Advanced Accounting Hoyle 10th Edition Solutions

Manual

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Advanced Accounting Hoyle 10th Edition Solutions Manual

Chapter 12 - Financial Reporting and the Securities and Exchange Commission

CHAPTER 12
FINANCIAL REPORTING AND THE SECURITIES AND
EXCHANGE COMMISSION
Chapter Outline
I. In the United States, the Securities and Exchange Commission (SEC), created by Act
of Congress, is responsible for ensuring that complete and reliable information
concerning publicly traded securities is available to investors.

A. Although the SEC regulates requirements created by many legislative acts, the most
significant are the Securities Act of 1933, the Securities Exchange Act of 1934, and the
Sarbanes-Oxley Act of 2002.

B. The SEC has sought to accomplish its objectives by working to achieve several goals
that include:

1. Assuring adequate disclosure of data before securities can be bought and sold,

2. Preventing the misuse of information by inside parties,

3. Regulating the operation of stock exchanges and other securities markets, and

4. Prohibiting the dissemination of materially misstated information.

C. Disclosure requirements of the SEC are contained primarily in two sets of regulations:

1. Regulation S-K establishes rules for all nonfinancial information, such as

management’s discussion of the issuer’s business activities.

2. Regulation S-X prescribes the form and content of the financial statements that are
included in the various filings.

D. The ability to establish disclosure requirements gives the SEC the ultimate authority for
accounting principles in this country, although it has generally allowed the FASB to set
official guidance.

E. The SEC's integrated disclosure system requires that most information that is reported to
the SEC must also go to the company's stockholders at various times throughout the
year.

II. As a direct result of the corporate accounting scandals exposed in 2001 and 2002,
Congress passed the Sarbanes-Oxley Act of 2002. This legislation has had a wide-
ranging impact on corporate financial reporting and the accounting profession as a
whole.

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 Chapter 12 - Financial Reporting and the Securities and Exchange Commission

A. One of the most important results of this act is the creation of the Public Company
Accounting Oversight Board.

1. This five-member board is appointed by the SEC and funded by fees assessed
against publicly traded companies.

2. The board has been given the authority to enforce auditing, quality control, and
independence standards. Such power reduces the accounting profession’s ability to
regulate itself as it has done in the past seven decades.

B. All accounting firms that audit companies with securities that are publicly traded must
register with the Public Company Accounting Oversight Board.

1. This registration process allows the new board to gather considerable information
from the public accounting firms.

2. All registered firms are subject to inspection by the Public Company Accounting
Oversight Board as often as each year.

C. The Sarbanes-Oxley Act eliminates a number of consulting services that an accounting

firm can perform for an audit client. The goal of this approach is to strengthen the
independence of the auditing profession.

D. The Sarbanes-Oxley Act also requires the audit committee of a company’s Board
of Directors to be made up of individuals who are independent of the
management. The audit committee is now responsible for the appointment and
compensation of the independent auditors.

III.Several methods can be used by the SEC to affect generally accepted accounting
principles in the United States.

A. Additional disclosure requirements.

B. Moratorium on specific accounting practices.

C. Challenging individual statements and other reporting by companies filing with the SEC.

D. Overruling the FASB (as shown by the rejection of SFAS 19).

IV. Companies that offer securities for sale to the public must meet a number of filing
requirements monitored by the SEC.

A. Registration statements are required prior to the issuance of any new security.

1. Depending on specific circumstances, specified forms are required for this purpose
(including Forms S-1, S-3, and 2-A).

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2. After completing the appropriate registration form, a company will normally receive a
letter of comments from the SEC indicating changes or explanations that are
requested.

3. Unless exempt from registration, securities cannot be sold until the registration
statement is made effective by the SEC.
B. Companies that have their securities publicly traded on an exchange must also make
regular periodic filings with the SEC. Some of the most common of these disclosure
documents are:

1. Form 10-K is an annual report presenting the company's activities and financial
position.

2. Form 10-Q contains condensed interim financial statements.

3. Form 8-K discloses the occurrence of a unique or significant happening.

4. A proxy statement (Form 14A) solicits voting power to be used at stockholders'

meetings.

V. The SEC has developed a system that allows investors to gain access to filed information
electronically over the Internet. This system is known as EDGAR and contains extensive
information and documentation relating to practically every publicly traded security.

Learning Objectives
Having completed Chapter 12 of this textbook, "Financial Reporting and the Securities and
Exchange Commission," students should be able to fulfill each of the following learning
objectives:

1. Understand the origin and expansive role of the Securities and Exchange Commission.

2. Describe the purpose(s) of various U.S. Security Laws.

3. Understand the Congressional rationale for enacting the Sarbanes-Oxley Act and the
responsibilities of the Public Accounting Oversight Board.

4. Describe the SEC’s role in establishing Generally Accepted Accounting Principles

(GAAP).

5. Define and describe an Issuer’s filings with the Securities and Exchange Commission.

6. Describe an Issuer’s registration process, various forms used by Issuers, and the
exemption(s) from registration.

Answer to Discussion Question

Is the Disclosure Worth the Cost?

