 Hello, and welcome to this session. This is Professor Farhad in this session. We will look at supplemental disclosure when it comes to the balance sheet. This topic is covered in intermediate accounting and shortly on the CPA exam, the FAR section. As always, I would like to remind you to connect with me on LinkedIn. YouTube is where I house more than 1,500 plus accounting, auditing, finance, and tax lectures. If you like my lectures, please like them. It helped me tremendously. Share them, put them in playlists. Let the world know about them. If you're benefiting from my lectures, it means other people might benefit as well, so please share the wealth. I also have a website. On my website, you can find additional resources, such as notes, PowerPoint slides, multiple choice questions, and other resources. And you'll have access to 2,000 CPA questions. If you are studying for your CPA exam, please take a look. Studybodypal.co is an artificial intelligence driven studybody platform that matches with a CPA or a CFA or any other test that you are studying for. They are located in 85 countries in 2,800 cities. Today, we're going to be discussing the supplemental disclosure, specifically the balance sheet. And the reason I'm showing this picture here, because that's not an easy for companies to prepare the supplemental disclosure. Sometime, they have to make a judgment what to include, what not to include, what information to collect. And there's a lot of work that goes into it. That's just showing you the big picture. There are four types of information that are supplemental to account titles and amount presented on the balance sheet. So simply put the balance sheet on its own. The titles and the numbers may not be good enough. We need to present more. Hello and welcome to the session. This is Professor Farhad. In this session, we would look at supplemental disclosure, specifically when we are dealing with the balance sheet. This topic is covered in intermediate accounting, as well the CPA FAR section. As always, I would like to remind you if you have not connected with me only then, please do so. YouTube is where I house all my 1,500-plus accounting, auditing, finance, and tax lectures. If you like my lectures, please like them. It helped me tremendously. Share them, put them in the playlist. Let the world know about them. If you're benefiting from my lectures, it means other people might benefit as well. On my website, you can find additional resources about the lectures, such as the PowerPoint slides, notes, quizzes, and additional CPA and exercise questions. Please check out my website. If you are looking for a study pal, you can use studypal.co. It's an artificial intelligence-driven study by the platform that match you with someone who's studying for the CPA, CFA, or any other exam. Today, we're going to be discussing supplemental disclosure, specifically the balance sheet supplemental disclosure. And the reason I have this picture is to remind you or to tell you that this is not an easy task for the company. What to disclose? What not to disclose? How much to disclose? And how much it's going to cost us to collect that information for disclosure? So simply put, there are four type of information that are supplemental to account titles and amount. So when we prepare the balance sheet, we're going to have, for example, account receivable, $5 million, and a long-term investment, $6.5 million, inventory, $3.6 million. Well, those are account title and amount. Those are not good enough by themselves. We need to disclose more information. And what information do we need about the balance sheet that will help us give us a complete picture about the company? Well, we have to know the contingencies. Is there any contingencies? Summary of accounting policies, contractual situations. Anytime they use a fair value, how did they come up with that fair value? Now, as you know with my lectures, once I have a list, I will go over this list separately, starting with contingency. What is a contingency? The contingency is, as can also, what if? What if something happened? We have an existing situation. What if we lose? We have a lawsuit. What if we lose this lawsuit? We have a tax dispute with the IRS. What happened if we lose this tax dispute? So it's defined as an existing situation involving uncertainty as to a possible gain. Well, if we have a possible gain, that's good. We don't have to do anything about it. Or possible loss, then we have to determine how much we should disclose about the loss. Also, we need to know about if there's a gain, that's up to us if you want to disclose or not. And that loss or gain might be resolved in the future. So the users wants to know, if we have this contingency, they want to know what would happen to them. So they want to know about that contingency. In short, there are uncertain occurrences that they might have material effect. And users are interested in that material effect. Because before they invest in you, before they invest in your company, they want to know if that happened, how would that affect them? If we have to pay this large lawsuit, well, what's going to happen to the cash flow? Should they invest? Should none I invest? So examples of contingencies or lawsuits guaranteeing the debt of other company, environmental obligation, environmental liabilities, environmental contingencies, those are examples of contingency. The second thing that we have to list as a supplemental to the financial statements, specifically the balance sheet, is summary of accounting policies. What is summary of accounting policies? Which method did we use to value the assets? And allocate cost among the balance sheet account. We have many methods. So we have to tell the users which method we are using. So we need to help the users understand and evaluate the financial statement component and the relationship. Okay, we need to disclose this, summary of significant accounting policy, preceding the notes and the financial statements. So basically we have to tell them which method we are using, for example, for inventory. Are we using FIFO or LIFO? How are we computing inventory? The cost for assumption. Depreciation, how are we depreciating our property, plant, and equipment? Are we using the straight line, the double declining balance, the sums of year's digit? How are we carrying our investments? Are we using amortized cost, equity, or fair value? Now, within fair value, we're gonna have a whole disclosure within fair value. The reason is sophisticated users. They want to know, if one company using LIFO, one company uses LIFO, those are not comparable, but sophisticated users can take the information and they can make sense out of it. Now they can factor the method