The financial statements of an organization should be informative and clear to understand, and they should cover the entirety of the business. Although most of the relevant information can be presented on the balance sheet, income statement, statement of cash flows and statement of changes in equity, there is sometimes additional information to convey. This information is typically not numerical, does not fit into financial records and is used to clarify an item reported on the other statements. In this situation, notes or disclosures to the financial statements are appropriate.
Typically, the additional information provided in a financial statement package is called the notes to the financial statements. However, the information can be referred to as the footnotes if the information is showed in a different manner. Alternatively, the section can be referred to as the disclosure section, the additional information section or have no heading at all.
Typical Notes to the Financial Statements
Notes often cover what accounting policies were used in various situations. For example, management has a few options regarding inventory valuation methods; the notes can indicate the method that is used.
A schedule of property, plant and equipment can also be prepared to show the additions, subtractions and impact of accumulated depreciation on the book value. Again, the balance sheet shows the aggregated dollar amount of noncurrent assets; this schedule simply increases the information’s transparency.
Other opportunities to incorporate notes include further breakdown of expense information, disclosures of financial instruments and their terms, and disclosure of dealings with related parties. Contingencies that may impact future business operations are listed in the notes if they are reasonably possible but cannot be estimated.
The notes can provide information about material items that occurred after the balance sheet date. For example, assume that financial statements were prepared for the period ending June 30. On July 3, there was a fire that damaged 30 percent of inventory on hand. This material fact should be conveyed in the notes because the fire occurred after balance sheet date.
Layout of the Notes
Most financial statement packages list the notes after the financial statements. All of these endnotes are reported together in their own section.
Footnotes can be incorporated onto the face of the financial statements. These notes use numerical references to correlate the note to the figure reported. For example, the balance sheet may report $10,000 of inventory. Next to this figure, the accountant places a number 1, places a 1 at the bottom of the page and describes how the inventory was valued using text at the bottom of the page.
Importance of the Notes
The notes to the financial statements supplement – not replace – the information reported in the financial statements. This allows for only basic information to be presented neatly on the financial statement and additional information to be communicated later. The notes to the financial statements are included in the audit, review or compilation of financial statements by an external accounting company.