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No ultimate answer exists to the question of how the SEC should weigh the costs of disclosure
versus the need for adequate information. Students often feel that the importance of the work of
the SEC is unquestioned. That is far from reality, as many business owners and investors will
advise. Businesses often resist all demands for additional disclosure as being unimportant and
not worth the cost of gathering the data. This is also far from reality.

This discussion question is intended to show the high cost to the American economy of ensuring
that adequate and fair information is available. The $400 million estimation that was made in
1975 is a staggering figure. Could investors have been appropriately protected for a smaller
amount? This question becomes especially relevant when coupled with the quotation from
George Bentson that "I found that there was little evidence of fraud related to financial
statements in the period prior to the enactment of the Securities Acts." The question is even
more interesting considering the accounting scandals that were discovered in 2001 and 2002.
These problems took place despite the presence of the SEC. On the other hand, perhaps the
disclosure and compliance is still inadequate and the cost of additional compliance will result in
future unknown benefits.

One method of approaching this question is to ask students to envision what would result if the
SEC was simply to be dissolved. How would companies entice investors into contributing
funds? What methods would companies invent to provide assurance to investors? Would more
or less money be invested? Would the allocation of resources to the various companies
throughout the country be changed? Would investors be adequately protected? How would a
new ‘start up’ company attract investors? In other words, does the work of the SEC have an
actual impact on the amount of investments that are made and the distribution of these funds to
the companies in the country?

Once the benefits of having an authority like the SEC are established, how should these
benefits be weighed against the cost of disclosure? Although $400 million (which was the
estimated cost thirty (30) years ago, is an extremely large amount, it is a very small number in
comparison to the dollars that are invested each year in the United States. Is this just the price
that must be paid to provide comfort to the investing public? Although no resolution can be
made of this question, it should provide for a good deal of class discussion.

\Answers to Questions

1. Many of the federal securities laws were passed initially in hopes of putting an end to
abuses that were present in securities trading. These problems were first brought to the
public's attention by the stock market crash in 1929. Two special concerns were the
manipulation of stock market prices in part through the dissemination of inaccurate financial
data and the misuse of information by insiders, such as corporate officers and directors.
However, the passage of legislative actions also was intended to help restore public
confidence in the capital market system that was and is so essential to the American
economy.

2. The corporate accounting scandals of this period took several forms. Some were based on
manipulating loopholes in generally accepted accounting principles to allow companies to
avoid adequately disclosing risky ventures. Others were simply fraudulent reporting of
transactions; expenses, for example, were recorded as assets to make the company’s
balance sheet(s) look better. Even others were based on the use of corporate funds for
personal benefit. The reasons for such behavior can be many and varied. Personal greed
is always a motivator. However, the need of a company to report ever-increasing profits in a
stock market that was rising at an amazing speed during the mid and late 1990s put
significant pressure on many executives. In hindsight, the lack of adequate safeguards in

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place at corporations, at accounting firms, and even at the SEC must also be considered as
playing a role in creating an environment where such practices were allowed to take place.

3. The Sarbanes-Oxley Act has numerous provisions, almost all of which are designed in one
way or another to restore public confidence. Several of those provisions include:

▪ A Public Company Accounting Oversight Board has been created to enforce and
regulate auditing, quality control, and independence standards.
▪ All accounting firms that audit publicly-held issuers of securities must register with the
Oversight Board and provide detailed information about their operations.
▪ All registered firms must be inspected by the Oversight Board to ensure adequate quality
control in their audit work.
▪ Registered firms are prohibited from providing certain consulting services to audit clients.
▪ Corporate audit committees must be composed of members of the Board of Directors
who are independent of management.
▪ Audit committees must have authority to employ and compensate the independent
auditors.

4. The Sarbanes-Oxley Act gives the SEC the power and responsibility to oversee the work of
the Public Company Accounting Oversight Board. For example, the five board members are
appointed by the SEC.

5. According to the Sarbanes-Oxley Act, accounting firms are only required to register with the
Public Company Accounting Oversight Board if they prepare, issue, or participate in the
preparation of an audit report for an “issuer.” An issuer is defined by the Act but normally
refers to any organization issuing securities to the public.

6. Registration with the PCAOB forces the accounting firm to (a) provide a significant amount
of information about its operations, (b) have its activities open to inspection by the Public
Company Accounting Oversight Board, and (c) be subject to the rulings and authority of this
Board.

7. The Sarbanes-Oxley Act gives the Public Company Accounting Oversight Board authority
over auditing independence rules. Therefore, all future changes made by this body will be
an indirect result of the legislation. Moreover, the Sarbanes-Oxley Act specifically
eliminated the accounting firms’ ability to provide certain non-attestation services to their
audit clients. It further required that audit committees be made up of members of an
organization’s Board of Directors who are independent of management. The audit
committee must then be responsible for the appointment and compensation of the
independent auditors.

8. Prior to the Sarbanes-Oxley Act, most accounting firms were required to undergo periodic
peer reviews of their audit documentation and their quality control procedures. However,
those reviews were largely done by one firm on another and, given the accounting scandals
discovered during 2001 and 2002, apparently did not do enough to ensure the quality of
audit work. The new inspection process will be carried out under the authority of the Public
Company Accounting Oversight Board. That inspection process will attempt to create a
process that goes further in making certain that every firm does quality work on

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every engagement.

