14869      1.18869      1.22987          1.31593   1.40710     1.50363
                                         8        1.17166      1.21840      1.26677          1.36857   1.47746     1.59385
                                         9        1.19509      1.24886      1.30477          1.42331   1.55133     1.68948
                                        10        1.21899      1.28008      1.34392          1.48024   1.62889     1.79085

                                        11        1.24337      1.31209      1.38423          1.53945   1.71034     1.89830
                                        12        1.26824      1.34489      1.42576          1.60103   1.79586     2.01220
                                        13        1.29361      1.37851      1.46853          1.66507   1.88565     2.13293
                                        14        1.31948      1.41297      1.51259          1.73168   1.97993     2.26090
                                        15        1.34587      1.44830      1.55797          1.80094   2.07893     2.39656

                                        16        1.37279      1.48451      1.60471          1.87298   2.18287     2.54035
                                        17        1.40024      1.52162      1.65285          1.94790   2.29202     2.69277
                                        18        1.42825      1.55966      1.70243          2.02582   2.40662     2.85434
                                        19        1.45681      1.59865      1.75351          2.10685   2.52695     3.02560
                                        20        1.48595      1.63862      1.80611          2.19112   2.65330     3.20714

                                        21        1.51567      1.67958      1.86029          2.27877   2.78596     3.39956
                                        22        1.54598      1.72157      1.91610          2.36992   2.92526     3.60354
                                        23        1.57690      1.76461      1.97359          2.46472   3.07152     3.81975
                                        24        1.60844      1.80873      2.03279          2.56330   3.22510     4.04893
                                        25        1.64061      1.85394      2.09378          2.66584   3.38635     4.29187

                                        26        1.67342      1.90029      2.15659          2.77247   3.55567     4.54938
                                        27        1.70689      1.94780      2.22129          2.88337   3.73346     4.82235
                                        28        1.74102      1.99650      2.28793          2.99870   3.92013     5.11169
                                        29        1.77584      2.04641      2.35657          3.11865   4.11614     5.41839
                                        30        1.81136      2.09757      2.42726          3.24340   4.32194     5.74349

                                        31        1.84759      2.15001      2.50008          3.37313   4.53804     6.08810
                                        32        1.88454      2.20376      2.57508          3.50806   4.76494     6.45339
                                        33        1.92223      2.25885      2.65234          3.64838   5.00319     6.84059
                                        34        1.96068      2.31532      2.73191          3.79432   5.25335     7.25103
                                        35        1.99989      2.37321      2.81386          3.94609   5.51602     7.68609

                                        36        2.03989      2.43254      2.89828          4.10393   5.79182     8.14725
                                        37        2.08069      2.49335      2.98523          4.26809   6.08141     8.63609
                                        38        2.12230      2.55568      3.07478          4.43881   6.38548     9.15425
                                        39        2.16474      2.61957      3.16703          4.61637   6.70475     9.70351
                                        40        2.20804      2.68506      3.26204          4.80102   7.03999    10.28572
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                                                                                               Future Value of 1   •   1333

                                                                  TABLE 6-1 FUTURE VALUE OF 1

                 8%          9%           10%          11%         12%        15%       Periods
             1.08000        1.09000      1.10000      1.11000     1.12000     1.15000      1
             1.16640        1.18810      1.21000      1.23210     1.25440     1.32250      2
             1.25971        1.29503      1.33100      1.36763     1.40493     1.52088      3
             1.36049        1.41158      1.46410      1.51807     1.57352     1.74901      4
             1.46933        1.53862      1.61051      1.68506     1.76234     2.01136      5

             1.58687        1.67710      1.77156      1.87041     1.97382     2.31306      6
             1.71382        1.82804      1.94872      2.07616     2.21068     2.66002      7
             1.85093        1.99256      2.14359      2.30454     2.47596     3.05902      8
             1.99900        2.17189      2.35795      2.55803     2.77308     3.51788      9
             2.15892        2.36736      2.59374      2.83942     3.10585     4.04556     10

             2.33164        2.58043      2.85312      3.15176     3.47855     4.65239     11
             2.51817        2.81267      3.13843      3.49845     3.89598     5.35025     12
             2.71962        3.06581      3.45227      3.88328     4.36349     6.15279     13
             2.93719        3.34173      3.79750      4.31044     4.88711     7.07571     14
             3.17217        3.64248      4.17725      4.78459     5.47357     8.13706     15