and they can make proper decision, but without knowing about the methods, they cannot make good comparison. Also the company must disclose information about their operation, the use of estimate. This is important, especially if we have significant estimate. How did we come up with our bad debt expense? How did you come up with our warranties? How did you come up with any other estimates that we made? Tell us how you come up with this. Is it based on past history, based on averages? How do you come up with this? And any vulnerabilities due to certain concentration, basically tell us about your risk. So those are important estimates. How did you come up with the estimates? And this is a disclosure about risk and certainty. So this is Chesapeake Corporation, operate in three business segments, which offer a diversity of product over a broad geographical base. The company is dependent on a single customer, I'm sorry, is not dependent on a single customer, a group of customer market, geographical area or supplier of material, labor or services, which is good. The financial statements include a necessary amount based on the judgment and estimate of management. So this is how they do the management, the management make the estimate. These estimates include allowance for bad debt, the cruel for landfill closing costs, environmental remediation, loss contingencies for litigation, so on and so forth. So they're telling us, how did they come up with these figures, as well as discount and other assumptions based on pension and post retirement expense? So this is a typical disclosure. Just telling us how did they come up with this? The third item that the company will have to talk about a little bit more is contractual situation. So if we have contract, how much do we have to disclose and what type of information we have to disclose? Well, contractual obligation of significance should be disclosed, if there's something, if we have a contractual obligation and it's significant, then we should disclose. What are some contractual obligation that are considered significance? Well, if you have a lease contract, tell us what are the criteria for the lease? Pension obligation. How are you computing your pension obligation? Stock compensation plan in the notes. Like if you have stock options, you're granting options. What's, how many options? What are the, what's the exercise price? How long do executives have time to come to exercise those options? So analysts want to know not only the amount of the liability, but how the liability will affect the financial statements in the present and in the future. For example, if you have an obligation, what discount rate you are using? What happened after discount rate went up or down? So more information gives the users more, more relevancy, a better decision making. And that's what we're trying to do. We should also disclose commitment, any commitment that we have if the amount is material. Now, what do you mean by commitment? We might have a commitment related to obligation to maintain a working capital. Maybe we promise a lender that we are maintaining a working capital. Maybe we have a commitment to limit payment of dividend. Well, investors wants to know this because if you have a lot of cash and on the side you have a commitment not to pay that cash and dividend, well, investors would be interested in that. To restrict use of assets. For example, you might pledging certain assets. Is there any restriction on that asset? Tell us, we're interested in that. To require the maintenance of a certain financial ratios. For example, if your current ratio has to be two, well, you're under a pressure. We need to know about this. We need to know because you're gonna be making different decision. If your current ratio is two, you have to maintain it at two or 1.5 or 2.2. The way you're gonna finance yourself that's gonna be different. That's relevant for us. So management in these situation must consider, must exercise considerable judgment, determine whether to admit something is important. Now, the rule of thumb is this. If you're not sure, disclose it. So when in doubt, it's better to disclose than not to disclose. Now, have it said so. A company like Enron, they disclose too much. Sometime the company disclosed too much that they confuse the users to a point where the users, it's like information overload and disclosure that's misleading rather than informative. So remember that disclosure has to have certain qualities and has to be good, understandable, makes sense, truthful, relevant to the users. Fair value disclosure, that's an important, very important concept because we're moving more and more toward fair value. We are reporting assets in liability that fair value, but right now, mostly financial instruments, cash ownership of interest, contractual right to receive or obligation to deliver cash or another financial instrument. Those are financial instruments like options, puts, calls, derivatives. If you have cash in foreign currency, like how did you come up with the fair value? That's important. If you have investments and stocks in other companies, are they publicly traded or not publicly traded? So how did you come up with the fair value? Simply put, how do you come up with the fair value? Now, companies are to follow the fair value and hierarchy that provide insight into how to determine the fair value. And we have three levels. Level one is the best level. It's the most reliable. And this is when you have observable inputs such as market prices for identical assets and or liabilities. Simply put here, if you own stocks in publicly traded companies, you own stocks in Apple, you own stocks in AT&T, you own stocks in Amazon. Guess what? If you own those stocks, those investments, there are public prices for those, easy to value, not a big deal. If you own a bond in Microsoft, well, bonds, Microsoft bonds are traded. You can value that bond. Level two obviously is less reliable. So as you go down, it's less reliable than level one. Measures, you measure value based on the market-based input, other than those included in level one, such as those based on market prices for similar assets and liabilities. Let's assume you own a building and you're reporting that building based on fair value now. There's no active market price for your building. I'm giving a building to illustrate the point. There is no active market price for your asset. Well, if a similar building in your environment, in your vicinity, in the city, on the block, or within a certain geographical area that's similar to yours, was sold at a certain price, you would say, well, my market value is based on that price because I'm very similar to that asset, to that other building. Or if you have