Footnote DisclosureThere are a great many circumstances under GAAP rules that require the accountant to report additional information in text form alongside the primary set of financial information, referred as “Footnote [or Disclosure]”, such as the nature of accounting policies being used to derive the statements, contingent liabilities, risks related to derivative instruments, discontinued operations, and error corrections. This post covers many of the most common footnotes that must be used. The primary focus of the footnote disclosures in this post are on accounting situations that apply to all industries. In addition to the cases noted here, there are also a number of footnote disclosures required for companies operating within specific industries, such as the banking, broadcasting, insurance, motion picture, and software industries. Enjoy!



A Note From Author [not a footote 🙂 ]: In cases where the amount of information is either excessively detailed or only applies to a narrow range of possible situations, the applicable GAAP documents are mentioned, so that you can explore the original text related to the issue. In some cases, example footnotes are added in order to clarify the required type of reporting.



Disclosure Of Accounting Changes

When a company initiates a change in accounting, the accountant must disclose the type of change, and describe why the change is being made. In addition, the footnote should list the dollar impact caused by the change for the current and immediately preceding reporting period, as well as the amount of the change in earnings per share. Further, the cumulative effect of the change on retained earnings should be noted.

An example is as follows:

The company switched from the FIFO to the LIFO inventory valuation method. Its reason for doing so was that a close examination of actual inventory flow practices revealed that the LIFO method more accurately reflected the actual movement of inventory. The net impact of this change in the current period was an increase in the cost of goods sold of $174,000, which resulted in an after-tax reduction in net income of $108,000. This also resulted in a reduction in the reported level of earnings per share of $0.02 per share. The same information for the preceding year was a reduction in net income of $42,000 and a reduction in earnings per share of $0.01. The cumulative effect of the change on beginning retained earnings for the current period was a reduction of $63,500.



Disclosure Of Accounting Policies

The financial statements should include a description of the principal accounting policies being followed, such as the method of inventory valuation, the type of depreciation calculation method being followed, and whether or not the lower of cost or market valuation approach is used for inventory costing purposes. Any industry-specific policies should also be disclosed, as well as any unusual variations on the standard GAAP rules.

An example is as follows:

The company calculates the cost of its inventories using the average costing method, and reduces the cost of inventory under the lower of cost or market rule on a regular basis. All fixed assets are depreciated using the sum-ofthe-years-digits method of calculation. Since many of the company’s boatbuilding contracts are multi-year in nature and only involve occasional contractually mandated payments from customers, it consistently uses the percentage of completion method to recognize revenues for these contractual arrangements.



Disclosure Of Asset Impairments

If a company writes down the value of assets due to the impairment of their value, the accountant should describe the assets, note which segment of the business is impacted by the loss, disclose the amount of the loss, how fair value was determined, where the loss is reported in the income statement, the remaining cost assigned to the assets, and the date by which the company expects to have disposed of them (if it expects to do so).

An example is as follows:

The company has written down the value of its server farm, on the grounds that this equipment has a vastly reduced resale value as a result of the introduction of a new generation of microprocessor chips. The services of an appraiser were used to obtain a fair market value, net of selling costs, to which their cost was reduced. The resulting loss of $439,500 was charged to the application service provider segment of the company, and is contained within the “Other Gains and Losses” line item on the income statement. The remaining valuation ascribed to these assets as of the balance sheet date is $2,450,000. There are no immediate expectations to dispose of these assets.



Disclosure Of Business Combinations

If a company enters into a business combination, the accountant should disclose the name of the acquired company, describe its general business operation, the cost of the acquisition, and the number of shares involved in the transaction. If there are contingent payments that are part of the purchase price, then their amount should also be disclosed, as well as the conditions under which the payments will be made. During the accounting period in which the combination is being completed, the accountant should also describe any issues that are still unresolved, as well as the plan for and cost of any major asset dispositions.

An example is as follows:

During the reporting period, the company acquired the Lie Dharma Corporation, which manufactures disposable gaskets. The transaction was completed under the purchase method of accounting, and involved a payment of $52 million in cash, as well as 100,000 shares of common stock. If the Lie Dharma Corporation can increase its profit level in the upcoming year by 25%, then an additional acquisition payment of $15 million will be paid to its former owners. There are no plans to dispose of any major Lie Dharma assets, but the majority of its accounting staff will be terminated as part of a plan to merge this function into that of the company. Termination costs associated with this change are expected to be no higher than $2,250,000.



Disclosure Of Callable Obligations

A company may have a long-term liability that can be called if it violates some related covenants. If it has indeed violated some aspect of the covenants, then the accountant must disclose the nature of the violation, how much of the related liability can potentially be called because of the violation, and if a waiver has been obtained from the creditor or if the company has acted to cancel the violation through some action.

An example is as follows:

The company has a long-term loan with a consortium of lenders, for which it violated the minimum current ratio covenant during the reporting period. The potential amount callable is one-half of the remaining loan outstanding, which is $5,500,000. However, the consortium granted a waiver of the violation, and also reduced the amount of the current ratio requirement from 2:1 to 1:1 for future periods.



Disclosure Of Commitments

There are many types of commitments that may require disclosure. For example, there may be a minimum purchase agreement that extends into future reporting periods, and that obligates a company to make purchases in amounts that are material. Also, a company may have made guarantees to pay for the debts of other entities, such as a subsidiary. If these commitments are material, then their nature must be disclosed in the footnotes. The rules are not specific about identifying the exact cost or probability of occurrence of each commitment, so the accountant has some leeway in presenting this information.