             3.42594        3.97031      4.59497      5.31089     6.13039     9.35762     16
             3.70002        4.32763      5.05447      5.89509     6.86604    10.76126     17
             3.99602        4.71712      5.55992      6.54355     7.68997    12.37545     18
             4.31570        5.14166      6.11591      7.26334     8.61276    14.23177     19
             4.66096        5.60441      6.72750      8.06231     9.64629    16.36654     20

             5.03383        6.10881      7.40025      8.94917    10.80385    18.82152     21
             5.43654        6.65860      8.14028      9.93357    12.10031    21.64475     22
             5.87146        7.25787      8.95430     11.02627    13.55235    24.89146     23
             6.34118        7.91108      9.84973     12.23916    15.17863    28.62518     24
             6.84847        8.62308     10.83471     13.58546    17.00000    32.91895     25

             7.39635        9.39916     11.91818     15.07986    19.04007    37.85680     26
             7.98806       10.24508     13.10999     16.73865    21.32488    43.53532     27
             8.62711       11.16714     14.42099     18.57990    23.88387    50.06561     28
             9.31727       12.17218     15.86309     20.62369    26.74993    57.57545     29
            10.06266       13.26768     17.44940     22.89230    29.95992    66.21177     30

            10.86767       14.46177     19.19434     25.41045    33.55511    76.14354     31
            11.73708       15.76333     21.11378     28.20560    37.58173    87.56507     32
            12.67605       17.18203     23.22515     31.30821    42.09153   100.69983     33
            13.69013       18.72841     25.54767     34.75212    47.14252   115.80480     34
            14.78534       20.41397     28.10244     38.57485    52.79962   133.17552     35

            15.96817       22.25123     30.91268     42.81808    59.13557   153.15185     36
            17.24563       24.25384     34.00395     47.52807    66.23184   176.12463     37
            18.62528       26.43668     37.40434     52.75616    74.17966   202.54332     38
            20.11530       28.81598     41.14479     58.55934    83.08122   232.92482     39
            21.72452       31.40942     45.25926     65.00087    93.05097   267.86355     40
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        1334     •   Accounting and the Time Value of Money

                                      TABLE 6-2 PRESENT VALUE OF 1 (PRESENT VALUE OF A SINGLE SUM)
                                                                                 1                    n
                                                                   PVFn,i                   (1   i)
                                                                            (1       i )n
                                      Periods      2%          21/2%             3%                   4%       5%       6%
                                         1        .98039       .97561            .97087               .96154   .95238   .94340
                                         2        .96117       .95181            .94260               .92456   .90703   .89000
                                         3        .94232       .92860            .91514               .88900   .86384   .83962
                                         4        .92385       .90595            .88849               .85480   .82270   .79209
                                         5        .90573       .88385            .86261               .82193   .78353   .74726

                                         6        .88797       .86230            .83748               .79031   .74622   .70496
                                         7        .87056       .84127            .81309               .75992   .71068   .66506
                                         8        .85349       .82075            .78941               .73069   .67684   .62741
                                         9        .83676       .80073            .76642               .70259   .64461   .59190
                                        10        .82035       .78120            .74409               .67556   .61391   .55839

                                        11        .80426       .76214            .72242               .64958   .58468   .52679
                                        12        .78849       .74356            .70138               .62460   .55684   .49697
                                        13        .77303       .72542            .68095               .60057   .53032   .46884
                                        14        .75788       .70773            .66112               .57748   .50507   .44230
                                        15        .74301       .69047            .64186               .55526   .48102   .41727

                                        16        .72845       .67362            .62317               .53391   .45811   .39365
                                        17        .71416       .65720            .60502               .51337   .43630   .37136
                                        18        .70016       .64117            .58739               .49363   .41552   .35034
                                        19        .68643       .62553            .57029               .47464   .39573   .33051
                                        20        .67297       .61027            .55368               .45639   .37689   .31180

                                        21        .65978       .59539            .53755               .43883   .35894   .29416
                                        22        .64684       .58086            .52189               .42196   .34185   .22751
                                        23        .63416       .56670            .50669               .40573   .32557   .26180
                                        24        .62172       .55288            .49193               .39012   .31007   .24698
                                        25        .60953       .53939            .47761               .37512   .29530   .23300

                                        26        .59758       .52623            .46369               .36069   .28124   .21981
                                        27        .58586       .51340            .45019               .34682   .26785   .20737
                                        28        .57437       .50088            .43708               .33348   .25509   .19563
                                        29        .56311       .48866            .42435               .32065   .24295   .18456
                                        30        .55207       .47674            .41199               .30832   .23138   .17411

