By James J. Newhard, CPA
Whenever I hear the expression, “the only easy day was yesterday,” I know that person was either in the military or a CPA in public practice. OK, perhaps that’s an exaggeration … but not by much. To practice in financial reporting requires extraordinary knowledge of disclosures. After all, disclosure is to financial reporting what location is to real estate – everything!
GAAP Disclosure Basics
For financial statements to be presented in accordance with U.S. generally accepted accounting principles (GAAP), the following disclosures are necessary:
- Disclosures required by specific authoritative pronouncements
- Disclosures that are deemed “generally accepted”
- Any additional disclosures necessary to prevent the financial statements from being misleading
The third bullet is the epitome of a true principles-based (professional judgment) disclosure requirement – to weigh all the factors and implications of the reporting of financial information to ensure users can fully understand and assess.
These disclosures are applied in several areas:
- In the body of the financial statements (in titles, classification, or even parenthetically)
- In the footnotes to the financial statements
- In supplemental information
However, be careful with information presented supplementally. If that information is required to be disclosed, and it is not already disclosed in either the body or footnotes, then there is a disclosure deficiency.
SPF Disclosure Basics
Recognizing that not all financial statements are in accordance with a general purpose framework such as U.S. GAAP, AU-C Section 800 establishes the disclosure considerations necessary for financial statements to be presented in accordance with a special purpose framework (SPF). These informative disclosures affect the use, understanding, and interpretation of the SPF financial statements. This guidance includes the following:
- A description of the SPF framework, and how the SPF differs from GAAP
- Informative disclosures similar to those required by GAAP when the SPF measures and recognizes account items the same as, or similar to, GAAP financial statements
- Either disclose items as required by GAAP or provide information that communicates the substance of the required GAAP disclosure when the item has a required disclosure under GAAP
- Any additional disclosures beyond those also required by the SPF that may be necessary to achieve fair presentation
Again, a significant amount of professional judgment is required, not to mention a strong and proficient knowledge of all applicable disclosures under GAAP. Accordingly, whatever happens in the work of the Financial Accounting Standards Board (FASB) and U.S. GAAP will impact SPF financial reporting disclosures.
Monitor Disclosure Framework Project
More and more, the FASB is prescribing and specifying disclosure guidance in its issued accounting standards that provides users with the context and details to better understand, assess, and evaluate financial positions and results. The disclosure framework project commenced about five years ago with the intent to better define the limits of information that can and should be provided in a set of general purpose financial statements, including the notes. This project also is, in no small part, a response to trends identified in an EY study (To the Point: Now Is the Time to Address Disclosure Overload, EY, 2012) that concluded that, based on the rate of increased disclosure requirements, companies are expected to devote about 500 pages of footnote disclosures and management discussion and analysis in annual reports by 2032.
To that point, a 2018 annual report for Sears has 14 pages devoted just to note 1 on significant accounting policies.
A new chapter (Chapter 8, Notes to Financial Statements) of FASB’s Conceptual Framework for Financial Reporting was issued in August 2018 to help the FASB improve procedures and promote consistent decision-making when determining disclosure requirements, but it is difficult to envision any significant pruning of required disclosures when the goal is to enhance the data and information available to financial statement users in all areas of relevance and materiality (defined by what influences or makes a difference to an investor or other decision maker) from a principles-based perspective.
What is the extent of information that is “useful?” What and by how much, if omitted or misstated, is it probable that the judgment of a reasonable person relying upon the financial information would have been changed or influenced by the inclusion or correction of the item?
So much more is to come, but I will end this column with two thoughts for consideration.
One: New standards such as ASC 606 on revenue recognition and ASC 842 on leasing have established extensive disclosures of the who, what, where, when, why, and how of the topic matters. Private companies using GAAP need to assess – even after applying favorable practical expedients and exemptions – whether the presented disclosure is sufficiently relevant and useful and prevents the financial statements from being misleading. Private companies using an SPF will also need to assess whether areas (such as tax accounting revenue or tax reporting lease expenses) need to parallel or convey the substance of the corollary GAAP disclosure.
Two: Reporting companies using GAAP may need to assess the applicability of several different topic areas for consideration of a specific set of transactions. For example, in a July 2019 Deloitte financial reporting alert (Assessing the Collectability of Operating Lease Receivables, Deloitte Financial Reporting Alert 19-1, 2019), the authors describe that considerations of a collectability issue for a lessor’s treatment and disclosure might lead to new Topic 326 (Current Expected Credit Losses) applications. However, the FASB issued ASU 2018-19, which indicates lessor collectability is not applicable under 326-30, but rather within 842 itself, and possibly 450 (Contingencies).
As we navigate a principles-based approach, legal liability and peer review necessitate deep dives into not only how financial data is presented, but how all necessary aspects of such data is disclosed.
James J. Newhard, CPA, is a sole practitioner in Paoli, a CPE presenter for Kaplan Financial Education – Powered by Loscalzo Institute, and a past president of PICPA’s Greater Philadelphia Chapter. Among his numerous state and chapter technical committees, he is a member of the Pennsylvania CPA Journal Editorial Board and the Accounting and Auditing Procedures Committee. He can be reached at email@example.com or @CatalystJimCPA.