9. "Regulation S-K" establishes disclosure and other reporting requirements for the
nonfinancial information that is contained in filings with the SEC.

10. "Regulation S-X" prescribes the form and content of the financial statements, notes, related
schedules, and any other financial information included in the various reports filed with the
SEC.

11. The Securities and Exchange Commission is composed of more than a dozen divisions and
major offices. These include the following:
— Division of Corporation Finance—ensures that standards for reporting and disclosure are
followed.
— Division of Market Regulation—regulates national securities exchanges and investment
brokers and dealers.
— Division of Enforcement—supervises investigations and directs enforcement activities.
— Office of the Chief Accountant—responsible for accounting and auditing matters in
connection with the securities laws.
— Office of Compliance Inspections and Examinations—verifies compliance by brokers,
dealers, and investment companies.

12. The Securities Act of 1933 regulates the initial offering of securities by a company or its
underwriters. This Act is often referred to as the “truth in securities act” and it is the statute
that now governs the issuers’ registration statements.

13. The Securities Exchange Act of 1934 regulates the subsequent buying and selling of
securities through brokers and exchanges. This regulation extends to virtually all aspects of
the resale of non-exempt securities.

14. The goals of the SEC are many. However, the most prominent goals are as follows:
— Ensuring that full and fair information is disclosed to all investors before securities can be
exchanged.
— Prohibiting the use of materially misstated information.
— Preventing the misuse of information, especially by parties inside of the company.
— Regulating the operation of securities markets.

15. Information to be included in proxy solicitation material includes the following data:
— Five-year summary of operations including sales, total assets, income from continuing
operations, and cash dividends per share.
— Description of business activities.
— Three-year summary of industry segments, export sales, and foreign and domestic
operations.
— A list of the directors of the company and its executive officers.
— Market price of the company's common stock for each quarterly period within the two
most recent years.
— Restrictions on the company's ability to continue dividend payments.
— Management's discussion and analysis of financial conditions, changes in financial
condition, and results of operations.
— All nonaudit services provided by the company's independent auditors.

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— Statement as to whether the board of directors approved all nonaudit work of the
independent auditors.
— Percentage of nonaudit fees paid to the independent auditors in relation to total annual
audit fees.
— Individual nonaudit fees that are larger than 3 percent of the annual audit fee.

16. A proxy statement is a request made to stockholders for the right to cast their votes at
stockholders' meetings. Obviously, the control of the entire company will rest with any group
that is able to get a majority of votes through proxy agreements. Thus, the proxy statements
are important because they are used in determining the control and direction of the company.

17. Any change made by the SEC in its Regulation S-X, the financial reporting regulation, will
have a direct impact on the form and content of the financial reporting of the publicly-held
companies in this country. Thus, the Commission has the ability to dictate generally
accepted accounting principles. In addition, Financial Reporting Releases are issued by the
SEC to explain changes to be made in accounting. Staff Accounting Bulletins are also
prepared to explain views on current reporting matters.

The SEC has historically limited the use of its authority over generally accepted accounting
principles to (1) disclosure issues and (2) areas of accounting where authoritative guidance
was thought to be lacking. For example, additional disclosure of specified matters may be
required in areas deemed important by the SEC. The Commission can also prohibit
practices that are not thought to be appropriate, especially where official guidance is not
available.

18. Financial Reporting Releases are issued by the SEC to explain desired changes in reporting
requirements. FRRs are used to supplement Regulations S-X and S-K. Staff Accounting
Bulletins inform the financial community of views on current matters relating to accounting
and disclosure issues.

19. Prior to 1977, the SEC had restricted the use of its accounting authority primarily to
disclosure requirements and areas of financial reporting where authoritative guidance was
not available. The FASB (and its predecessors in the private sector) had been allowed to
establish generally accepted accounting principles in the U.S. The setting of accounting
standards was viewed as a process that should be based on theory and research rather
than being subjected to government edict. However, when the SEC overruled the FASB's
method of reporting unsuccessful exploration costs incurred by gas and oil producing
companies, several important precedents were set. The government (through the SEC)
showed that it was willing to become a more active participant in setting rules for the
accounting profession. The FASB (and other authoritative bodies) then had to be more
concerned about pleasing the government prior to establishing standards. Many concerns
were raised at the time (as well as since then) as to whether the development of generally
accepted accounting principles should be at the mercy of the federal government.

20. Registration statements are designed to disclose and make available adequate relevant
data about both a company and its new stock or bond (security) before the security can be
issued to the public.

21. Disclosure of sufficient information – Registration Statement disclosure - is required by the

Securities Act of 1933.

22. Part I of a registration statement is called a prospectus and must be furnished to every
potential buyer of the securities to be issued. It contains information such as financial

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statements and supplementary data, an explanation of the intended use of the money being
raised, a description of the capital structure of the company, and a description of the
business and the properties that it holds.