                                        31        .54125       .46511            .39999               .29646   .22036   .16425
                                        32        .53063       .45377            .38834               .28506   .20987   .15496
                                        33        .52023       .44270            .37703               .27409   .19987   .14619
                                        34        .51003       .43191            .36604               .26355   .19035   .13791
                                        35        .50003       .42137            .35538               .25342   .18129   .13011

                                        36        .49022       .41109            .34503               .24367   .17266   .12274
                                        37        .48061       .40107            .33498               .23430   .16444   .11579
                                        38        .47119       .39128            .32523               .22529   .15661   .10924
                                        39        .46195       .38174            .31575               .21662   .14915   .10306
                                        40        .45289       .37243            .30656               .20829   .14205   .09722
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                                                                                          Present Value of 1   •   1335

                                                                            TABLE 6-2 PRESENT VALUE OF 1

                              8%            9%          10%         11%       12%        15%       Periods
                            .92593       .91743       .90909       .90090   .89286     .86957         1
                            .85734       .84168       .82645       .81162   .79719     .75614         2
                            .79383       .77218       .75132       .73119   .71178     .65752         3
                            .73503       .70843       .68301       .65873   .63552     .57175         4
                            .68058       .64993       .62092       .59345   .56743     .49718         5

                            .63017       .59627       .56447       .53464   .50663     .43233         6
                            .58349       .54703       .51316       .48166   .45235     .37594         7
                            .54027       .50187       .46651       .43393   .40388     .32690         8
                            .50025       .46043       .42410       .39092   .36061     .28426         9
                            .46319       .42241       .38554       .35218   .32197     .24719        10

                            .42888       .38753       .35049       .31728   .28748     .21494        11
                            .39711       .35554       .31863       .28584   .25668     .18691        12
                            .36770       .32618       .28966       .25751   .22917     .16253        13
                            .34046       .29925       .26333       .23199   .20462     .14133        14
                            .31524       .27454       .23939       .20900   .18270     .12289        15

                            .29189       .25187       .21763       .18829   .16312     .10687        16
                            .27027       .23107       .19785       .16963   .14564     .09293        17
                            .25025       .21199       .17986       .15282   .13004     .08081        18
                            .23171       .19449       .16351       .13768   .11611     .07027        19
                            .21455       .17843       .14864       .12403   .10367     .06110        20

                            .19866       .16370       .13513       .11174   .09256     .05313        21
                            .18394       .15018       .12285       .10067   .08264     .04620        22
                            .17032       .13778       .11168       .09069   .07379     .04017        23
                            .15770       .12641       .10153       .08170   .06588     .03493        24
                            .14602       .11597       .09230       .07361   .05882     .03038        25

                            .13520       .10639       .08391       .06631   .05252     .02642        26
                            .12519       .09761       .07628       .05974   .04689     .02297        27
                            .11591       .08955       .06934       .05382   .04187     .01997        28
                            .10733       .08216       .06304       .04849   .03738     .01737        29
                            .09938       .07537       .05731       .04368   .03338     .01510        30

                            .09202       .06915       .05210       .03935   .02980     .01313        31
                            .08520       .06344       .04736       .03545   .02661     .01142        32
                            .07889       .05820       .04306       .03194   .02376     .00993        33
                            .07305       .05340       .03914       .02878   .02121     .00864        34
                            .06763       .04899       .03558       .02592   .01894     .00751        35

                            .06262       .04494       .03235       .02335   .01691     .00653        36
                            .05799       .04123       .02941       .02104   .01510     .00568        37
                            .05369       .03783       .02674       .01896   .01348     .00494        38
                            .04971       .03470       .02430       .01708   .01204     .00429        39
                            .04603       .03184       .02210       .01538   .01075     .00373        40
8658d_ch24.qxd   1/17/03   12:53 PM   Page 1336 mac18 mac18:df_169:8658D:

        1336     •   Accounting and the Time Value of Money

                                      TABLE 6-3 FUTURE VALUE OF AN ORDINARY ANNUITY OF 1
                                                                                    (1   i )n    1
                                      Periods      2%          21/2%               3%                4%        5%         6%
                                         1       1.00000     1.00000         1.00000             1.00000     1.00000     1.00000
                                         2       2.02000     2.02500         2.03000             2.04000     2.05000     2.06000
                                         3       3.06040     3.07563         3.09090             3.12160     3.15250     3.18360
                                         4       4.12161     4.15252         4.18363             4.24646     4.31013     4.37462
                                         5       5.20404     5.25633         5.30914             5.41632     5.52563     5.63709

