Post on 28-Oct-2014
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Prepared by Coby Harmon
University of California, Santa Barbara
Intermediate Accounting
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Intermediate Accounting
14th Edition
24Full Disclosure in Financial Reporting
Kieso, Weygandt, and Warfield
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1. Review the full disclosure principle and describe implementation
problems.
2. Explain the use of notes in financial statement preparation.
3. Discuss the disclosure requirements for major business segments.
4. Describe the accounting problems associated with interim reporting.
5. Identify the major disclosures in the auditor’s report.
6. Understand management’s responsibilities for financials.
7. Identify issues related to financial forecasts and projections.
8. Describe the profession’s response to fraudulent financial reporting.
Learning ObjectivesLearning ObjectivesLearning ObjectivesLearning Objectives
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Accounting policies
Common notes
Full Disclosure Principle
Notes to Financial
Statements
Disclosure Issues
Auditor’s and Management’s
Report
Current Reporting
Issues
Increase in reporting requirements
Differential disclosure
Special transactions or events
Post-balance-sheet events
Diversified companies
Interim reports
Auditor’s report
Management’s reports
Reporting on forecasts and projections
Internet financial reporting
Fraudulent financial reporting
Criteria for accounting and reporting choices
Full Disclosure in Financial ReportingFull Disclosure in Financial ReportingFull Disclosure in Financial ReportingFull Disclosure in Financial Reporting
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Full disclosure principle calls for financial reporting of any
financial facts significant enough to influence the judgment
of an informed reader.
Financial disasters at Microstrategy, PharMor,
WorldCom, and AIG highlight the difficulty of implementing
the full disclosure principle.
LO 1 Review the full disclosure principle and describe implementation problems.
1. Full Disclosure Principle1. Full Disclosure Principle1. Full Disclosure Principle1. Full Disclosure Principle
24-6 LO 1 Review the full disclosure principle and describe implementation problems.
Full Disclosure PrincipleFull Disclosure PrincipleFull Disclosure PrincipleFull Disclosure Principle
Illustration 24-1Types of FinancialInformation
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Increase in Reporting Requirements
Reasons:
Complexity of business environment.
Necessity for timely information.
Accounting as a control and
monitoring device.
LO 1 Review the full disclosure principle and describe implementation problems.
Full Disclosure PrincipleFull Disclosure PrincipleFull Disclosure PrincipleFull Disclosure Principle
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Differential Disclosure
LO 1 Review the full disclosure principle and describe implementation problems.
Full Disclosure PrincipleFull Disclosure PrincipleFull Disclosure PrincipleFull Disclosure Principle
“Big GAAP versus Little GAAP”.
FASB takes the position that there should be one set of
GAAP.
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Notes are the means of amplifying or explaining the items
presented in the main body of the statements.
LO 2 Explain the use of notes in financial statement preparation.
2. Notes to the Financial Statements2. Notes to the Financial Statements2. Notes to the Financial Statements2. Notes to the Financial Statements
Accounting Policies
Companies should present a statement identifying the accounting
policies adopted (Summary of Significant Accounting Policies).
24-10 LO 2 Explain the use of notes in financial statement preparation.
Notes to the Financial StatementsNotes to the Financial StatementsNotes to the Financial StatementsNotes to the Financial Statements
Which of the following should be disclosed in a Summary of
Significant Accounting Policies?
a. Types of executory contracts.
b. Amount for cumulative effect of change in accounting
principle.
c. Claims of equity holders.
d. Depreciation method followed.
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Common Notes Inventory
Property, Plant, and Equipment
Creditor Claims
Equityholders’ Claims
Contingencies and Commitments
Fair Values
Deferred Taxes, Pensions, and Leases
Changes in Accounting Principles
LO 2 Explain the use of notes in financial statement preparation.
Notes to the Financial StatementsNotes to the Financial StatementsNotes to the Financial StatementsNotes to the Financial Statements
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Disclosure of Special Transactions or Events
Related-party transactions
► Nature of relationship.
► A description of the transactions for each of the
periods for which income statements are presented.
► Dollar amounts of transactions for each of the
periods for which income statements are presented.
► Amounts due from or to related parties.
Errors and fraud.
LO 2 Explain the use of notes in financial statement preparation.
3. Disclosure Issues3. Disclosure Issues3. Disclosure Issues3. Disclosure Issues
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If a business entity entered into certain related party transactions, it
would be required to disclose all the following information except the
a. nature of the relationship between the parties to the
transactions.
b. nature of any future transactions planned between the parties
and the terms involved.
c. dollar amount of the transactions for each of the periods for
which an income statement is presented.
d. amounts due from or to related parties as of the date of each
statement of financial position presented.
