The most important information about the financial condition, financial results, and changes in the financial condition of the company is contained in the financial statements. They include a minimum amount of information about some essential elements of the financial reports. However, behind each number in the financial statements, there is other information that is not disclosed in the reports themselves. For example:
- operating environment
- risks faced by the company (external and internal)
- assessment of the possible consequences of such risks
- accounting policies used in the preparation of financial statements
- accounting estimates and assumptions
- details of some indicators of financial statements and comments to them
- intentions and obligations of the enterprise
- events after the reporting date, which can significantly affect the decision of users
- other financial and non-financial information.
So, where can a reader see more details about all the elements presented in the report broken down and explained? As you might have guessed, it is the notes to financial statements the provide narrative descriptions or disaggregation of items presented in the financial statements and information about items that do not qualify for recognition.
The notes to the financial statement are an integral part of the financial statements. Notes provide users with additional information not disclosed in the financial statements, but which is necessary for correct and fair presentation. They explain the data presented in the reports, as well as provide additional information that helps to better understand their content. In other words, this portion of the reporting is used to enhance the understandability of the statements.
It should be noted that this document can have different names depending on the country where it is prepared, however, regardless of the name, all these documents reveal roughly the same information. In many countries, the notes to the financial statement are an obligatory element of the financial statements of enterprises and provide a set of indicators and explanations that give details and justification for the items in the financial statements.
For the convenience of analyzing the items of financial statements and the notes to them, they are submitted structured in the order of presentation of each item of the financial statement, and cross-references are made to any related information in the notes. For example, an item of the Balance sheet, which reflects the balance of intangible assets at the initial and residual value and the amount of accumulated depreciation, in the notes can be broken down by types, periods of use, and the like.
Who Should Provide Notes to Financial Statements?
Not every organization is required to provide notes to financial statements along with the financial reports. Partnerships and sole proprietorships, for instance, are not required to prepare this additional information. At the same time, if they apply for a loan or seek additional funds, bankers and investors may request that they supply notes as well.
Corporations, however, are required to include notes to financial statements when they prepare the reports. When it comes to private corporates that are not listed on stock exchanges, they should fill out an SEC template. Public corporations, on the other hand, are required to disclose all information that might influence a credit or investment decision.
Fraud Clues in the Notes
The notes to the financial statements are included with the 10Q or 10K that the company files with the SEC. There are usually lots of notes to the financial statements, where the reader will find important disclosures. Despite this, these notes do not tell the whole store because many things are not required to be disclosed.
The attentive reader can use the information that is presented to learn more about the company’s operations and financial position. One can ask if the information and the notes agree with what has been presented in the financial reports and look for discrepancies in the numbers. Do the explanations make sense in the light of the numbers reported and what is not presented in the notes.
If you want to find undisclosed items, you should look for sources of outside information, such as news reports that may point out important internal events. These sources may provide important clues to material information that should have been disclosed in the notes.
You can also analyze the reports themselves and other information after the close of an accounting period. Is there anything that has happened later on that suggests not a complete disclosure of information in the notes to financial statement in a prior period? This might show that this company is capable of doing this again.