                                         6       6.30812     6.38774         6.46841             6.63298     6.80191     6.97532
                                         7       7.43428     7.54743         7.66246             7.89829     8.14201     8.39384
                                         8       8.58297     8.73612         8.89234             9.21423     9.54911     9.89747
                                         9       9.75463     9.95452        10.15911            10.58280    11.02656    11.49132
                                        10      10.94972    11.20338        11.46338            12.00611    12.57789    13.18079

                                        11      12.16872    12.48347        12.80780            13.48635    14.20679    14.97164
                                        12      13.41209    13.79555        14.19203            15.02581    15.91713    16.86994
                                        13      14.68033    15.14044        15.61779            16.62684    17.71298    18.88214
                                        14      15.97394    16.51895        17.08632            18.29191    19.59863    21.01507
                                        15      17.29342    17.93193        18.59891            20.02359    21.57856    23.27597

                                        16      18.63929    19.38022        20.15688            21.82453    23.65749    25.67253
                                        17      20.01207    20.86473        21.76159            23.69751    25.84037    28.21288
                                        18      21.41231    22.38635        23.41444            25.64541    28.13238    30.90565
                                        19      22.84056    23.94601        25.11687            27.67123    30.53900    33.75999
                                        20      24.29737    25.54466        26.87037            29.77808    33.06595    36.78559

                                        21      25.78332    27.18327        28.67649            31.96920    35.71925    39.99273
                                        22      27.29898    28.86286        30.53678            34.24797    38.50521    43.39229
                                        23      28.84496    30.58443        32.45288            36.61789    41.43048    46.99583
                                        24      30.42186    32.34904        34.42647            39.08260    44.50200    50.81558
                                        25      32.03030    34.15776        36.45926            41.64591    47.72710    54.86451

                                        26      33.67091    36.01171        38.55304            44.31174    51.11345    59.15638
                                        27      35.34432    37.91200        40.70963            47.08421    54.66913    63.70577
                                        28      37.05121    39.85980        42.93092            49.96758    58.40258    68.52811
                                        29      38.79223    41.85630        45.21885            52.96629    62.32271    73.63980
                                        30      40.56808    43.90270        47.57542            56.08494    66.43885    79.05819

                                        31      42.37944    46.00027        50.00268            59.32834    70.76079    84.80168
                                        32      44.22703    48.15028        52.50276            62.70147    75.29883    90.88978
                                        33      46.11157    50.35403        55.07784            66.20953    80.06377    97.34316
                                        34      48.03380    52.61289        57.73018            69.85791    85.06696   104.18376
                                        35      49.99448    54.92821        60.46208            73.65222    90.32031   111.43478

                                        36      51.99437    57.30141        63.27594            77.59831    95.83632   119.12087
                                        37      54.03425    59.73395        66.17422            81.70225   101.62814   127.26812
                                        38      56.11494    62.22730        69.15945            85.97034   107.70955   135.90421
                                        39      58.23724    64.78298        72.23423            90.40915   114.09502   145.05846
                                        40      60.40198    67.40255        75.40126            95.02552   120.79977   154.76197
8658d_ch24.qxd    1/17/03   12:53 PM    Page 1337 mac18 mac18:df_169:8658D:

                                                                            Future Value of an Ordinary Annuity of 1   •   1337

                                        TABLE 6-3 FUTURE VALUE OF AN ORDINARY ANNUITY OF 1

                 8%           9%             10%         11%          12%           15%        Periods
                 1.00000      1.00000        1.00000     1.00000      1.00000        1.00000      1
                 2.08000      2.09000        2.10000     2.11000      2.12000        2.15000      2
                 3.24640      3.27810        3.31000     3.34210      3.37440        3.47250      3
                 4.50611      4.57313        4.64100     4.70973      4.77933        4.99338      4
                 5.86660      5.98471        6.10510     6.22780      6.35285        6.74238      5

              7.33592         7.52334        7.71561     7.91286      8.11519        8.75374      6
              8.92280         9.20044        9.48717     9.78327     10.08901       11.06680      7
             10.63663        11.02847       11.43589    11.85943     12.29969       13.72682      8
             12.48756        13.02104       13.57948    14.16397     14.77566       16.78584      9
             14.48656        15.19293       15.93743    16.72201     17.54874       20.30372     10