Part II of the registration statement provides information that is needed by the SEC staff.
Part II includes data such as marketing arrangements for the new securities, the expenses
of the issuance, sales to special parties, and the like.

23. Revenues are raised by the SEC through a registration fee for shares being initially issued.
In 1999, this fee was .0264 of 1 percent of the value of the securities offered.

24. In the filing of registration statements, a number of different forms are available depending
upon the circumstances. Of these forms, these two are especially common:

— Form S-1 which is used by new registrants or by companies that have filed with the SEC
for less than 36 months;
— Form S-3 which is completed by larger companies, including foreign issuers that have
filed with the SEC for a considerable length of time and have a significant following in the
stock market. Form S-3 permits incorporation of other documents by reference. This
permits inclusion of significant data concerning the Issuer, where the data has appeared
in other filings.

25. Incorporation by reference is a process allowed when preparing filings with the SEC, and
often other governmental agencies. It is intended to reduce the quantity of redundant
information that must be processed. When data is required that has already appeared in a
previous filing, the company need only refer to the earlier disclosure rather than repeat the
information.

26. A pre-filing conference is a meeting between a prospective registrant and the staff of the
SEC in hopes of resolving potential problems that may be expected to arise in an upcoming
filing. The reporting and disclosure of complicated financial transactions may be discussed
by the parties. The conference may also be used to determine the appropriate handling of
unusual problems.

27. A letter of comments (which is also known as a "deficiency letter") is issued by the SEC to a
filing company after a registration statement has been reviewed. The letter lists changes and
additional disclosures that the SEC feels are necessary before the registration statement
can be made effective.

28. A prospectus is the first part of a registration statement, the portion that has to be furnished
to every potential buyer of a new security. The prospectus discloses a significant amount of
specified information about the issuing company as well as about the new security. For
example, the financial statements of the company must be included along with a description
of current business operations. The prospectus also informs potential buyers of the intended
use of the new funds and the capital structure of the company.

29. Certain new security issues are exempt from the registration requirements monitored by the
SEC. For example, securities sold within a single state are normally not subject to these
federal laws. In addition, the securities of banks, savings and loan associations, and
governments do not come under the Securities Act of 1933. Several other offerings are also
exempt from completing formal registration statements although other legal filings may be
required:

Private placements to a limited number of sophisticated investors;

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Securities issued to current stockholders without a commission being paid (usually a

stock dividend);
Securities issued by nonprofit organizations;
Small offerings of no more than $5 million;
Offerings of no more than $5 million made to 35 or fewer purchasers (and an
unlimited number of accredited investors).

30. Private placements of securities have become extremely popular in recent years because
they are exempt from the registration requirements of the SEC. The securities are issued to
no more than 35 sophisticated investors (identified as having knowledge and experience in
financial matters) who already have sufficient information available to them about the issuing
company. The securities can also be issued to an unlimited number of accredited investors
(such as banks, insurance companies, and individuals with a net worth of more than $1
million). General solicitation is not permitted.

31. Blue sky laws are securities laws enforced by individual states. In contrast to federal
securities laws, blue sky laws usually apply only to sales that are restricted to a particular
state.

32. A wrap around filing is one in which a company uses its annual report to shareholders to
fulfill reporting requirements of the SEC in a Form 10-K. Rather than repeat the information
within the Form 10-K, incorporation by reference is used to direct the SEC to the location of
the required data in the annual report.

33. Form 8-K is not issued on a regular basis but only when disclosure of a unique or significant
occurrence is to be made. Thus, a company has some choice as to the necessity of issuing
a Form 8-K. The SEC does, however, list several events that require disclosure in this
manner:

—resignation of a director;
—change in control of the company;
—acquisition or disposition of assets;
—changes in independent accountants;
—bankruptcy or receivership.

34. The Management's Discussion and Analysis (MD&A) is a narrative description of the
company's past, its present, and its future. The management describes its priorities,
accomplishments, and concerns. In many cases, the MD&A allows the management to
share information with owners and other interested parties that would not otherwise be
conveyed.

35. The Form 10-K is an annual report (financial statements and related information) whereas
the Form 10-Q contains condensed interim financial statements.

36. The EDGAR system is intended to allow companies to file information with the SEC in an
electronic format and then make that information available on-line to all interested parties.

Answers to Problems

1. D – A is false because intrastate offerings are typically exempt from

registration; B is false because the 1934 Securities Act regulates post-issuance
trading of securities; and C is false because blue sky legislation is state law.

