If you are considering an investment, you probably know that you can begin to evaluate a company’s financial health by viewing the financial statements. These statements show a company’s earnings, what it is doing with its cash and its assets and liabilities, among other items. One place you might not think to look is in the footnotes to the financial statements. This section can contain some important accounting disclosure notes not found elsewhere in the financial statements.
Accounting disclosure notes are included in the footnotes to an entity’s financial statements. These notes reveal certain important facts about an entity’s finances that are not shown elsewhere in the financial statements. These disclosure notes disclose facts and situations that are considered “material” (e.g., significant) and are done either as a requirement or in “good faith.”
Accountants use certain assumptions in preparing an entity’s financial statements. These are referred to as “fundamental accounting assumptions” and are part of generally accepted accounting principles (GAAP). When an entity diverts from these assumptions, there must be an accounting disclosure note in the footnotes of the financial statements. These assumptions include an inference that the company will continue to be in business for the near future, which is called “going concern.” Another assumption is that the company’s accounting policies are consistent over time. It is also generally assumed that the company recognizes income and costs when they happen, which is the accrual basis of accounting.
Another area where an accounting disclosure note could be required is accounting policies. The policies that the preparer of the financial statement and the entity employ should be disclosed in the financial statements. Any time an accepted policy is not followed, there must be a disclosure note citing this instance. Accounting policies affect many areas of the financial statements and include methods of depreciation, inventory values, investment and fixed asset values and an entity’s consideration of goodwill. If an entity departs from the way it traditionally treats these policies, it must disclose the departure in the financial statements.
Having listed two of the main areas where accounting disclosure notes are required, there are many other areas. If there is a transaction between parties that are related, this must be disclosed. If there is a known merger or acquisition occurring in the near future, it would be in the best interest of the shareholders to reveal this fact in a disclosure note. Essentially, any time there is a major event or important fact related to a company’s financial health that is not included anywhere else in the financial statements, this item should be reported via an accounting disclosure note.