             16.64549        17.56029       18.53117    19.56143     20.65458       24.34928     11
             18.97713        20.14072       21.38428    22.71319     24.13313       29.00167     12
             21.49530        22.95339       24.52271    26.21164     28.02911       34.35192     13
             24.21492        26.01919       27.97498    30.09492     32.39260       40.50471     14
             27.15211        29.36092       31.77248    34.40536     37.27972       47.58041     15

             30.32428        33.00340       35.94973    39.18995     42.75328       55.71747     16
             33.75023        36.97371       40.54470    44.50084     48.88367       65.07509     17
             37.45024        41.30134       45.59917    50.39593     55.74972       75.83636     18
             41.44626        46.01846       51.15909    56.93949     63.43968       88.21181     19
             45.76196        51.16012       57.27500    64.20283     72.05244      102.44358     20

             50.42292        56.76453       64.00250    72.26514     81.69874      118.81012     21
             55.45676        62.87334       71.40275    81.21431     92.50258      137.63164     22
             60.89330        69.53194       79.54302    91.14788    104.60289      159.27638     23
             66.76476        76.78981       88.49733   102.17415    118.15524      184.16784     24
             73.10594        84.70090       98.34706   114.41331    133.33387      212.79302     25

             79.95442        93.32398      109.18177   127.99877    150.33393      245.71197     26
             87.35077       102.72314      121.09994   143.07864    169.37401      283.56877     27
             95.33883       112.96822      134.20994   159.81729    190.69889      327.10408     28
            103.96594       124.13536      148.63093   178.39719    214.58275      377.16969     29
            113.28321       136.30754      164.49402   199.02088    241.33268      434.74515     30

            123.34587       149.57522      181.94343   221.91317    271.29261      500.95692     31
            134.21354       164.03699      201.13777   247.32362    304.84772      577.10046     32
            145.95062       179.80032      222.25154   275.52922    342.42945      644.66553     33
            158.62667       196.98234      245.47670   306.83744    384.52098      765.36535     34
            172.31680       215.71076      271.02437   341.58955    431.66350      881.17016     35

            187.10215       236.12472      299.12681   380.16441    484.46312     1014.34568     36
            203.07032       258.37595      330.03949   422.98249    543.59869     1167.49753     37
            220.31595       282.62978      364.04343   470.51056    609.83053     1343.62216     38
            238.94122       309.06646      401.44778   523.26673    684.01020     1546.16549     39
            259.05652       337.88245      442.59256   581.82607    767.09142     1779.09031     40
8658d_ch24.qxd   1/17/03   12:53 PM   Page 1338 mac18 mac18:df_169:8658D:

        1338     •   Accounting and the Time Value of Money

                                      TABLE 6-4 PRESENT VALUE OF AN ORDINARY ANNUITY OF 1
                                                                                         (1       i )n
                                      Periods      2%          21/2%               3%                    4%      5%         6%
                                         1        .98039       .97561           .97087                .96154     .95238     .94340
                                         2       1.94156      1.92742          1.91347               1.88609    1.85941    1.83339
                                         3       2.88388      2.85602          2.82861               2.77509    2.72325    2.67301
                                         4       3.80773      3.76197          3.71710               3.62990    3.54595    3.46511
                                         5       4.71346      4.64583          4.57971               4.45182    4.32948    4.21236

                                         6       5.60143      5.50813          5.41719               5.24214    5.07569    4.91732
                                         7       6.47199      6.34939          6.23028               6.00205    5.78637    5.58238
                                         8       7.32548      7.17014          7.01969               6.73274    6.46321    6.20979
                                         9       8.16224      7.97087          7.78611               7.43533    7.10782    6.80169
                                        10       8.98259      8.75206          8.53020               8.11090    7.72173    7.36009

                                        11       9.78685      9.51421          9.25262               8.76048    8.30641    7.88687
                                        12      10.57534     10.25776          9.95400               9.38507    8.86325    8.38384
                                        13      11.34837     10.98319         10.63496               9.98565    9.39357    8.85268
                                        14      12.10625     11.69091         11.29607              10.56312    9.89864    9.29498
                                        15      12.84926     12.38138         11.93794              11.11839   10.37966    9.71225