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2. B – Remember that regulation S-X focuses upon financial information

disclosure.
3. C – Regulation S-K addresses non-financial information filed with the SEC
while Regulation S-X addresses the form and content of financial documentation
filed with the SEC.
4. A – Remember that the 1933 Act deals with Registration and the 1934 Act
deals with Regulation.
5. C – Not all auditing firms are required to register with the PCAOB, only those
firms that prepare, issue, or participate in the preparation of an audit report for an
issuer.
6. C – The SEC appoints the five (5) PCAOB members.
7. B – Selection of the auditor and approval of the related contract, including the
fees, is done by the firm’s audit committee. This committee must be composed
of members of the client’s board who are independent of management.
8. A – The 1933 Act deals with the requirements for registration of a security
prior to its initial offering.
9. D – S-3 is the form for registering securities if / when the issuer already has a
significant public market following.
10. D – The SEC’s 1977 stand vis-à-vis oil and gas accounting principles was a
unique situation wherein the SEC overruled the FASB as far as proper accounting
treatment.
11. C – Recall that the letter of comments / deficiency letter relate to the SEC’s
response subsequent to an issuer’s filing of a Registration Statement.
12. B – This is a useful approach to referencing data which has already been
provided to the SEC, or other agency, so that the data is not redundantly
produced.
13. A - Recall that the letter of comments / deficiency letter relate to the SEC’s
response subsequent to an issuer’s filing of a Registration Statement.
14. D – The prospectus must be furnished to all potential new security buyers and
is provided to the SEC as part of the registration statement filing.
15. C – Smaller public offerings of less than $5 million may be exempt from
registration, however, $5.9 million exceeds this threshold.
16. B – A prospectus is filed only in connection with the initial offering of a
security. Therefore it is not ‘regularly’ filed with the SEC, unless the issuer is
‘regularly’ issuing new securities.
17. C – Shelf registrations consist of registering securities in advance so that a
large issuer may subsequently offer the securities without the need of additional
SEC approval.

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18. C – EDGAR = Electronic Data Gathering Analysis and Retrieval system.

19. (20 Minutes) (Series of questions about securities regulations).
a. Blue Sky Laws—Individual state laws that regulate the issuance of
securities when the transactions are limited to the residents of the state in
which the issuing company is organized and principally doing business.
Such securities are exempted from regulation by federal securities laws.
b. S-8 Statement—A registration statement that must be filed with the SEC and
made effective by that body before a company can issue securities in
connection with employee stock plans.
c. Letter of Deficiencies—A request by the SEC for changes, explanations, or
more information before a registration statement is made effective. The
Division of Corporation Finance of the SEC reviews the registration
statement and provides the company with a letter of deficiencies so that the
company will be able to furnish the additional data needed or make the
appropriate changes. This is also referred to as a Letter of Comment or
Comment Letter.
d. Public Company Accounting Oversight Board—This five (5) member Board
was created by the Sarbanes-Oxley Act of 2002 as a result of the corporate
accounting scandals that rocked the stock market and the investing
community during 2001 and 2002. This Board falls under the jurisdiction of
the SEC and has wide-ranging responsibilities from the registration of
accounting firms and the inspection of these same firms to the
establishment of auditing, quality control, and independence standards.
e. Prospectus— The prospectus is the first part of a registration statement that
contains financial statements for the company and indicates the use to be
made of the money received from the sale of the securities, the capital
structure of the company, and a description of the business and its
properties. Every potential buyer of the new security must be furnished with
a prospectus.

20. (20 Minutes) (Discussion of the Securities Act of 1933 and the Securities
Exchange Act of 1934)

The Securities Act of 1933 and the Securities Exchange Act of 1934 were
passed to help rebuild confidence in the capital market system of the United
States. Economic development in this country is based on generating large
amounts of monetary capital through the issuance of stocks and bonds. To
entice sufficient investment, public trust in the integrity of the system must be
maintained. Following the stock market crash of 1929, public confidence
reached a low level. Federal securities laws were subsequently passed in
hopes of achieving several objectives designed to restore trust in the capital
markets. Several aspects of these laws should be noted:

— Companies were required to supply adequate information to potential

buyers before a new security could be issued.

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— Companies having publicly traded securities were required to maintain an

adequate and continual flow of information to the public.
— Stock markets were to be regulated.
— Manipulation of stock market prices was to be eliminated.
— The use of inside information by corporate officials and directors was made
Illegal.

To help achieve these goals, the Securities and Exchange Commission (SEC)
was created to monitor the capital market system. For example, registration
statements had to be filed with the SEC before new stocks or bonds could be
issued to the public. These statements were reviewed and could not become
effective until all necessary disclosures and financial information were
properly presented. Periodic filings (such as Form 10-K and Form 10-Q) were
also required of companies having securities that were publicly traded.
Because of its ability to require specific types of financial information, the SEC
has the ultimate authority to develop generally accepted accounting principles
in this country. The SEC also has the power to investigate possible
misconduct in connection with corporate reporting and to seek prosecution
where necessary.

21. (15 Minutes) (Description of the registration process)

In filing a registration statement for a new security, a company must first

select the appropriate SEC Registration form. For example, Form S-1 is used
by new registrants while Form S-3 is filed by large companies that already
have a significant following in the securities markets. Appropriate disclosures
and other required data are then prepared in accordance with Regulation S-K
and Regulation S-X. When the SEC receives the completed form, it is put
through a review. All nonfinancial and financial information are verified
against various standards. Legal aspects of the document are also checked
along with the report of the independent auditor. A letter of comments
(commonly referred to as a "deficiency letter") is prepared by the SEC to
indicate changes and added disclosures that are considered necessary. The
registrant has the right to discuss these issues with the SEC staff if company
officials disagree with any part of the letter of comments. After the SEC is
satisfied that the registration statement fulfills all rules, it is made effective.
The first part of this document, the prospectus, must be made available to any
potential buyer of the new security.