LO 2 Explain the use of notes in financial statement preparation.
Disclosure IssuesDisclosure IssuesDisclosure IssuesDisclosure Issues
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Post-Balance Sheet-Events (Subsequent Events)
LO 2 Explain the use of notes in financial statement preparation.
Disclosure IssuesDisclosure IssuesDisclosure IssuesDisclosure Issues
1 - Events that provide additional
evidence about conditions that
existed at the balance sheet date.
2 - Events that provide
evidence about conditions that
did not exist at the balance
sheet date.
Illustration 24-3Time Periods forSubsequent Events
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______ 1. Settlement of federal tax case at a cost considerably in
excess of the amount expected at year-end.
______ 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. Issuance of a significant number of ordinary shares.
E24-2 (Post-Balance-Sheet Events): For each of the following
subsequent events, indicate whether a company should (a) adjust the
financial statements, (b) disclose in notes to the financial statements, or
(c) neither adjust nor disclose.
LO 2 Explain the use of notes in financial statement preparation.
Disclosure IssuesDisclosure IssuesDisclosure IssuesDisclosure Issues
a
c
b
b
c
b
24-16 LO 2 Explain the use of notes in financial statement preparation.
Disclosure IssuesDisclosure IssuesDisclosure IssuesDisclosure Issues
______ 7. Loss of a significant customer.
______ 8. Prolonged employee strike.
______ 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.
______ 12. Merger with another company of comparable size.
c
c
a
c
a
b
E24-2 (Post-Balance-Sheet Events): For each of the following
subsequent events, indicate whether a company should (a) adjust the
financial statements, (b) disclose in notes to the financial statements, or
(c) neither adjust nor disclose.
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Reporting for Diversified Companies
LO 3
Disclosure IssuesDisclosure IssuesDisclosure IssuesDisclosure Issues
Investors and investment analysts income statement, balance
sheet, and cash flow information on the individual segments
that compose the total income figure.
Illustration 24-5Segmented IncomeStatement
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Objective of Reporting Segmented Information
LO 3 Discuss the disclosure requirements for major business segments.
Disclosure IssuesDisclosure IssuesDisclosure IssuesDisclosure Issues
To provide information about the different types of business
activities in which an enterprise engages and the different
economic environments in which it operates.
Meeting this objective will help users:
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.
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Basic Principles
LO 3 Discuss the disclosure requirements for major business segments.
Disclosure IssuesDisclosure IssuesDisclosure IssuesDisclosure Issues
GAAP requires that general-purpose financial statements
include selected information on a single basis of segmentation.
A company can meet the segmented reporting objective by
providing financial statements segmented based on how the
company’s operations are managed (management
approach).
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Identifying Operating Segments
LO 3 Discuss the disclosure requirements for major business segments.
Disclosure IssuesDisclosure IssuesDisclosure IssuesDisclosure Issues
An operating segment is a component of an enterprise:
a. That engages in business activities from which it earns
revenues and incurs expenses.
b. Whose operating results are regularly reviewed by the
company’s chief operating decision maker.
c. For which discrete financial information is available.
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Quantitative Materiality Test: Must satisfy one to determine
whether the segment is significant enough to warrant actual
disclosure.
1. Its revenue is 10 percent or more of the combined revenue of all the
company’s operating segments.
2. The absolute amount of its profit or loss is 10 percent or more of the
greater, in absolute 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.
3. Its identifiable assets are 10 percent or more of the combined assets
of all operating segments.
LO 3
Disclosure IssuesDisclosure IssuesDisclosure IssuesDisclosure Issues
Identifying Operating Segments
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Quantitative Materiality Test: In applying these tests, the
company must consider two additional factors.
1. Segment data must explain a significant portion of the company’s
business. Specifically, the segmented results must equal or exceed
75 percent of the combined sales to unaffiliated customers for the
entire company.
2. The FASB decided that 10 is a reasonable upper limit for the
number of segments that a company must disclose.
LO 3
Disclosure IssuesDisclosure IssuesDisclosure IssuesDisclosure Issues
LO 3 Discuss the disclosure requirements for major business segments.
Identifying Operating Segments
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Materiality Test Illustration
LO 3
Disclosure IssuesDisclosure IssuesDisclosure IssuesDisclosure Issues
Reporting segments are therefore A, C, D, and E, assuming that these four segments have enough sales to meet the 75 percent of combined sales test.