                                        16      13.57771     13.05500         12.56110              11.65230   10.83777   10.10590
                                        17      14.29187     13.71220         13.16612              12.16567   11.27407   10.47726
                                        18      14.99203     14.35336         13.75351              12.65930   11.68959   10.82760
                                        19      15.67846     14.97889         14.32380              13.13394   12.08532   11.15812
                                        20      16.35143     15.58916         14.87747              13.59033   12.46221   11.46992

                                        21      17.01121     16.18455         15.41502              14.02916   12.82115   11.76408
                                        22      17.65805     16.76541         15.93692              14.45112   13.16300   12.04158
                                        23      18.29220     17.33211         16.44361              14.85684   13.48857   12.30338
                                        24      18.91393     17.88499         16.93554              15.24696   13.79864   12.55036
                                        25      19.52346     18.42438         17.41315              15.62208   14.09394   12.78336

                                        26      20.12104     18.95061         17.87684              15.98277   14.37519   13.00317
                                        27      20.70690     19.46401         18.32703              16.32959   14.64303   13.21053
                                        28      21.28127     19.96489         18.76411              16.66306   14.89813   13.40616
                                        29      21.84438     20.45355         19.18845              16.98371   15.14107   13.59072
                                        30      22.39646     20.93029         19.60044              17.29203   15.37245   13.76483

                                        31      22.93770     21.39541         20.00043              17.58849   15.59281   13.92909
                                        32      23.46833     21.84918         20.38877              17.87355   15.80268   14.08404
                                        33      23.98856     22.29188         20.76579              18.14765   16.00255   14.23023
                                        34      24.49859     22.72379         21.13184              18.41120   16.19290   14.36814
                                        35      24.99862     23.14516         21.48722              18.66461   16.37419   14.49825

                                        36      25.48884     23.55625         21.83225              18.90828   16.54685   14.62099
                                        37      25.96945     23.95732         22.16724              19.14258   16.71129   14.73678
                                        38      26.44064     24.34860         22.49246              19.36786   16.86789   14.84602
                                        39      26.90259     24.73034         22.80822              19.58448   17.01704   14.94907
                                        40      27.35548     25.10278         23.11477              19.79277   17.15909   15.04630
8658d_ch24.qxd   1/17/03   12:53 PM    Page 1339 mac18 mac18:df_169:8658D:

                                                                        Present Value of an Ordinary Annuity of 1   •   1339

                                       TABLE 6-4 PRESENT VALUE OF AN ORDINARY ANNUITY OF 1

                 8%          9%            10%          11%         12%          15%        Periods
             1.92593          .91743        .90909      .90090       .89286      .86957        1
             1.78326         1.75911       1.73554     1.71252      1.69005     1.62571        2
             2.57710         2.53130       2.48685     2.44371      2.40183     2.28323        3
             3.31213         3.23972       3.16986     3.10245      3.03735     2.85498        4
             3.99271         3.88965       3.79079     3.69590      3.60478     3.35216        5

             4.62288         4.48592       4.35526     4.23054      4.11141     3.78448        6
             5.20637         5.03295       4.86842     4.71220      4.56376     4.16042        7
             5.74664         5.53482       5.33493     5.14612      4.96764     4.48732        8
             6.24689         5.99525       5.75902     5.53705      5.32825     4.77158        9
             6.71008         6.41766       6.14457     5.88923      5.65022     5.01877       10

             7.13896         6.80519       6.49506     6.20652      5.93770     5.23371       11
             7.53608         7.16073       6.81369     6.49236      6.19437     5.42062       12
             7.90378         7.48690       7.10336     6.74987      6.42355     5.58315       13
             8.24424         7.78615       7.36669     6.98187      6.62817     5.72448       14
             8.55948         8.06069       7.60608     7.19087      6.81086     5.84737       15

             8.85137         8.31256       7.82371     7.37916      6.97399     5.95424       16
             9.12164         8.54363       8.02155     7.54879      7.11963     6.04716       17
             9.37189         8.75563       8.20141     7.70162      7.24967     6.12797       18
             9.60360         8.95012       8.36492     7.83929      7.36578     6.19823       19
             9.81815         9.12855       8.51356     7.96333      7.46944     6.25933       20

            10.01680         9.29224       8.64869     8.07507      7.56200     6.31246       21
            10.20074         9.44243       8.77154     8.17574      7.64465     6.35866       22
            10.37106         9.58021       8.88322     8.26643      7.71843     6.39884       23
            10.52876         9.70661       8.98474     8.34814      7.78432     6.43377       24
            10.67478         9.82258       9.07704     8.42174      7.84314     6.46415       25