22. (10 Minutes) (Discussion of the SEC's influence on generally accepted

accounting principles)

The SEC has far-ranging authority over the accounting principles in this
country. Through its ability to modify Regulation S-X, the SEC holds the power
to alter the financial reporting of publicly-traded companies. The SEC has
historically chosen to limit such changes to disclosure requirements with the

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creation of accounting principles being left to the FASB (and its predecessors)
Thus, the private sector of the accounting profession had been given de facto
responsibility for developing generally accepted accounting principles.
Although occasionally the object of criticism, this system (theoretically)
allows accounting standards to be the result of research and study rather than
government edict. However, the SEC has often acted in accounting areas
where clear authoritative guidance was not available. In such cases, additional
disclosure may be required or the Commission can decide to restrict or even
prohibit a particular accounting procedure. The SEC did overrule in 1977 the
FASB's method of accounting for unsuccessful exploration and drilling costs
incurred by gas and oil producing companies. This action set several
important precedents. First, it reaffirmed the SEC's ability to be involved in the
standards-setting process. Second, notice was served to the FASB that the
private sector needed to make certain that the SEC was satisfied prior to
issuing new pronouncements.

23. (10 Minutes) (Listing of forms that are filed with the SEC on a regular periodic
basis)

Numerous forms may have to be filed regularly with the SEC by a publicly-held
company. Four of these forms (Form 10-K, Form 10-Q, Form 8-K, and proxy
statements) are most commonly encountered.

— Form 10-K is an annual report filed shortly after a company's year-end.

— Form 10-Q contains condensed interim financial statements and must be
filed after the end of each quarter, other than the year-end quarter – because
the 10-K is filed after the year-end quarter.
— Form 8-K is only filed when needed to disclose the occurrence of a unique
or significant event such as the resignation of a director, changes in
control, acquisition or disposition of assets, changes in independent
accountants, and bankruptcy. Depending upon the frequency of these
‘unique’ events, the Form 8-K may not actually be filed regularly or
periodically.
— Proxy statements (Form 14A) are requests for the right to cast a
stockholder's votes at annual (or other) meetings. Included in the
information that must be provided are financial statements, disclosure of
matters that are to be voted on, and an identification of the party making the
solicitation.

24. (5 Minutes) (Describe the forms used to file with SEC for registration
purposes)

Some of the most commonly used forms for registering securities to be

offered to the public are as follows:

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— Form S-1—for new registrants or companies that have been filing with the
SEC for less than 36 months. This form is used when no other form is
prescribed.
— Form S-3—for larger companies that already have a significant following in
the stock market.
— Form S-4—for securities issued in connection with business combinations.
— Form S-8—for securities issued in connection with employee stock plans.
— Form S-11—for securities issued by various real estate companies.
— Form SB-1—used by small businesses to register up to $10 million of
securities.
— Form SB-2—for small businesses.
— Form F-3—for a foreign issuer.

25. (10 Minutes) (Discussions of the Form 8-K and proxy statements)

The Form 8-K is designed to ensure the immediate disclosure by a company of

any unique or significant event. Thus, any interested parties are able to obtain
needed information without having to wait for a quarterly or annual statement.
The filing of the Form 8-K must generally be made within 15 days of the
occurrence. Events that necessitate the filing of a Form 8-K are left to the
discretion of the company and its management. However, the SEC does list
several circumstances that require such disclosure including the resignation
of a director, change in control of the company, acquisition or disposition of
assets, change in independent auditors, and bankruptcy.

A proxy statement is the package of information that must accompany the

request made to a stockholder for the right to cast that owner's votes at a
stockholders' meeting. Since obtaining a significant number of proxies would
allow an individual or company to influence or control an organization, the
request for proxy rights is closely monitored by the SEC. The proxy statement
has to be filed with the SEC before being distributed and must include
specified information such as:
—an annual report,
—a disclosure of all matters that will be voted upon at the meeting, and
—an identification of the party or parties making the solicitation.

26. (10 Minutes) (Describe responsibilities of the Public Company Accounting

Oversight Board)

The Sarbanes-Oxley Act of 2002 is a wide-ranging piece of legislation that

covers a large number of different areas of corporate financial reporting.
Much of this Act deals with the establishment of the Public Company
Accounting Oversight Board (PCAOB). The PCAOB is created / addressed in
Title I of the Act.

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Chapter 12 - Financial Reporting and the Securities and Exchange Commission

The PCAOB will now be in charge of all auditing, independence, and quality
control standards for the accounting profession. PCAOB has the legal
authority to write such rules and / or to simply oversee the work done by the
profession (through the Auditing Standards Board and the AICPA). The
ultimate authority for such rules now lies clearly with the PCAOB as illustrated
at Title I, Sec. 103(a)(1) of the Act.

