What are Financial Statement Notes?
Financial statement notes are the supplemental notes that are added to the published financial statements of a company. The notes are used to explain further the numbers included in the financial statements, as well as the accounting policies adopted by the company. They help different types of users, such as financial analysts and investors, to interpret all the numbers added in the financial statements.
When conducting an audit of the financial statements, the auditor conducts a thorough investigation of all the information contained in the financial statements, including the footnotes. Auditors use the footnotes to determine how the adopted accounting policies impact the reported results and the actual position of the company.
The footnotes may also provide information on underlying issues relating to the overall financial health of the company. The auditor bases his audit opinion on the financial statement numbers, as well as the explanatory notes.
- Financial statement notes refer to the additional notes included in the financial statements of a company,
- The notes are used to make important disclosures that explain the numbers in the financial statements of a company.
- Common notes to the financial statements include accounting policies, depreciation of assets, inventory valuation, subsequent events, etc.
Common Notes to the Financial Statements
The following are the common items that may appear in the notes to the financial statements:
1. Basis of presentation
The first section in the financial statement notes explains the basis of preparing and presenting the key financial statements.
2. Accounting policies
The accounting policies section provides information on the accounting policies adopted by the management in preparing the financial statements. Disclosing the accounting policies helps users interpret and understand the financial statements better.
Some of the disclosures included here are the depreciation method used, how the company values inventory, accounting for intangibles, etc. All the accounting policies adopted in the financial statements must be disclosed in the section.
3. Depreciation of assets
Depreciation refers to the reduction in the value of an asset over time due to normal wear and tear. The asset depreciation section provides information on the method adopted by the company when depreciating the assets.
Depending on the depreciation method used, there may be significant fluctuations between the net income in the income statement and the value reported in the balance sheet. Providing information on the depreciation method in the footnotes informs the users of the differences in net incomes reported in the financial statements.
4. Valuation of inventory
The valuation of inventory note informs users how the company valued its inventory, making it easy for them to compare inventory figures from one period to another or vis-à-vis other competing entities. The section provides information on two main inventory issues, i.e., how inventory amount is stated and the method used to determine inventory cost.
GAAP rules require companies to state their inventory lower of cost or market (LCM). It means that the company will value the inventory at the lowest replacement cost, which can be either the wholesale cost of inventory or the cost of the inventory in the market. On the method of determining inventory cost, GAAP allows three different assumptions, which include the weighted average, specific identification, and the first-in, first-out (FIFO) method.
5. Subsequent events
Information on any subsequent events can be found also in the financial statement notes section. Subsequent events refer to events that occur after the balance sheet date but before the release of the financial statements. How the company handles the events depends on whether they are recognized or unrecognized.
Recognized events are events that affect the financial statements, and, therefore, require changes to be made to the financial statements. On the other hand, unrecognized events have not been captured as of the balance sheet date and, therefore, do not affect the financial statement being issued.
An example of an unrecognized event is the sale of a company’s division or theft of a machine in the factory. Unrecognized events should be disclosed in the footnotes since they do not require an adjustment of the financial statements.
6. Intangible assets
The notes to the financial statement also include information on any intangible assets owned by the company. Intangibles are assets that have no physical form, and they include trademarks and patents. The section details all the intangible assets that the company owns and how it determined the value of intangibles reported on the balance sheet.
7. Consolidation of financial statements
The consolidation of financial statements section confirms that the statements under audit or being issued contain financial statements of all of the subsidiaries of the company. It details the basis of consolidating the financial statements, and any deviations from the subsidiaries should be explained.
8. Employee benefits
The employee benefits section of the footnotes mentions the benefits that the company provides to its employees, including health insurance, health savings accounts, retirement plans, etc.
Some of the information that a company should disclose in the footnotes include the health and welfare plans for its employees, such as the medical, vacation, and fringe benefits. It should also provide information about the paid and unpaid expenses and liabilities for employee retirement plans, including the medical costs of retired employees.
9. Contingent liability
A contingent liability refers to liability that has not occurred, but the conditions are favorable for the liability to occur in the future. An example of a contingent liability is a lawsuit against the company or an income tax dispute. Disclosing the contingent liabilities informs users that the company will incur a loss in the future if the impending event ends up against the company’s favor.
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