01.08 Notes to the financial statements

Question 1

What is the purpose of the financial statements?

Answer 1

To give users information for making decisions.

Question 2

Are disclosures required by GAAP?

Answer 2

Yes. Not all relevant information can be presented directly in the statements. GAAP requires that FS be accompanied by informative disclosures that provide more detail about the amounts presented and help users interpret and understand the FS.

Question 3

True or false: a summary of significant accounting policies is a required disclosure.

Answer 3

True. This disclosure is required because users’ understanding of FS amounts is greatly facilitated by knowing the methods used in preparing the statements.

Question 4

What is the purpose of the significant accounting policies disclosure.

Answer 4

To identify accounting principles used (where GAAP allows alternatives) and the methods of applying those principles.

Question 5

What are examples of significant accounting policies?

Answer 5

Revenue recognition policies
Inventory costing system (e.g. FIFO, LIFO)
Depreciation method (e.g. straight-line)
Long-term contract accounting (e.g. over time, at a point in time)
Criteria for classification of investments (e.g. cash equivalents)
Basis of consolidation

Question 6

Is the summary of significant accounting policies required to be disclosed in interim statements?

Answer 6

It is not required in interim statements if the policies have not changed.

Question 7

What are examples of other disclosures?

Answer 7

Related party transactions
Noncurrent liabilities
Capital structure
Contingent liabilities and gains
Contractual obligations
Material changes in account balances
Errors and irregularities
Illegal acts
Governmental assistance

Question 8

What is management’s discussion and analysis?

Answer 8

MD&A is a narrative written by management. It is not considered part of the footnotes. Publicly held firms are required to include MD&A in the annual report.

Question 9

What is included in management’s discussion and analysis?

Answer 9

The MD&A provides management’s discussion about the operations of the firm, its liquidity, capital resources, management’s views on the firm’s financial condition, changes in financial condition and results of operations through analysis of the FS. The MD&A explains details on the effects of significant and unusual events. It also provides forward-looking information not reflected in the FS.

Question 10

Does GAAP require certain information about risks and uncertainties to be disclosed?

Answer 10

Yes. The applicable accounting standard provides for selectivity whereby specified criteria are used to screen all the possible risks, so that the required disclosures are limited to matters that materially affect a particular entity.

Question 11

In regards to risks and uncertainties, what are the disclosures concerned with?

Answer 11

The disclosures are primarily concerned with risks and uncertainties that could materially affect FS amounts within one year of the date the FS are issued.

Question 12

What are the sources of risk and uncertainty that the disclosures involve?

Answer 12

Nature of the entity’s operations
Use of estimates in FS
Certain significant estimates
Current vulnerability due to significant concentrations in certain aspects of operations
The entity’s ability to exist as a going concern

Question 13

What is a severe impact?

Answer 13

A severe impact is a significant financially disruptive effect on the normal functioning of the firm, where severe is greater than material but less than catastrophic. Bankruptcy is an example of catastrophic.

Question 14

What are the four sets of concentrations that the standard applies to?

Answer 14

1. concentrations in the volume of business with a customer, supplier, lender, grantor or contributor.
2. concentrations in revenue from specific products, services, or fund-raising sources.
3. concentrations in specific sources of services, materials, labor, licenses, or other rights used in operations.
4. concentrations in the market of geographic area of operations.

Question 15

What is the criteria that requires a concentration to be disclosed?

Answer 15

1. the concentration exists at the balance sheet date
2. the entity is vulnerable to the risk of a near-term severe impact because of a concentration
3. it is at least reasonably possible that events capable of causing a severe impact will occur in the near term.

Question 16

For disclosable concentrations, what is required to be disclosed?

Answer 16

1. information adequate to inform users about the nature of the risk associated with the concentration
2. for concentrations of labor subject to collective bargaining agreements, the firm must disclose the percentage of labor force covered by the agreement and the percentage of labor force covered by the agreement that will expire within one year
3. for concentrations of operations located outside the entity’s home country, the firm must disclose the carrying amounts of net assets and the geographic areas which they are located.

Question 17

True or false: management must asses the entity’s ability to continue as a going concern?

Answer 17

True.

Question 18

How should management assess the entity’s ability to continue as a going concern?

Answer 18

Management’s assessment should be based on facts and circumstances that are “known or reasonably knowable” as of the date the FS are issued.

Question 19

What does substantial doubt mean?

Answer 19

Substantial doubt means that it is probable that the entity will be unable to meet its obligations.

Question 20

What is the look-forward period for the going concern assessment?

Answer 20

One year from issuance of the FS.

Question 21

What should be considered when assessing the entity’s ability to meet its obligations?

Answer 21

1. the company’s current financial position
2. conditional and unconditional obligations due or anticipated in the next year
3. funds necessary to maintain operations considering the company’s current financial condition, obligations, and other expected cash flows in the next year
4. other - negative financial trends, default on loans, labor difficulties, significant litigation.

Question 22

Are disclosures required if there are no going concern uncertainties?

Answer 22

No. disclosures are required only when conditions give rise to substantial doubt about the entity’s going concern. If the substantial doubt is alleviated because management developed a plan to mitigate the effects of the uncertainties, the disclosures are still needed, and the disclosures would include a description of management’s plans to alleviate the substantial doubt.