All accounting firms that prepare, issue, or participate in the preparation of an

audit report for an issuing organization will now have to register with the
PCAOB in order to continue providing such services. This registration
provides the PCAOB with the ability to gather an almost unlimited amount of
information about the firms such as disagreements with audit clients, annual
fees from both audit and nonaudit services, and the like.

The PCAOB must periodically inspect the work of each of the registered
accounting firms. The depth and breadth of this inspection will ultimately
probably encompass both audit documentation and compliance with quality
control standards. Large firms may undergo annual inspection whereas
smaller firms will only be inspected every three years.

27. (20 Minutes) (Discussion of financial reporting and the SEC)

a. Staff Accounting Bulletins—According to the website (www.sec.gov) of the

Securities and Exchange Commission, “Staff Accounting Bulletins reflect
the Commission staff’s views regarding accounting-related disclosure
practices. They represent interpretations and policies followed by the
Division of Corporation Finance and the Office of the Chief Accountant in
administering the disclosure requirements of the federal securities laws.”
b. Wrap around filing—the process of using the annual report furnished to
shareholders to fulfill many of the requirements of the Form 10-K to be filed
with SEC. The company simply indicates the location of the required
information (a process known as incorporation by reference) within the
annual report.
c. Incorporation by reference—using information in one document filed with
the SEC to fulfill other reporting requirements. In this manner, the amount of
redundant information being reported is reduced. This process is usually
part and parcel of a wrap around filing.
d. Division of Corporation Finance—a division of the SEC that establishes
standards of reporting and disclosure. This division also reviews the
registration statements that are filed with the SEC and issues any needed
letters of comments.
e. Integrated disclosure system—the use of information that is being given to
stockholders to meet the filing requirements of the SEC.
f. Management's discussion and analysis—an inclusion in the Form 10-K that
serves as the management's description of its priorities, accomplishments,
and concerns. The narrative describes the company's past performance,
present condition, and future direction.

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Chapter 12 - Financial Reporting and the Securities and Exchange Commission

g. Chief accountant of the SEC—the office of the SEC that is ultimately

responsible for all accounting and auditing matters that involve the
securities laws.

28. (10 Minutes) (Listing of organizations that are exempt from the registration
requirements of the SEC)

— Governments
— Banks
— Savings and loan associations
— Companies that restrict the exchange of their securities to within one state
— Companies that restrict an issuance to its own stockholders where no
commission is paid to solicit the exchange
— Nonprofit organizations
— Companies that make small offerings of no more than $5 million (although a
Regulation A offering circular must still be filed)
— Companies that make offerings of no more than $1 million to any number of
investors within a 12-month period.
— Companies that make small offerings of no more than $5 million to 35 or
fewer purchasers and an unlimited number of accredited investors.
— Companies making private placements to no more than 35 sophisticated
investors.

Develop Your Skills

RESEARCH CASE 1

The purpose of this question is to allow the student the opportunity of working
with the actual regulations posted on the SEC web site. The URL given in the
problem will take the student to the entire set of rules set out under Regulation A
– for Conditional Small Issue(s) Exemptions. This information covers topics such
as offering statements, offering circulars, and the filing of sales material. The
student can literally read through the entirety of Regulation A in about fifteen (15)
minutes

For this assignment, the student should probably focus on the heading “Scope of
Exemption.” This reference provides several pages of information on the
exemption from filing a registration statement that is provided to companies by
Regulation A. There are a number of issues that the student might want to report
on in connection with this question:

— Where does the company have to be legally incorporated? (The U.S., Canada,
or one of the territories or possessions of the U.S.)

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— What is the total amount that can be received for the securities being issued?
(Not more than $5 million)
— When both cash and non-cash consideration are received, how is the total
amount of consideration determined? (It is based on the cash price)
— What filing must be made with the SEC? (In most cases, a Form 1-A. The
student can click on the link and see a complete copy of Form 1-A)
— Can advertisements of the securities be made? (Yes, published ads as well as
radio and television ads are allowed as long as only specified information is
included)

If Domer Corporation is a development stage company, the exempt provisions of

Regulation A may not apply. Specifically, Reg. Sec. 230.251 (a) (3) provides that
the exemption is not available to “a development stage company that either has
no specific business plan or purpose, or has indicated that its business plan is to
merge with an unidentified company or companies”. Thus Domer’s status as a
development stage company, depending upon the status of its business plan,
may preclude its use of the Regulation A exemption.

RESEARCH CASE 2

The SEC v. Calvo case involves a situation similar to the fact pattern in this
research case. The student is directed to this case because of the many
similarities. Use of legal / case research is a very valuable skill for accounting
students and practitioners as courts ultimately interpret vague rules, regulations,
statutes, and definitions. As was suggested in the text, the definition of ‘security’
is very broad.

The 1933 Securities Act defines ‘security’ very broadly to include investment
contracts. Investment contracts involve: (i) an investment of money or other
consideration; (ii) for a common enterprise or undertaking; and (iii) with the
expectation of profits to be derived from the efforts of others.

