Accounting Footnote Disclosures Part II [Accountant Must Used]

Accounting Footnote Disclosures 
Disclosure Of Error Corrections

When an error correction is made, it is to the financial results of a prior period. The disclosure is primarily contained within the line items on the face of the financial statements. However, the accompanying footnotes should also describe the nature of the error.

An example is as follows:

An error was discovered in the 2008 financial statements, whereby depreciation was incorrectly calculated on the straight line basis for several major plant installations involving the Pacific cement facility. The double declining balance method should have been used, as per company policy for assets of this nature. Correction of the error resulted in a decrease in the reported net income, net of income taxes, of $147,500.

 

 

Disclosure Of Goodwill

If a company elects to immediately write down some or all of the goodwill recorded on its books, there must be disclosure of the reasons for doing so. The footnote should specify why an impairment of goodwill has occurred, the events that have caused the impairment to take place, those portions of the business to which the impaired goodwill is associated, and how the company measured the amount of the loss. Any calculation assumptions used in determining the amount of the write down should be noted.

An example is as follows:

The company has taken a write down of $1,200,000 in its goodwill account. This write down is specifically tied to the increase in competition expected from the approval of a competing patent, given to Westernland Steel Company, which will allow it to produce steel much more efficiently than the company’s Lie Dharma Company, to which the $1,200,000 in goodwill is associated. This write down is based on the assumption that the Arbuthnot Foundry will not be able to compete with Westernland Steel for longer than four years—consequently, the present value of all goodwill that will remain on the company’s books four years from the date of these financial statements has been written off.

 

 

Disclosure Of Income Taxes

If a company does not recognize a tax liability, then the accountant should disclose the temporary differences, at a summary level, for which no tax liability is recorded, as well as those circumstances under which a liability would be recorded. The accountant should also list any permanent unrecognized tax liabilities related to investments in foreign entities. The accountant should itemize the amount of any net operating loss carryforwards and related credits, as well as the dates on which they expire. In addition, one should present a reconciliation of the statutory tax rate to the actual rate experienced by the organization during the reporting period, though privately held entities can restrict this reporting to a description of the general types of reconciling items.

The amounts of the following items related to income taxes must be attached to the income statement or reported within it:

  • Any investment tax credit.
  • Changes in tax assets or liabilities caused by changes in valuation estimates.
  • Changes in tax assets or liabilities caused by regulatory changes.
  • Net operating loss carryforwards.
  • Tax-reducing government grants.
  • The current tax expense.
  • The deferred tax expense.

 

 

Disclosure Of Intangibles

If a company has a material amount of intangible assets on its books, the accountant\ should describe the types of intangibles, the amortization period and method used to offset their value, and the amount of accumulated amortization.

An example is as follows:

The company has $1,500,000 of intangible assets on its books that is solely comprised of the estimated fair market value of patents acquired through the company’s acquisition of the LieDharma Company under the purchase method of accounting. This intangible asset is being amortized over 15 years, which is the remaining term of the acquired patents. The accumulated amortization through the reporting period is $300,000.

 

 

Disclosure Of Inventory

If a company uses the LIFO valuation method, it should note the financial impact of any liquidation in LIFO inventory layers. Also, if a company uses other methods of valuation in addition to LIFO, then the extent to which each method is used should be described. Irrespective of the type of valuation method used, a company must reveal whether it is using the lower of cost or market adjustment (and the extent of any losses), whether any inventories are recorded at costs above their acquisition costs, whether any inventory is pledged as part of a debt arrangement, and the method of valuation being used.

An example is as follows:

The company uses the LIFO valuation method for approximately 65% of the total dollar value of its inventories, with the FIFO method being used for all remaining inventories. The company experienced a loss of $1.50 per share during the period that was caused by the elimination of LIFO inventory layers. The company also lost $0.74 per share during the period as a result of a write down of inventory costs to market. The company records no inventories above their acquisition costs. As of the balance sheet date, the company had pledged $540,000 of its inventory as part of a line of credit arrangement with the First Federal Industrial Credit Bank.

 

 

Disclosure Of Investments

If a company holds any investments, the accountant must disclose the existence of any unrealized valuation accounts in the equity section of the balance sheet, as well as any realized gains or losses that have been recognized through the income statement. The classification of any material investments should also be noted (that is, as available for sale or as held to maturity).

If investments are accounted for under the equity method, then the name of the entity in which the investment is made should be noted, as well as the company’s percentage of ownership, the total value based on the market price of the shares held, and the total amount of any unrealized appreciation or depreciation, with a discussion of how these amounts are amortized. The amount of any goodwill associated with the investment should be noted, as well as the method and specifications of the related amortization.

If this method of accounting is used for an investment in which the company’s share of investee ownership is less than 20%, then the reason should be noted; similarly, if the method is not used in cases where the percentage of ownership is greater than 20%, then the reasoning should also be discussed.

Finally, the accountant should reveal the existence of any contingent issuances of stock by the investee that could result in a material change in the company’s share of the investee’s reported earnings.

 

 

Disclosure Of Leases

If a company is leasing an asset that is recorded as an operating lease, the accountant must disclose the future minimum lease payments for the next five years, as well as the terms of any purchase, escalation, or renewal options. If an asset lease is being recorded as a capital lease, then the accountant should present the same information, as well as the amount of depreciation already recorded for these assets. Capital lease information should also include a summary, by major asset category, of the gross cost of leased assets.