Illustration 24-6Data for Different PossibleReporting Segments
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Disclosure IssuesDisclosure IssuesDisclosure IssuesDisclosure Issues
LO 3 Discuss the disclosure requirements for major business segments.
Materiality Test Illustration
The 75 percent test is computed as follows.
75% of combined sales test: 75% x $2,150 = $1,612.50. The sales of A,
C, D, and E total $2,000 ($100 + $700 + $300 + $900); therefore, the 75
percent test is met.
Illustration 24-6Data for Different PossibleReporting Segments
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Segmented Information Reported
LO 3 Discuss the disclosure requirements for major business segments.
Disclosure IssuesDisclosure IssuesDisclosure IssuesDisclosure Issues
1. General information about operating segments.
2. Segment profit and loss and related information.
3. Segment assets.
4. Reconciliations.
5. Information about products and services and geographic
areas.
6. Major customers.
24-26 LO 3 Discuss the disclosure requirements for major business segments.
Disclosure IssuesDisclosure IssuesDisclosure IssuesDisclosure Issues
Revenue of a segment includes
a. only sales to unaffiliated customers.
b. sales to unaffiliated customers and intersegment
sales.
c. sales to unaffiliated customers and interest
revenue.
d. sales to unaffiliated customers and other revenue
and gains.
24-27 LO 3 Discuss the disclosure requirements for major business segments.
Disclosure IssuesDisclosure IssuesDisclosure IssuesDisclosure Issues
The profession requires disaggregated information in the
following ways:
a. products or services.
b. geographic areas.
c. major customers.
d. all of these.
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Interim Reports
LO 4 Describe the accounting problems associated with interim reporting.
Disclosure IssuesDisclosure IssuesDisclosure IssuesDisclosure Issues
Cover periods of less than one year.
Two viewpoints exist:
1. Discrete approach
2. Integral approach
Companies should use the same accounting principles for
interim reports that they use for annual reports.
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Unique Problems of Interim Reporting
LO 4 Describe the accounting problems associated with interim reporting.
Disclosure IssuesDisclosure IssuesDisclosure IssuesDisclosure Issues
(1) Advertising and similar costs
(2) Expenses subject to year-end adjustment
(3) Income taxes
(4) Extraordinary items
(5) Earnings per share
(6) Seasonality
24-30 LO 4 Describe the accounting problems associated with interim reporting.
Disclosure IssuesDisclosure IssuesDisclosure IssuesDisclosure Issues
In considering interim financial reporting, how does the
profession conclude that such reporting should be viewed?
a. As a "special" type of reporting that need not follow
generally accepted accounting principles.
b. As useful only if activity is evenly spread throughout the
year so that estimates are unnecessary.
c. As reporting for a basic accounting period.
d. As reporting for an integral part of an annual period.
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Illustration 24-13Auditor’s Report
Auditor’s and Management’s ReportsAuditor’s and Management’s ReportsAuditor’s and Management’s ReportsAuditor’s and Management’s Reports
Auditor’s Report
Unqualified Opinion –
auditor expresses the
opinion that the financial
statements are presented
fairly in accordance with
GAAP. Other opinions:
Qualified
Adverse
Disclaim
LO 5
24-32 LO 5 Identify the major disclosures in the auditor’s report.
Auditor’s and Management’s ReportsAuditor’s and Management’s ReportsAuditor’s and Management’s ReportsAuditor’s and Management’s Reports
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.
Going Concert
Lack of Consistency
Emphasis of a Matter
Auditor’s Report
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Qualified opinion contains an exception to the standard
opinion. Usual circumstances may include:
1. Scope limitation.
2. Statements do not fairly present financial position or
results of operations because of:
a. Lack of conformity with GAAP.
b. Inadequate disclosure.
Auditor’s and Management’s ReportsAuditor’s and Management’s ReportsAuditor’s and Management’s ReportsAuditor’s and Management’s Reports
LO 5 Identify the major disclosures in the auditor’s report.
Auditor’s Report
24-34 LO 5 Identify the major disclosures in the auditor’s report.
Auditor’s and Management’s ReportsAuditor’s and Management’s ReportsAuditor’s and Management’s ReportsAuditor’s and Management’s Reports
Management’s Report
The SEC mandates inclusion of management’s discussion
and analysis (MD&A).
Management highlights favorable or unfavorable trends
related to liquidity, capital resources, and results of
operations.
