Notes To Financial Statements

Question 1

Accounting policies include the choice of accounting methods made by the firm, the principles and methods specific to an industry, and any unusual or innovative applications of GAAP. What information should be disclosed in the summary of significant accounting policies?

Answer 1

1. The chosen depreciation method
2. The chosen method of valuing inventory
3. The securities classified as cash and cash equivalents
4. The basis for consolidation: amortization policies and revenue recognition policies.
5. Revenue recognition method. e.g. Basis of profit recognition on long-term construction contracts (percentage of completion v. completed contract). A user is much better equipped to evaluate the firm’s financial performance and position with the knowledge of the revenue recognition method used by the firm.

Question 2

What are the noncurrent liability disclosures?

Answer 2

Noncurrent liability disclosures:

1. Combined aggregate amount of maturities on borrowings for each of the five years following the balance sheet
2. Sinking fund requirements
3. Aggregate amount of payments for unconditional obligations to purchase fixed or minimum amounts of goods or services.
4. Fair value of each financial debt instrument in the financial statements or in the notes.
5. The nature of the firm’s liabilities, interest rates, maturity dates, conversion options, assets pledged as collateral, and restrictions.

Question 3

What are the capital structure disclosures?

Answer 3

Capital structure disclosures include:

1. Rights and privileges of outstanding securities
2. The number of shares issued during the annual fiscal period and any subsequent interim period presented.
3. Liquidation preferences of preferred stock– if the liquidation value of preferred stock is considerably in excess of par value, this information should be disclosed in the equity section of the balance sheet.
4. Other preferred stock disclosures: can be in footnotes or in equity section of balance sheet:
   (a) Aggregate or per-share amounts at which preferred stock can be called or is subject to redemption through sinking fund operations
   (b) Aggregate or per-share amounts of arrearages for cumulative preferred stock
5. Redeemable preferred stock: For each of the 5 years following the balance sheet date, the amount of redemption requirements for all types of redeemable capital stock must be disclosed in the notes to the financial statements..

Question 4

Errors and irregularities are required to be disclosed in the footnotes. If a prior period is affected, a prior period adjustment is recorded which corrects the beginning balance of retained earnings and any other accounts affected in the year of discovery.

The nature and impacts of Illegal Acts (e.g. illegal contributions and bribes) on the financial statements should be disclosed fully in the notes.

Answer 4

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Question 5

GAAP requires disclosure of all significant concentrations of credit risk from receivables and other financial instruments in the notes. What does the disclosure of concentration of credit risk tell the user?

Answer 5

Credit risk is an important input to assess the ability of a firm to collect its receivables. A concentration of credit risk occurs when receivables from different sources reflect similar economic risks (for example, a group if receivables from several firms within the same industry).

Question 6

What types of material related party transactions must be disclosed?

Answer 6

Material related party transactions must be disclosed unless they are ordinary business transactions, such as payment of employees, compensation arrangements, expense allowances, and other routine transactions.