a piece of land or whatever you are valuing, you would look at similar asset with similar characteristics, but this is basically indirect, like market-based input, but those are not as direct as level one, where you have an active market. Level three is the least reliable, and this is where you have to disclose the most, are based on unobservable input, such as companies' own data or assumptions. So here the company has an asset, has an investment, and there's no similar investment to it, so they cannot have level two and there is no level one, obviously, there is no level two. So the company will have to, for example, assume cash flow, then they have to do cash flow analysis. For example, and this investment, it's gonna give us 10 payments of $100,000 for the next five years, and they will have to determine an interest rate, discount those payments and find the present value. Again, the company's own data, they're determining the future cash flow, they're determining the discount rate, and they're determining the fair value. So this is unobservable. So the company must provide significant additional disclosure related to level three. So if you are saying I'm using level three disclosure, well, you better disclose a lot about how you computed this level three, because no one knows except you, so let the users know about this. Now those are the four things that we supplement the disclosure. Now how do we disclose them? Well, the communication has to be effective, how we disclose. Effective communication of the information is required in the financial statement. As I told you, Enron, they disclosed everything but was misleading. The disclosure themselves were misleading. So accountants have developed certain method that have proven useful in disclosing the information. And if you are an auditor, you'll need to be familiar with this. If you're an analyst or any users of financial statements, so you need to know what these methods are and how do you read them. And the common methods are parenthetical explanation where you can look at them notes, cross-reference and contra-items, and supporting schedule. I'll show you one example of each. But again, the best way to do this is to actually look at financial statements. So if you pull an annual report, it's gonna be full of those, but I'm just gonna just show you what to look for. This is an example of parenthetical explanation. Simply put, you have common start and here in parentheses you're telling them how many shares are issued. And now, for example, this doesn't have to be here. This could be in the notes. Okay, for example, you'd see C, note five, okay? But here they're just putting the numbers here on the face of the financial statement. So one way to do it is this way. The other way to do things is to look at the notes. For example, inventory is 2,718 notes. 2 million, 2.7 million or 2.7 billion. It's in millions, okay? Now what you do is you would say C, note 11. You go to note 11 and it will break down inventory for you how they came up with the total. So on the balance sheet, we'll show the totals on the balance sheet. So the balance sheet would only show this number. That's on the balance sheet. But we need more information and here's more information. Also, how did we come up with this? LIFO inventory method is used for most of the international paper U.S. inventories. Approximately 70% of the raw material and finished goods were valued using this method. If LIFO, notice here, even they told you a LIFO method has been used. It would have been increased total inventory balances by approximately 170 million. So even telling you were using LIFO, but if you're comparing us to a LIFO company increase 170 million to our inventory. So this is a note. A cross-reference and contra items, this is very important when you're doing audit like cross-referencing information. For example, here cash on deposit was sinking fund trustee for redemption of bonds and they say 800,000 C current liabilities. So if you go under current liabilities, you would see bond payable to redeem in 2018 C current assets, 2.3 million. So basically those information, they some complement each other. So how much cash deposit do we have? And what's our liability? And this is how much the cash deposit that we have for the bond. And this is the amount of the bond. But if you don't know how much cash that we have for this bond so far, you'd say C current assets. So it's basically they reference each other. So if you go to the bond, you would know how much cash we have. If you go to the cash, you'd say how much cash do we have for that bond? So this is cross-referencing. Contra items are, you should be familiar with contra items. Those are contra account on the balance sheet that either reduce an asset, liability or equity. Examples would be accumulated depreciation or allowance for bad debt. Allowance for bad debt reduces account receivable, accumulated depreciation reduces equipment. And discount on bonds, that's another contra liability. Also we have treasury stock as a contra liability too. Adjunct account increase either an asset or a liability or an equity account. Adjunct accounts increase the account, premium on bonds payable. For example, is reported as a plus to the bond. That's another, if you have any contra items, you will show them, you will explain them. Last but not least is supporting schedule. For example, here property, plant and equipment is $643,300. Now they said C schedule three. If you go to schedule three, which is right here, schedule three, they will have a breakdown. Yes, the total is there, but they will have the breakdown. How much did they start the year with? Land, building and equipment and other fixed asset. How much did they buy? How much did they sold during the year? How much depreciation was taken? How much depreciation retired was taken? And what's the accumulated depreciation at the end? And this is the total for each category. And this is the total. So on the balance sheet, you only see one figure. On the balance sheet, you only see this figure. But look at how much information they gave you about this figure. They gave you the beginning balances as well as the changes, then the ending balances. So more information is better for the users because they can see what's going on. Now, if you have any questions about this topic, please email me. If you want additional lectures, exercises to supplement this, please visit my website. This is intermediate accounting. I have free intermediate accounting courses and you have plenty of resources to reinforce this. If you like this recording, please like it, share it, put it in playlist, let the world know about it. Thank you very much and good luck if you're studying for your CPA exam.