An example is as follows:

The company has entered into a contract to purchase a minimum of 500,000 tons of coal per year for the next 20 years at a fixed price of $20.50 per ton, with no price escalation allowed for the duration of the contract. The company’s minimum annual payment obligation under this contract is $10,250,000. The price paid under this contract is $1.75 less than the market rate for anthracite coal as of the date of these statements, and had not significantly changed as of the statement issuance date.



Disclosure Of Compensating Balances

A company may have an arrangement with its bank to keep some minimum portion of its cash in an account at the bank. Since this cash cannot be drawn down without incurring extra fees, it is essentially not usable for other purposes. If this is a significant amount, it should be split away from the cash balance on the balance sheet and either listed as a separate line item in the current assets section (if the related borrowing agreement expires in the current year) or as a long-term asset (if the related borrowing agreement expires in a later year).



Disclosure Of Contingent Liabilities

A contingent liability may require a business entity to pay off a liability, but either the amount of the liability cannot reasonably be determined at the report date, or the requirement to pay is uncertain. The most common contingent liability is a lawsuit whose outcome is still pending. If the contingent amount can be reasonably estimated and the outcome is reasonably certain, then a contingent liability must be accrued. However, in any case where the outcome is not as certain, the accountant should describe the nature of the claim in the footnotes. Also, if a lower limit to the range of possible liabilities has been accrued due to the difficulty of deriving a range of possible estimates, then the upper limit of the range should be included in the footnotes. Finally, if a loss contingency arises after the financial statement date but before the release date, then this information should also be disclosed.

An example is as follows:

The company has one potential contingent liability. The insurance claim related to earthquake damage to the company’s California assembly plant. The insurance company is disputing its need to pay for this claim, on the grounds that the insurance renewal payment was received by it one day after the policy expiration date. Company counsel believes that the insurance company’s claim is groundless, and that it will be required to pay the company the full amount of the claim after arbitration is concluded. The total amount of the claim is $1,285,000.



Disclosure Of Continued Existence Doubts

If there is a significant cause for concern that the business entity being reported upon will not continue in existence, then this information must be included in the footnotes.

An example is as follows:

The company has $325,000 of available funds remaining in its line of credit, which it expects to use during the next fiscal year. Thus far, the company has been unable to obtain additional equity or financing to supplement the amount of this line of credit. Given the continuing losses from operations that continue to be caused by a downturn in the chemical production industry, management believes that the company’s financing difficulties may result in its having difficulty continuing to exist as an independent business entity.



Disclosure Of Customers

If a company has revenues from individual customers that amount to at least 10% of total revenues, then the accountant must report the amount of revenues from each of these customers, as well as the name of the business segment (if any) with which these customers are doing business.

An example is as follows:

The company does a significant amount of its total business with two customers. One customer, comprising 15% of total revenues for the entire company, also comprises 52% of the revenues of the Appliances segment. The second customer, comprising 28% of total revenues for the entire company, also comprises 63% of the revenues of the Government segment.



Disclosure Of Debt Extinguishment

If a company experiences a gain or loss through a debt extinguishment transaction, the accountant should describe the transaction, the amount of the gain or loss (which must also be recorded as a line item under the “Extraordinary Items” section of the income statement), the impact on income taxes and earnings per share, and the source of funds used to retire the debt.

An example is as follows:

The company retired all of its callable Series D bonds during the period. The funds used to retire the bonds were obtained from the issuance of Series A preferred stock during the period. The debt retirement transaction resulted in an extraordinary gain of $595,000, which had after-tax positive impacts on net income of $369,000 and on per share earnings of $0.29.



Disclosure Of Derivatives

The disclosure of derivatives-related information is a complex area with different reporting rules for different types of derivatives. For more detail on this topic, one can consult FASB Statement Numbers 105, 107, 115, 119, and 133. In general, the fair value of a derivative instrument must be disclosed, as well as the assumptions used to calculate the fair value. If the accountant feels that it is not possible to derive a fair value, then one must disclose much of the information that would normally be used to arrive at a fair value—the carrying value, effective interest rate, and maturity date. The risk issues related to derivatives must also be disclosed, such as the maximum amount of any potential loss, collateral that might be lost as a result of derivative transactions, and the transactions for which hedges are used to manage risk. Disclosure should also include the reason for engaging in the use of derivatives.



Disclosure Of Discontinued Operations

When some company operations are expected to be discontinued, the accountant should identify the discontinued segment at the earliest possible date, as well as the expected date on which the discontinuation will take place. The disclosure should also note the method of disposal, such as sale to a competitor or complete abandonment. If the discontinuation is occurring in the current reporting period, then the accountant should also itemize both the results of operations for the discontinued operation up until the date of disposal, and any proceeds from sale of the operations.

An example is as follows:

The company has elected to discontinue its Dharma Putra Overnight Delivery Service Division. No buyer of this business is expected, so the company expects to shut down the operation no later than February of this year. No significant proceeds are expected from the sale of assets, since most of its assets will be absorbed into other operations of the company.



Disclosure Of Earnings Per Share

When earnings per share (EPS) data is included in the financial statements, the accountant must also disclose the following information:

Omitted securities. Describe any securities that have been omitted from the diluted earnings per share calculation on the grounds that they are anti-dilutive, but which could have a dilutive effect in the future.

Preferred dividends impact. Note the impact of dividends on preferred stock when calculating the amount of income available for the basic EPS calculation.

Reconcile basic and diluted EPS. The accountant must present a reconciliation of the numerators and denominators for the calculations used to derive basic and diluted EPS for income related to continuing operations.

Subsequent events. The accountant must describe any event that occurs after the date of the financial statements, but before the date of issuance that would have had a material effect on the number of common shares outstanding if it had occurred during the accounting period being reported upon.

Read the next disclosures:

Accounting Footnote Disclosures Part II [Accountant Must Used]