In the instant example, the Tasch Corporation will ‘manage’ the customer’s
enterprise, the customer’s are investing money, and the customers are expecting
a profit – ie: the guaranteed return. A court would very likely conclude that the
“service agreements” constitute an investment contract and thus a security. The
next issue / question to address is whether the Tasch Corporation can / will be
able to structure the issuance of these securities in a manner to avoid the
registration requirements.

ANALYSIS CASE 1

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Chapter 12 - Financial Reporting and the Securities and Exchange Commission

This assignment requires the student to utilize the EDGAR database to find
recent company filings by any publicly-held company. The results that a student
gets will depend on the company name that is entered. The student may actually
be overwhelmed by the amount of filings that a company must make with the
SEC. For example, a search for Dell would display more than thirty-five (35)
filings in just the first nine (9) months of 2009.

a. A number of 8-K forms can be found for most companies. Companies now
tend to err on the side of over-disclosure with regard to 8-K filings, many of which
merely incorporate by reference various press releases or other publicity-related
filings. The specific content of the 8-K each student locates will depend on when
the student completes the case analysis.

b. A further investigation of the Dell filings leads to a Form 10-K issued on March
26, 2009, that contains many attachments including the annual report for 2008.
This Form 10-K provides extensive information to supplement the data normally
reported to shareholders.

c. Finally, a definitive proxy statement can be located for Dell (DEF 14-A), as of
June 1, 2009 that contains (among other information) the following letter:

NOTICE OF ANNUAL MEETING

AND
PROXY STATEMENT
2009

June 1, 2009

Dear Fellow Stockholders:

On behalf of the Board of Directors, it is my pleasure to invite you to Dell’s 2009 Annual Meeting of
Stockholders. The meeting will be held on Friday, July 17, 2009, at 8:00 a.m. Central Daylight Time, in
Ballrooms B and C of the Austin Convention Center, 500 E. Cesar Chavez, Austin, Texas 78701. For
your convenience, we are also offering a Webcast of the meeting. If you choose to view the Webcast, go
to www.dell.com/investor shortly before the meeting time and follow the instructions provided. If you miss
the meeting, you can view a replay of the Webcast on that site.

You will find information regarding the matters to be voted on in the attached Notice of Annual Meeting of
Stockholders and Proxy Statement. We are sending many of our stockholders a notice regarding the
availability of this proxy statement, our Annual Report on Form 10-K for Fiscal 2009 and other proxy
materials via the Internet. This electronic process gives you fast, convenient access to the materials,
reduces the impact on the environment and reduces our printing and mailing costs. A paper copy of these
materials can be requested using one of the methods described in the materials.

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Chapter 12 - Financial Reporting and the Securities and Exchange Commission

You may visit www.dell.com/investor to access an interactive Fiscal 2009 Year-in-Review, as well as
various web-based reports, executive messages and timely information on Dell’s global business.

This meeting is for Dell stockholders. To attend the meeting in person, you will need an admission ticket
or an account statement showing your ownership of Dell stock as of May 22, 2009, and proper photo
identification. An admission ticket can be printed at www.proxyvote.com, or is included in the proxy
materials if you received a paper copy of the proxy materials.

Whether or not you plan to attend the meeting in person, please submit your vote using one of the voting
methods described in the attached materials. Submitting your vote by any of these methods will not affect
your right to attend the meeting and vote in person should you so choose. However, if your shares are
held through a broker or other nominee, you must obtain a legal proxy from the record holder of your
shares in order to vote at the meeting.

If you have any questions concerning the meeting, please contact our Investor Relations Department at
512-728-7800 or Investor_Relations@dell.com. For questions regarding your stock ownership, you may
contact our transfer agent, American Stock Transfer & Trust Company, at 800-937-5449 or
www.amstock.com.

Sincerely,

Michael S. Dell
Chairman of the Board and Chief Executive Officer

This is the kind of information that students often have not had the opportunity to
access unless they have explored the SEC web site.

Communication Case 1

Here, the student is asked to investigate and review that actual statutory
components of the Sarbanes-Oxley Act of 2002. This Act encompasses
approximately seventy (70) pages and contains an extensive list of requirements
for auditors covered by the Statute.

The first issue to consider for the Wojtysiak firm is whether it is presently
required to register with the Public Company Accounting Oversight Board
(PCAOB). It is not, however, if the Wojtysiak firm becomes the audit firm for the
new publicly traded client (and ‘issuer’) then the firm will likely be required to
register and then be subjected to additional disclosures and inspections, most
likely on a triennial basis. Additionally, the Wojtysiak firm will need to carefully
consider what services it can offer to the new client in light of the Sarbanes-Oxley
independence requirements.

The student will most likely wish to consider and incorporate the following
provisions of the Act.

▪ Section 102 – Registration with the Board.

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Chapter 12 - Financial Reporting and the Securities and Exchange Commission

▪ Section 103 – Auditing, quality control, and independence standards and

rules.
▪ Section 104 – Inspections of registered public accounting firms.
▪ Section 108 – Accounting standards.
▪ Section 201 – Services outside the scope of practice of auditors.
▪ Section 203 – Audit partner rotation.

The student should be able to write an extensive report on the impact of

Sarbanes-Oxley on the Wojtysiak firm, based on these and other provisions of the
Act.

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