The Importance and Uses of Notes to the Financial Statements

February 4, 2009 by  
Filed under Accounting

statementsThe complete set of financial statements include the balance sheet, income statement, statement of changes in equity, cash flow statement and notes to the financial statements. If you will read the first four financial statements mentioned above, you will see notes referring to numbers after each accounts in those financial statements. At the footer of the balance sheet, income statement, statement of changes in equity and cash flow statement, you will see a phrase saying “see accompanying notes to the financial statements” or “the accompanying notes are integral parts of these financial statements”. The first four financial statements are linked to the notes to the financial statements to provide clearer and complete financial information to the users of financial statements.

The notes to the financial statements provide detailed and more comprehensive information that clarifies the information contained in the main financial statements like the balance sheet and income statement. Usually, all the information that cannot be placed in the main financial statements are placed in the notes to the financial statements.

Sometimes, it may become boring for other users of financial statement to read the notes to the financial statements since it is the longest and most comprehensive part of financial statements. However, it is very important for users of financial statements like investors, creditors and owners to read the notes to the financial statements. These notes contain significant information such as the company’s general information, basis of preparation of the financial statements, accounting policies applied and breakdowns of main accounts in the face of the financial statements

For accountants, the preparation of notes to the financial statements is usually the hardest and most time consuming part of preparing the final financial statements. It requires not only the analytical skills of the accountants but also requires their technical skills in language and communication.

The readers of financial statements must read the notes to support their understanding of the balance sheet, income statements, statement of changes in equity and cash flow. For example, an income statement that shows a loss for the period may be considerable because the entity is just on its first year of operations. The company’s general information such as the date of registration is stated in the notes to the financial statements.

The notes to the financial statements usually contain the following information:

1. Company information (e.g., registration details, primary purpose and place of business)

2. Basis of preparation and basis of consolidation (e.g., in accordance with GAAP or IFRS)

3. Summary of accounting policies adopted (e.g., accounting standards for cash, receivables, inventory, investments or property, plant and equipment)

4. Significant accounting judgments and estimates (e.g., estimated lives of property, plant and equipment)

5. Schedules, breakdown, movements or analysis of accounts in the balance sheet and income statement. (e.g., breakdown of cash and movements of property and equipment)

6. Events after the balance sheet date (e.g., after the balance sheet date decision of a certain litigation or enactment of laws and other events occurring after the balance sheet date that may affect the financial statements)

7. Capital management, policies and procedures (e.g., assurance of going concern and debt-to-equity ratio requirements)

8. Risk management, objectives and policies (e.g., credit risk, currency risk, liquidity risk and market price risk)

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