Company Disclosures of Significant Accounting Policies

Disclosures in the notes to a company’s financial statements and accompanying discussion provide a good source for obtaining information on the possible effect that financial reporting standards may have on the company’s financial statements. This disclosure can occur in two main forms:

• Disclosures relating to critical and significant accounting policies; and
• Disclosures regarding changes in accounting policies

Company Disclosures

Disclosures relating to critical and significant accounting policies

Financial reporting standards restrict alternatives but allow companies to maintain flexibility in matching their accounting methods with their underlying economic fundamentals. Companies may, therefore, use estimates and choose among alternative accounting policies. Under IFRS and US GAAP, companies are required to disclose their selected accounting policies and estimates in the notes to the financial statements. Companies can also discuss in the management’s discussion and analysis those policies that management deems to be most important.

When analyzing a company’s financial reporting disclosures, key questions to ask include:

• Which policies have the company discussed?
• Do the policies appear to cover all significant balances appearing on the financial statements?
• Which policies have been identified as requiring significant estimates?
• Have any changes in these disclosures occurred from one year to the next?

Disclosures regarding changes in accounting policies

Changes in accounting policies can result from initially applying a new accounting standard or from a company voluntarily changing which allowable policy it uses.

Companies are required to disclose information on all changes in accounting policies. IFRS also requires a company to discuss pending implementations of new standards and the known or estimable information relevant to assessing the impact of the new standards.

Adequate disclosure can bring attention to significant changes in reported financial statement amounts which could materially affect security valuation.

In relation to a new standard yet to be implemented, a company may arrive at and disclose any one of the following:

• The standard is not applicable;
• The standard will not have any material impact;
• The company’s management is still evaluating the impact; and
• Any possible impact from adoption is being discussed.

Of the four possible disclosures, the one which indicates that management is still evaluating the impact creates the most uncertainty about whether the change might materially affect the company. Disclosures indicating the expected impact provides the most useful information.

Companies may also choose to quantify the expected impact of accounting standards that have been changed but are not yet effective as at the financial reporting date.

Users of financial statements can use these disclosures to adjust their expectations about a company’s assets, liabilities, and equity. This can assist with financial statement forecasting and confirmation of the impact of these changes on the company’s financial ratios.

Question

Which of the following disclosures provide the most uncertainty in relation to the impact of a new standard on a company’s operations?

A. The standard will not have any material impact.

B. Management is still evaluating the impact.

C. The standard is not applicable.

Solution

The correct answer is B.

When a company discloses that its management is still evaluating the impact, this tends to create the most uncertainty about whether the change might materially affect the company. Options A and C present disclosures that are meaningful to users of the financial statements.

Reading 22 LOS 22i:

Analyse company disclosures of significant accounting policies