24-35 LO 5 Identify the major disclosures in the auditor’s report.
Auditor’s and Management’s ReportsAuditor’s and Management’s ReportsAuditor’s and Management’s ReportsAuditor’s and Management’s Reports
The MD&A section of a company's annual report is to cover the
following three items:
a. income statement, balance sheet, and statement of
owners' equity.
b. income statement, balance sheet, and statement of cash
flows.
c. liquidity, capital resources, and results of operations.
d. changes in the stock price, mergers, and acquisitions.
24-36 LO 6 Understand management’s responsibilities for financials.
Auditor’s and Management’s ReportsAuditor’s and Management’s ReportsAuditor’s and Management’s ReportsAuditor’s and Management’s Reports
Management’s Responsibilities for Financial Statements
The Sarbanes-Oxley Act requires the SEC to develop
guidelines for all publicly traded companies to report on
management’s responsibilities for, and assessment of, the
internal control system.
24-37 LO 7 Identify issues related to financial forecasts and projections.
Current Reporting IssuesCurrent Reporting IssuesCurrent Reporting IssuesCurrent Reporting Issues
Reporting on Financial Forecasts and Projections
Financial forecast is a set of prospective financial statements
that present, a company’s expected financial position, results of
operations, and cash flows.
Financial projections are prospective financial statements
that present, given one or more hypothetical assumptions, an
entity’s expected financial position, results of operations, and
cash flows. Regulators have established a Safe Harbor Rule.
24-38 LO 7 Identify issues related to financial forecasts and projections.
Current Reporting IssuesCurrent Reporting IssuesCurrent Reporting IssuesCurrent Reporting Issues
Which of the following best characterizes the difference between a
financial forecast and a financial projection?
a. Forecasts include a complete set of financial statements, while
projections include only summary financial data.
b. A forecast is normally for a full year or more and a projection
presents data for less than a year.
c. 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.
d. A forecast includes data which can be verified about future
expectations, while the data in a projection is not susceptible to
verification.
24-39 LO 7 Identify issues related to financial forecasts and projections.
Current Reporting IssuesCurrent Reporting IssuesCurrent Reporting IssuesCurrent Reporting Issues
Internet Financial Reporting
A large proportion of companies’ websites contain links to their
financial statements and other disclosures.
Allows firms to communicate more easily and quickly with
users.
Allow users to take advantage of tools such as search
engines.
Can help make financial reports more relevant by allowing
companies to report expanded disaggregated data.
24-40 LO 8 Describe the profession’s response to fraudulent financial reporting.
Current Reporting IssuesCurrent Reporting IssuesCurrent Reporting IssuesCurrent Reporting Issues
Fraudulent Financial Reporting
Intentional or reckless conduct, whether through act or omission,
that results in materially misleading financial statements.
Frauds involving such well-known companies as Enron,
WorldCom, Adelphia, and Tyco indicate that more must be
done to address this issue.
24-41 LO 8 Describe the profession’s response to fraudulent financial reporting.
Current Reporting IssuesCurrent Reporting IssuesCurrent Reporting IssuesCurrent Reporting Issues
Fraudulent Financial Reporting
Causes of Fraudulent Financial Reporting
Common causes are the desire
► to obtain a higher stock price,
► to avoid default on a loan covenant, or
► to make a personal gain of some type (additional
compensation, promotion).
24-42 LO 8 Describe the profession’s response to fraudulent financial reporting.
Current Reporting IssuesCurrent Reporting IssuesCurrent Reporting IssuesCurrent Reporting Issues
Fraudulent Financial Reporting
Causes of Fraudulent Financial Reporting
Common opportunities for fraudulent financial reporting
► Absence of a board of directors or audit committee.
► Weak or nonexistent internal accounting controls.
► Unusual or complex transactions.
► Accounting estimates requiring significant judgment.
► Ineffective internal audit staffs.
24-43 LO 9 Understand the approach to financial statement analysis.
Perspective on Financial Statement Analysis
A logical approach to financial statement analysis is necessary,
consisting of the following steps.
1. Know the questions for which you want to find answers.
2. Know the questions that particular ratios and comparisons
are able to help answer.
3. Match 1 and 2 above. By such a matching, the statement
analysis will have a logical direction and purpose.
APPENDIXAPPENDIX 24A BASIC FINANCIAL STATEMENT ANALYSIS
24-44 LO 9 Understand the approach to financial statement analysis.
