Notes to Financial Statements
In addition to the amounts that are reported on the face of the financial statements, US GAAP requires that additional information be provided as notes to the financial statements. To alert the readers of these important disclosures, each financial statement is required to make reference to them. The following are some examples of the reference found at the bottom of each financial statement:
- See accompanying notes.
- See accompanying notes to the financial statements.
- The accompanying notes are an integral part of these financial statements.
- The accompanying Notes to the Financial Statements are an integral part of this statement.
- See Notes to Consolidated Financial Statements.
The notes (or footnote disclosures) are required by the full disclosure principle because the amounts and line descriptions on the face of the financial statements are not sufficient information. In fact, there may be some large potential losses that cannot be expressed as a specific amount, but they are critical information for lenders, investors, and others.
The notes usually begin with the corporation's significant accounting policies. This note describes how revenues were recognized on the income statement, how inventory is accounted for, etc. Our review of the financial statements of 20 publicly-traded corporations showed notes on the following topics:
- Nature of business
- Employee benefit plans
- Basis of consolidation
- Accounts receivable
- Pensions and postretirement health plans
- Use of estimates
- Fair value measurement
- Revenue recognition
- Property, plant and equipment
- Long-term debt and available credit
- Fiscal periods
- Goodwill and other intangible assets
- Commitments and contingencies
- Foreign currency translation
- Deferred compensation
- Stock options
- Business segments
- Stock repurchase program
- Significant customers
- Impairment of long-lived assets
- Accumulated other comprehensive income
- Cash and cash equivalents
- Accrued liabilities
- Recent accounting pronouncements
Sophisticated investors and lenders will read closely the notes to the financial statements. If the corporation's shares of stock are publicly traded, they will also read the additional information presented in the corporation's Annual Report to the Securities and Exchange Commission, Form 10-K.
Other Information Pertaining to Financial Statements
Consolidated Financial Statements
It is common for a large business to consist of several legal corporations. However, those separate legal corporations (called subsidiaries) are owned and controlled by one of the corporations (the parent corporation). The shares of common stock of the parent corporation are often traded on a major stock exchange. Those stockholders are interested in receiving financial statements which report the results and financial position of the entire economic entity, which is all of the subsidiaries and the parent corporation.
The consolidated financial statements report the results of the transactions that occurred between the economic entity and its customers, suppliers, and others outside of the economic entity. For example, the consolidated income statement will report the sales made to customers who are outside of the economic entity. (The sales and the related purchases made between the subsidiaries and between the subsidiaries and the parent corporation are not included.)
Similarly, a consolidated balance sheet will report the amounts owed to lenders outside of the economic entity. (The loans and borrowings between subsidiaries and between the subsidiaries and the parent corporation are not included.)
In the review of 20 corporations whose stock was traded on a major stock exchange, all of the corporations had:
- consolidated income statements
- consolidated statements of comprehensive income
- consolidated balance sheets
- consolidated statements of stockholders' equity
- consolidated statements of cash flows
- notes to the consolidated financial statements
Comparative Financial Statements
When a financial statement contains the amounts for two or more years, the financial statement is referred to as a comparative financial statement. For example, the income statement of a large corporation with its shares of stock traded on a stock exchange might have as its heading "Consolidated Statements of Income" and will report the amounts for 2019, 2018, and 2017. This allows the user to compare sales that occurred in 2019 to the sales that occurred in 2018 and in 2017.
The balance sheet of the same corporation will have as its heading "Consolidated Balance Sheets" and will report the amounts as of the final instant as of December 31, 2019 and the final instant as of December 31, 2018.
Audited Financial Statements
Some corporations may be required to have their external financial statements audited. This requires independent certified public accountants to provide assurance that the financial statements present fairly the financial position, results of operations, and cash flows of the corporation according to US GAAP.
If a corporation's stock is not traded on a stock exchange and no one requires audited financial statements, the financial statements do not have to be audited. (Corporations with its stock trading on a stock exchange must have its financial statements audited by a registered firm of independent CPAs.)
When a U.S. corporation's shares of stock are traded on a stock exchange, we say that the shares are publicly traded or publicly held. We also refer to the corporation as a publicly-traded corporation.
In addition to US GAAP the external financial statements of a publicly-traded U.S. corporation must also comply with the reporting requirements of the U.S. government agency, Securities and Exchange Commission (SEC). Among the many required reports is the Annual Report to the SEC, Form 10-K. The Form 10-K must include audited, comparative financial statements.
Typically, the large, publicly-held corporations will be issuing consolidated financial statements. Examples of the headings are shown below. (In parentheses we show the number of years for which amounts will appear.)
- Consolidated statements of income (3 years)
- Consolidated statements of comprehensive income (3 years)
- Consolidated balance sheets (end-of-year amounts for 2 years)
- Consolidated statements of stockholders' equity (3 years)
- Consolidated statements of cash flows (3 years)
- Notes to the consolidated financial statements
Since the corporation's shares of stock are publicly traded, the consolidated financial statements must be audited by a registered firm of independent certified public accountants.
Other parts of Form 10-K include Management's Discussion and Analysis of Financial Condition and Results of Operations, as well as a certification by management on the corporation's internal controls, a statement of management's responsibility for the financial statements, disclosures of risk, legal proceedings, and more.
In addition to the annual consolidated financial statements, the publicly-held corporation will issue quarterly consolidated financial statements. These are referred to as interim financial statements and will be more condensed (fewer details), reviewed by the registered CPA and will be part of the corporation's Quarterly Report to the Securities and Exchange Commission (Form 10-Q).
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