            10.80998         9.92897       9.16095     8.48806      7.89566     6.49056       26
            10.93516        10.02658       9.23722     8.54780      7.94255     6.51353       27
            11.05108        10.11613       9.30657     8.60162      7.98442     6.53351       28
            11.15841        10.19828       9.36961     8.65011      8.02181     6.55088       29
            11.25778        10.27365       9.42691     8.69379      8.05518     6.56598       30

            11.34980        10.34280       9.47901     8.73315      8.08499     6.57911       31
            11.43500        10.40624       9.52638     8.76860      8.11159     6.59053       32
            11.51389        10.46444       9.56943     8.80054      8.13535     6.60046       33
            11.58693        10.51784       9.60858     8.82932      8.15656     6.60910       34
            11.65457        10.56682       9.64416     8.85524      8.17550     6.61661       35

            11.71719        10.61176       9.67651     8.87859      8.19241     6.62314       36
            11.77518        10.65299       9.70592     8.89963      8.20751     6.62882       37
            11.82887        10.69082       9.73265     8.91859      8.22099     6.63375       38
            11.87858        10.72552       9.75697     8.93567      8.23303     6.63805       39
            11.92461        10.75736       9.77905     8.95105      8.24378     6.64178       40
8658d_ch24.qxd   1/17/03   12:53 PM   Page 1340 mac18 mac18:df_169:8658D:

        1340     •   Accounting and the Time Value of Money

                                      TABLE 6-5 PRESENT VALUE OF AN ANNUITY DUE OF 1
                                                                                         (1       i )n   1

                                                                  PVF-ADn,i    1
                                      Periods      2%          21/2%            3%                       4%     5%         6%
                                         1       1.00000      1.00000          1.00000              1.00000    1.00000    1.00000
                                         2       1.98039      1.97561          1.97087              1.96154    1.95238    1.94340
                                         3       2.94156      2.92742          2.91347              2.88609    2.85941    2.83339
                                         4       3.88388      3.85602          3.82861              3.77509    3.72325    3.67301
                                         5       4.80773      4.76197          4.71710              4.62990    4.54595    4.46511

                                         6       5.71346      5.64583          5.57971              5.45182    5.32948    5.21236
                                         7       6.60143      6.50813          6.41719              6.24214    6.07569    5.91732
                                         8       7.47199      7.34939          7.23028              7.00205    6.78637    6.58238
                                         9       8.32548      8.17014          8.01969              7.73274    7.46321    7.20979
                                        10       9.16224      8.97087          8.78611              8.43533    8.10782    7.80169

                                        11       9.98259      9.75206          9.53020              9.11090    8.72173    8.36009
                                        12      10.78685     10.51421         10.25262              9.76048    9.30641    8.88687
                                        13      11.57534     11.25776         10.95400             10.38507    9.86325    9.38384
                                        14      12.34837     11.98319         11.63496             10.98565   10.39357    9.85268
                                        15      13.10625     12.69091         12.29607             11.56312   10.89864   10.29498

                                        16      13.84926     13.38138         12.93794             12.11839   11.37966   10.71225
                                        17      14.57771     14.05500         13.56110             12.65230   11.83777   11.10590
                                        18      15.29187     14.71220         14.16612             13.16567   12.27407   11.47726
                                        19      15.99203     15.35336         14.75351             13.65930   12.68959   11.82760
                                        20      16.67846     15.97889         15.32380             14.13394   13.08532   12.15812

                                        21      17.35143     16.58916         15.87747             14.59033   13.46221   12.46992
                                        22      18.01121     17.18455         16.41502             15.02916   13.82115   12.76408
                                        23      18.65805     17.76541         16.93692             15.45112   14.16300   13.04158
                                        24      19.29220     18.33211         17.44361             15.85684   14.48857   13.30338
                                        25      19.91393     18.88499         17.93554             16.24696   14.79864   13.55036

                                        26      20.52346     19.42438         18.41315             16.62208   15.09394   13.78336
                                        27      21.12104     19.95061         18.87684             16.98277   15.37519   14.00317
                                        28      21.70690     20.46401         19.32703             17.32959   15.64303   14.21053
                                        29      22.28127     20.96489         19.76411             17.66306   15.89813   14.40616
                                        30      22.84438     21.45355         20.18845             17.98371   16.14107   14.59072

