FINANCIAL DISCLOSURES (FOOTNOTES)

So far, this series of articles has discussed the accountants letter, the balance sheet and the income statement. After scrutinizing these, a sophisticated financial statement reader will turn his or her attention to the footnotes.

Generally accepted accounting requires disclosure of a tremendous amount of information, designed to give the reader a more complete understanding of a Company's financial condition. Without these disclosures, a financial statement is considered incomplete. This article discusses some of the most significant disclosure items for a closely held business.

SIGNIFICANT ACCOUNTING POLICIES

The first footnote is usually a discussion of significant accounting policies. This should include the basis of valuing inventories (LIFO, FIFO or other), depreciation methods, principles peculiar to the Company's industry and any unusual accounting policies.

CASH

Restrictions on cash accounts should be disclosed. Also, deposits in excess of federally insured limits should be disclosed as a "concentration of credit risk".

ACCOUNTS RECEIVABLE

Receivables that have been factored must be disclosed. Receivables from one customer in excess of ten percent of total receivables should be disclosed, in order to show "concentration of credit risk". Note that generally accepted accounting principles require bad debts to be written off using the allowance method.

INVENTORY

Besides the basis of valuation, the major classes of inventory, such as finished goods or work in process, should be disclosed.

NOTES RECEIVABLE

The terms of notes receivable should be disclosed, as well as receivables from related parties.

ACCOUNTS PAYABLE

Payables to one vendor in excess of ten percent of total accounts payable needs to be disclosed as a "concentration of credit risk".

NOTES PAYABLE

The interest rates, maturity dates, subordinate features, pledged assets and restrictive covenants should be disclosed. Leases capitalized as loans payable must be disclosed, as are unused letters of credit. A schedule of aggregate loan maturities for each of the next five years should be included.

INCOME TAXES

The income tax footnote should describe the components of current and deferred taxes and should disclose any tax loss carryforwards available for future years. S Corporations, partnerships and proprietorships should disclose that the entity does not generally pay tax.

STOCKHOLDER'S EQUITY

For each class of stock, par values and number of shares authorized, issued and outstanding are usually disclosed on the balance sheet. Changes in stockholder's equity must be disclosed by footnote.

PENSION AND PROFIT SHARING PLANS

A description of each plan and the amount of cost should be disclosed.

OPERATING LEASES

If a Company is leasing property and the lease is not treated as a loan, the aggregate future minimum lease payments for each of the next five years must be disclosed.

CONTINGENCIES

Exposure to loss in excess of an amount accrued must be disclosed. Two examples are lawsuits in progress and corporate guarantee of another company's loans.

RELATED PARTIES

Any related party transactions, no matter how small, must be disclosed. This includes sales between sister companies, loans from stockholders and rent paid to corporate officers.

SUBSEQUENT EVENTS

Events that arose subsequent to the balance sheet date, but prior to the date the financial statements were prepared must be disclosed. An example would be if a fire destroyed a warehouse after the Company's year end.

GOING CONCERN

If there is substantial doubt that an entity will continue to exist for a year, the financial statements disclose the conditions causing the doubt, the possible effects and management's plans. Typically, going concern is caused by recurring losses, large losses, poor cash flow, or overdrafts in owner's equity.

OTHER DISCLOSURES

The list of disclosures is long. For instance, you might see accounting method changes, correction of an accounting error, business combinations, development stage enterprise, investments in marketable securities, research and development and troubled debt restructuring footnotes. Also, many industries have industry specific disclosure.

WHAT'S NEXT?

In the the last article in this series, we will go back to the balance sheet and income statement and analyze activity ratios.

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