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Foundation for New Era Philanthropy, Lincoln Savings , and Loan, Orion Pictures, International Harvester. They're all bankrupt. And this disparate collection shares something else in common: their bankruptcies were all surprises. Part of the fault for this lies in the failure of our financial reporting system to provide early warnings of impending trouble.
Historically, our system has focused on the measurement of assets, liabilities and income. Accountants hope these measurements help users predict the future but, until recently, we have rarely provided any disclosures that directly alert readers to upcoming problems and risks.
Iri the early 1990s the FASB partially addressed this oversight by requiring disclosures of off-balance sheet risks and concentrations of credit risks. In addition, the SEC mandated extensive discussions of risks in the Management's Discussion and Analysis section of the 10-k. Both the FASB and the SEC requirements focus on financial risks, e.g., undiversified financial asset portfolios or possible liquidity problems. Little was disclosed about operating risks.
A recent pronouncement issued by the Accounting Standards Executive Committee (AcSEC) addresses this void. On December 30,1994, the AcSEC issued Statement of Position (SOP) 94-6, Disclosure of Certain Significant Risks and Uncertainties. SOP 94-6 mandates disclosures in four areas: (1) the nature of a company's operations, (2) the role of estimates in the preparation of financial statements, (3) risks due to estimates used in the preparation of financial statements and (4) risks deriving from concentrations in the operating environment of the company. This article will examine the reporting requirements in these four areas.
Before we begin, we should briefly discuss the applicability and authority of SOP 94-6. Some of the disclosures required by the SOP are already called for by SFAS No. 5, Accounting for Contingencies, and SFAS No.14, Financial Reporting by Segments of a Business Enterprise. The reporting and disclosure requirements contained in these documents, however, largely apply to companies that are either of a certain size or are publicly traded. SOP 94-6 extends many of the disclosure requirements contained in these pronouncements to all companies and not-for-profit entities and, in addition, expands the amount of information disclosed.
The FASB identifies SOPs as an integral part of GAAP, falling just behind FASB statements and interpretations in authority. Accordingly, SOP 94-6 does not contradict...