                                        31      23.39646     21.93029         20.60044             18.29203   16.37245   14.76483
                                        32      23.93770     22.39541         21.00043             18.58849   16.59281   14.92909
                                        33      24.46833     22.84918         21.38877             18.87355   16.80268   15.08404
                                        34      24.98856     23.29188         21.76579             19.14765   17.00255   15.23023
                                        35      25.49859     23.72379         22.13184             19.41120   17.19290   15.36814

                                        36      25.99862     24.14516         22.48722             19.66461   17.37419   15.49825
                                        37      26.48884     24.55625         22.83225             19.90828   17.54685   15.62099
                                        38      26.96945     24.95732         23.16724             20.14258   17.71129   15.73678
                                        39      27.44064     25.34860         23.49246             20.36786   17.86789   15.84602
                                        40      27.90259     25.73034         23.80822             20.58448   18.01704   15.94907
8658d_ch24.qxd   1/17/03   12:53 PM   Page 1341 mac18 mac18:df_169:8658D:

                                                                             Present Value of an Annuity Due of 1   •   1341

                                           TABLE 6-5 PRESENT VALUE OF AN ANNUITY DUE OF 1

                 8%          9%           10%          11%         12%           15%        Periods
             1.00000        1.00000        1.00000     1.00000     1.00000      1.00000        1
             1.92593        1.91743        1.90909     1.90090     1.89286      1.86957        2
             2.78326        2.75911        2.73554     2.71252     2.69005      2.62571        3
             3.57710        3.53130        3.48685     3.44371     3.40183      3.28323        4
             4.31213        4.23972        4.16986     4.10245     4.03735      3.85498        5

             4.99271        4.88965        4.79079     4.69590     4.60478      4.35216        6
             5.62288        5.48592        5.35526     5.23054     5.11141      4.78448        7
             6.20637        6.03295        5.86842     5.71220     5.56376      5.16042        8
             6.74664        6.53482        6.33493     6.14612     5.96764      5.48732        9
             7.24689        6.99525        6.75902     6.53705     6.32825      5.77158       10

             7.71008        7.41766        7.14457     6.88923     6.65022      6.01877       11
             8.13896        7.80519        7.49506     7.20652     6.93770      6.23371       12
             8.53608        8.16073        7.81369     7.49236     7.19437      6.42062       13
             8.90378        8.48690        8.10336     7.74987     7.42355      6.58315       14
             9.24424        8.78615        8.36669     7.98187     7.62817      6.72448       15

             9.55948        9.06069        8.60608     8.19087     7.81086      6.84737       16
             9.85137        9.31256        8.82371     8.37916     7.97399      6.95424       17
            10.12164        9.54363        9.02155     8.54879     8.11963      7.04716       18
            10.37189        9.75563        9.20141     8.70162     8.24967      7.12797       19
            10.60360        9.95012        9.36492     8.83929     8.36578      7.19823       20

            10.81815       10.12855        9.51356     8.96333     8.46944      7.25933       21
            11.01680       10.29224        9.64869     9.07507     8.56200      7.31246       22
            11.20074       10.44243        9.77154     9.17574     8.64465      7.35866       23
            11.37106       10.58021        9.88322     9.26643     8.71843      7.39884       24
            11.52876       10.70661        9.98474     9.34814     8.78432      7.43377       25

            11.67478       10.82258       10.07704     9.42174     8.84314      7.46415       26
            11.80998       10.92897       10.16095     9.48806     8.89566      7.49056       27
            11.93518       11.02658       10.23722     9.54780     8.94255      7.51353       28
            12.05108       11.11613       10.30657     9.60162     8.98442      7.53351       29
            12.15841       11.19828       10.36961     9.65011     9.02181      7.55088       30

            12.25778       11.27365       10.42691     9.69379     9.05518      7.56598       31
            12.34980       11.34280       10.47901     9.73315     9.08499      7.57911       32
            12.43500       11.40624       10.52638     9.76860     9.11159      7.59053       33
            12.51389       11.46444       10.56943     9.80054     9.13535      7.60046       34
            12.58693       11.51784       10.60858     9.82932     9.15656      7.60910       35

            12.65457       11.56682       10.64416     9.85524     9.17550      7.61661       36
            12.71719       11.61176       10.67651     9.87859     9.19241      7.62314       37
            12.77518       11.65299       10.70592     9.89963     9.20751      7.62882       38
            12.82887       11.69082       10.73265     9.91859     9.22099      7.63375       39
            12.87858       11.72552       10.75697     9.93567     9.23303      7.63805       40
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