What are notes to financial statements and what is their purpose? The financial statements tell us about the important financial information of a certain business or entity which also help us make more informed judgments, such as whether we should infuse more capital or not to the business (for business owners), invest more fund or not (for investors), lend money or not (for creditors), or even whether we should continue working or find another employer (for employees). The complete set of financial statements include the balance sheet (statement of financial position), statement of comprehensive income, statement of cash flow, statement of changes in equity, and the accompanying notes to financial statements.
The balance sheet tells the financial condition or health of a business. Income statement shows us how the business performs. The cash flow statement gives us the cash (cash and cash equivalents) flows from operating, investing and financing activities. The statement of changes in equity tells us the effects of the company’s performance, transactions with the owners and other factors to the equity or capital from the beginning to the end of the reporting period. However, the first four components of the financial statements are still not sufficient to give their readers the clearer understanding that they need to make financial and economic judgments. Thus, the notes to financial statements are required to accompany the information shown on the face of the financial statements. For example, if you want to know the breakdown and movement analysis of the property, plant and equipment shown on the face of the balance sheet, you refer to the note that is cross-referenced to such asset.
What should notes to financial statements present?
According to International Accounting Standard (IAS) 1, the Notes to Financial Statements must (a) present information about the basis of preparation of the financial statements and the specific accounting policies used, (b) disclose any information required by IFRSs that is not presented elsewhere in the financial statements and, (c) provide additional information that is not presented elsewhere in the financial statements but is relevant to an understanding of any of them. The Notes should also be cross-referenced from the face of the financial statements to the relevant note.
Particularly, IAS 1.114 suggests that the notes should normally be presented in the following order:
1. a statement of compliance with IFRSs
2. a summary of significant accounting policies applied, including:
-the measurement basis (or bases) used in preparing the financial statements
-the other accounting policies used that are relevant to an understanding of the financial statements
3. supporting information for items presented on the face of the statement of financial position (balance sheet), statement of comprehensive income (and income statement, if presented), statement of changes in equity and statement of cash flows, in the order in which each statement and each line item is presented
4. other disclosures, including:
– contingent liabilities and unrecognized contractual commitments
– non-financial disclosures, such as the entity’s financial risk management objectives and policies
The notes also disclosed the judgments that management has made in the process of applying the entity’s accounting policies that have the most significant effect on the amounts recognized in the financial statements and the information about the key assumptions concerning the future, and other key sources of estimation uncertainty at the end of the reporting period, that have a significant risk of causing a material adjustment to the carrying amounts of assets and liabilities within the next financial year. These disclosures do not involve disclosing budgets or forecasts.
The following disclosures are also required by IAS 1.126 if not disclosed elsewhere in information published with the financial statements:
1. domicile and legal form of the entity
2. country of incorporation
3. address of registered office or principal place of business
4. description of the entity’s operations and principal activities
5. if it is part of a group, the name of its parent and the ultimate parent of the group
6. if it is a limited life entity, information regarding the length of the life
Take note that the presentation requirement of notes to financial statements may be different for different types of company, such as the disclosures required for SMEs (Small and Medium-sized Entities) and for public companies. To learn more about IFRS for SMEs, please visit this discussion from IASPlus.com. To read and download sample audited Notes to Financial Statements of publicly listed companies in the Philippines, please visit our post “sample audited financial statements”.
Victorino Q. Abrugar is a marketing strategist and business consultant from Tacloban City, Philippines. Vic has been in the online marketing industry for more than 7 years, practicing problogging, web development, content marketing, SEO, social media marketing, and consulting.
Notably, BIR has came with with mandatory notes on taxes and SEC is now becoming strict on the compliance with notes and failure to do so entitles some penalties. Notes to FS is the next thing that CPA practitioners must learn and entrepreneurs must be fully aware of for their protection.