Analysis includes an understanding that
1. Financial statements report on the past.
2. Single ratio by itself is not likely to be very useful.
3. Awareness of the limitations of accounting numbers used in
an analysis.
Perspective on Financial Statement Analysis
APPENDIXAPPENDIX 24A BASIC FINANCIAL STATEMENT ANALYSIS
24-45 LO 10 Identify major analytic ratios and describe their calculation.
Ratio Analysis
APPENDIXAPPENDIX 24A BASIC FINANCIAL STATEMENT ANALYSIS
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Illustration 24A-1
LO 10 Identify major analytic ratios and describe their calculation.
Ratio Analysis
APPENDIXAPPENDIX 24A BASIC FINANCIAL STATEMENT ANALYSIS
24-47
Illustration 24A-1
LO 10 Identify major analytic ratios and describe their calculation.
Ratio Analysis
APPENDIXAPPENDIX 24A BASIC FINANCIAL STATEMENT ANALYSIS
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Illustration 24A-1
LO 10 Identify major analytic ratios and describe their calculation.
Ratio Analysis
APPENDIXAPPENDIX 24A BASIC FINANCIAL STATEMENT ANALYSIS
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Illustration 24A-1
LO 10 Identify major analytic ratios and describe their calculation.
Ratio Analysis
APPENDIXAPPENDIX 24A BASIC FINANCIAL STATEMENT ANALYSIS
24-50 LO 11 Explain the limitations of ratio analysis.
Based on historical cost.
Use of estimates.
Achieving comparability among firms in a given industry.
Substantial amount of important information is not
included in a company’s financial statements.
Limitations of Ratio Analysis
APPENDIXAPPENDIX 24A BASIC FINANCIAL STATEMENT ANALYSIS
24-51 LO 12 Describe techniques of comparative analysis.
Illustration 24A-2Comparative Analysis
APPENDIXAPPENDIX 24A BASIC FINANCIAL STATEMENT ANALYSIS
24-52 LO 13 Describe techniques of percentage analysis.
Percentage (Common Size) Analysis
APPENDIXAPPENDIX 24A BASIC FINANCIAL STATEMENT ANALYSIS
Illustration 24A-3
24-53 LO 13 Describe techniques of percentage analysis.
Percentage (Common Size) Analysis
APPENDIXAPPENDIX 24A BASIC FINANCIAL STATEMENT ANALYSIS
Illustration 24A-4
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RELEVANT FACTS
Due to the broader range of judgments allowed in more principles-based IFRS, note disclosures generally are more expansive under IFRS compared to GAAP.
GAAP and IFRS have similar standards on post-statement of financial position (subsequent) events. That is, under both sets of standards, events that occurred after the statement of financial position date, and which provide additional evidence of conditions that existed at the statement of financial position date, are recognized in the financial statements. Subsequent events under IFRS are evaluated through the date that financial instruments are “authorized for issue.” GAAP uses the date when financial statements are “issued.” Also, for share dividends and splits in the subsequent period, IFRS does not adjust but GAAP does.
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RELEVANT FACTS
Like GAAP, IFRS requires that for transactions with related parties, companies disclose the amounts involved in a transaction; the amount, terms, and nature of the outstanding balances; and any doubtful amounts related to those outstanding balances for each major category of related parties.
Following the recent issuance of IFRS 8, “Operating Segments,” the requirements under IFRS and GAAP are very similar.
Neither GAAP nor IFRS require interim reports. Rather, the SEC and stock exchanges outside the United States establish the rules. In the United States, interim reports generally are provided on a quarterly basis; outside the United States, six-month interim reports are common.
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Which of the following is false?
a. In general, IFRS note disclosures are more expansive
compared to GAAP.
b. GAAP and IFRS have similar standards on subsequent events.
c. Both IFRS and GAAP require interim reports although the
reporting frequency varies.
d. Segment reporting requirements are very similar under IFRS
and GAAP.
IFRS SELF-TEST QUESTION
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Subsequent events are reviewed through which date under IFRS?
a. Statement of financial position date.
b. Sixty days after the year-end date.
c. Date of independent auditor’s opinion.
d. Authorization date of the financial statements.
IFRS SELF-TEST QUESTION
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Under IFRS, share dividends declared after the statement of financial
position date but before the end of the subsequent events period are:
a. accounted for similar to errors as a prior period adjustment.
b. adjusted subsequent events, because they are paid from prior
year earnings.
c. not adjusted in the current year’s financial statements.
d. recognized on a prospective basis from the date of declaration.
IFRS SELF-TEST QUESTION
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