Are footnotes part of financial statements?

Financial statement footnotes provide an important element regarding a business’ activities -- they provide context. Absent discussion in the footnotes about how the business conducts its operations, measures its results and sees its future prospects, the statements alone cannot provide a complete picture of the state of the business. The focus when drafting the footnotes should be on accuracy, clarity and disclosing all reasonably likely material risks.

Financial Footnoes Defined

1. The purpose of footnotes is to fill in the gaps created by the financial statements. Financial statements can tell an informed investor a lot about the state of the business, but only if the reader knows what he is looking at. While the numbers in the reports may be considered accurate, without a discussion regarding how those accounts were measured the information will have negligible value. Also, financial statements are backward-looking; the information presented is only current as of the end of the period. Generally, these statements are not released until weeks after that date. Financial statements can provide forward-looking information and discuss important events that have occurred since the end of the financial statements’ measurement period.

Accounting Policies

1. There are two important categories of financial footnotes. The first describes the accounting policies and methods of the disclosing business. These notes will focus on how each account and line items in the statements are measured. So for example, an important footnote regards Inventory. A good footnote will identify how inventory is valued on the financial statements as well as how it would have been valued if another popular valuing method was used. This way, not only will the investor know what method was used but the choice's impact.

Reporting Additional Information

1. The second class of footnotes is additional information. This is meant to inform the reader of future events and other issues that the statements do not reference. Examples of possible information to disclose are possible future lawsuits, significant products coming to market soon and other events that could affect profitability. To determine what should be disclosed, consider all financial and operational data regarding the company and try to recognize any trends or possible occurrences. Then evaluate whether any of these possibilities could happen, and if any of these prospects did occur, whether it would materially affect the company’s financial prospects. Materiality is defined by whether a reasonable person would consider that development important when making an investment decision. If the possibility in question is material and at least reasonably likely to occur, it should be disclosed.

MD&A

1. The Securities and Exchange Commission (SEC) also requires that all U.S. publicly traded companies provide a “Management’s Discussion and Analysis of Financial Condition and Results of Operations” (MD&A). The MD&A tells the story of the business, both in terms of where it is and where it is going. Where the other footnotes provide targeted information segmented according to specific elements of the financial statements, the MD&A provides an overall view regarding how all the elements interact. Writing the MD&A is a balancing act. The best MD&As disclose all events and circumstances that are reasonably likely to occur and would have a material effect on the financial statements, while not overwhelming the reader with gratuitous information.

Considerations

1. When preparing financial statements and tax returns, consult with a certified public accountant (CPA). This article does not provide legal advice; it is for educational purposes only. Use of this article does not create any attorney-client relationship.

   These footnotes contain significant information on vital things such as; accounting methodologies used for recording and reporting transactions, pension plan details, and stock option compensation information.

   Footnotes to the financial statements;

   • refer to additional information provided in a company’s financial statements.
   • Describe the items that are left out of the balance sheet and income statement.
   • It helps to clarify they would cloud the data reported in the financial statements.
   • May also include information regarding future activities that are anticipated to have a notable impact on the business or its activities.

   For example;

   Descriptions of upcoming new product releases or a potential product recall; in international accounting standard – 1, it is stated that a detailed explanation of each item of accounts of the financial statements is to be stated.

   That is,

   in this respect principles adopted in preparing companies accounts, the basis on which transactions have been arranged and accounted for, and disclosure of all information are to be taken into consideration.

   Notes to the financial statements of a company are shown in 3 groups;

   1. Structural,
   2. Adopted principles,
   3. Other related affairs.

   Structural

   This part includes the following methods:

   1. On what basis the financial statements are prepared and what principles have been adopted in maintaining accounts of transactions are to be stated clearly.
   2. It is to be narrated clearly whether accounting standards have property been followed in preparing financial statements.
   3. The additional information regarding the matters which have been ignored in preparing financial statements is to be stated.

   Notes to the financial statements are to be presented in order so that relationships among income statements, balance sheets, and cash flow are indicated.

   Notes present assertive and analytical information regarding financial statements.

   A detailed discussion is made on items exhibited in the balance sheet, income statement, cash flow, and statement of changing capital. Besides, it also presents information regarding probable matters.

   Moreover,

   it presents the matters which have been encouraged by accounting standards for transparency purpose.

   The notes are presented in such a way that the matters relating to financial statements are easily understandable in comparison with those of other companies.

   With this end in view these include:

   1. How far the accounting standard has been adopted.
   2. The followed principles of accounting and measuring methods.
   3. The helping information of the accounting items presented in financial statements.
   4. Other matters such as contingent liabilities, detailed disclosure of financial and non- financial matters.

   In some cases, it is noted that the arrangement of notes differs in succession.

   For example,

   The rate of interest on investments and adjustment of the principal amount of investment each is applicable for income statements and balance sheets.

   But it is said that the basis of financial statements and adopted principles of accounting are two separate issues.

   Preparation of adopted principles of accounting

   In this case, the matters which are considered are;

   1. The basis of preparation of financial statements.
   2. The accounting principles adopted in the preparation of financial statements. Besides, for their easy understanding of the information regarding who has used and analyzed the methods which have been adopted in measuring money with its historical cost, current cost, realization cost, or present cost should be stated in detail. Besides, methods adopted in case of;
      • earning a profit
      • the
      • the merger of business
      • the joint venture
      • depreciation or write off of assets
      • loan
      • contract of construction
      • investment
      • financial documents
      • research and development cost
      • inventory
      • income tax
      • reserve
      • employee’s benefit expense
      • foreign exchange
      • business and geographical affairs
      • cash and cash equivalent
      • overvaluation
      • government contribution
      • the lease is to be taken into consideration.

   Other matters

   In preparation of financial statements, the business organizations will also have to mention the following matters if not stated otherwise:

   1. Size of company, legal entity, its structure, registration, address, and any other place where a business is run or registered.
   2. Business activities of the company and detailed information regarding the expansion of the business.
   3. Source of the company, source of the entire group of companies, information regarding the company.
   4. Some employees in a year or a particular period.

   In the practical field, an accountant presents the explanations and analysis of financial statements through notes.

   Are footnotes required in financial statements?

   Although footnotes are a required part of any financial statement, there are no standards for clarity or conciseness. Management is required to disclose information "beyond the legal minimum" to avoid the risk of being sued.

   Are footnotes part of a company's financial report?

   The exact nature of these footnotes varies, depending upon the accounting framework used to construct the financial statements (such as GAAP or IFRS). Footnotes are an integral part of the financial statements, so you must issue them to users along with the financial statements.

   What are footnotes in financial statements?

   Footnotes to the financial statements refer to additional information that helps explain how a company arrived at its financial statement figures. They also help to explain any irregularities or perceived inconsistencies in year to year account methodologies.

   What are included in the financial statements?

   A set of financial statements includes two essential statements: The balance sheet and the income statement.

   The balance sheet (sometimes also known as a statement of financial position).

   The income statement (which may include the statement of retained earnings or it may be included as a separate statement).