An example is as follows:

The company is leasing a number of machineries, which are all recorded as operating leases. There are no escalation or renewal options associated with these leases. There are purchase options at the end of all lease terms that are based on the market price of the copiers at that time. The future minimum lease payments for these leases are:

2005 = $195,000
2006 = 173,000
2007 = 151,000
2008 = 145,000
2009 = 101,000

 

 

Disclosure Of Loans

If a company has entered into a loan agreement as the creditor, the accountant should describe each debt instrument, as well as all maturity dates associated with principal payments, the interest rate, and any circumstances under which the lender can call the loan (usually involving a description of all related covenants). In addition, the existence of any conversion privileges by the lender and any assets to be used as collateral should be described. Other special disclosures involve the existence of any debt agreements entered into subsequent to the date of the financial statements, related party debt agreements, and the unused amount of any outstanding letters of credit.

An example is as follows:

The company has entered into a line of credit arrangement with the First Federal Commercial Bank, which carries a maximum possible balance of $5,000,000. The loan has a variable interest rate that is 1/2% higher than the bank’s prime lending rate. The loan’s interest rate as of the date of the financial statements is 8 3/4%. As of the date of the financial statements, the company had drawn down $750,000 of the loan balance. Collateral used to secure the loan is all accounts receivable and fixed assets. The loan must be renegotiated by December 31, 2009; in the meantime, the bank can call the loan if the company’s working capital balance falls below $2,000,000, or if its current ratio drops below 1.5 to 1.

 

 

Disclosure Of Non-Monetary Exchanges

If a business engages in the barter of advertising in exchange for goods or services, it must disclose the estimated amount of revenue or expense involved in these transactions. If the fair value of these transactions could not be determined, then the type of advertising used or issued, as well as its volume, must be disclosed.

An example is as follows:

The company gives traffic reports to radio stations in exchange for a prenegotiated amount of advertising time, which it then sells to cover the cost of its traffic reporting function. During the period, it exchanged traffic report information to three radio stations in exchange for 5,412 minutes of advertising time. It sold these blocks for an average of $54 per minute, resulting in $292,248 in revenues.

 

 

Disclosure Of Prior Period Adjustments

Prior period adjustments should be itemized for all reporting periods that they impact, both at gross and net of income tax effect. This should be done as line items within the financial statements. However, if the accountant wishes to introduce a greater degree of clarity in relation to any such changes, then also including the information in a footnote would be acceptable.

An example is as follows:

The company discovered that the inventory in an outlying warehouse was not counted during the year-end physical inventory count for both of the years reported in the financial statements. The amount of the overlooked inventory in 2008 was $230,000 and in 2009 was $145,000. Retroactive inclusion of these inventory amounts in the financial statements for those years would have resulted in an increase in net income of $142,600 in 2008 and $89,900 in 2007.

 

 

Disclosure Of Related Party Transactions

If there are transactions with related parties, the accountant should disclose the relationship, the degree of control over the company by the related party, the amount and terms of any transactions between the parties, and the nature of any economic dependency between the parties.

An example is as follows:

The company leases its central office location from L.D. Putra at a lease rate of $25.80 per square foot, which is $8.10 above the current market rate. Based on the total square footage at this location of 12,500 feet, this represents an excess payment over the market rate of $221,250 per year. The lease expires in three years. Mr. Putra is a 20% shareholder in the company, sits on its Board of Directors, and also owns the Putra Distributorship, which is a principal supplier of bearings to the company.

 

 

Disclosure Of Segment Information

If a company is publicly held, the accountant must disclose information about its operating segments in considerable detail, which is described in FASB Statement Number 131. In general, this should include a discussion of the means by which management splits the organization into separate reporting segments. It should also identify the types of products that comprise each segment’s revenue, the nature of any inter-company transactions between reporting segments, and the reasons for any differences between reported results by segment and consolidated results.

A comprehensive disclosure of segment information can be presented in a grid format that itemizes information for each segment in a separate column, and that summarizes the total for all segments, net of adjustments, into a consolidated company-wide total.

 

 

Disclosure Of Significant Risks

The accountant must disclose in the footnotes that the creation of any financial statement requires the use of some estimates by management. This notation should be accompanied by a list of any significant items in the financial statements that are based on management estimates, and that could result in material changes if the estimates should prove to be incorrect. The footnotes should also disclose the existence of any concentrations of revenue with certain customers, as well as concentrations of supplies with certain vendors. In addition, geographic concentrations of business activity should be disclosed, plus the existence of any collective bargaining agreements that cover a significant proportion of the workforce.

An example is as follows:

Twenty-three percent of the company’s total revenue is to a single customer; there are purchase agreements in place that commit this customer to similar purchase volumes for the next three years. In addition, 10% of company revenues are earned from its Palestine operation, to which management assigns a high risk of loss if political disturbances in this area continue. Finally, 43% of the company’s direct labor force is covered by a collective bargaining agreement with the International Brotherhood of Electrical Workers; the related union agreement is not due to expire for three years.

 

 

Disclosure Of Subsequent Events

If any event occurs subsequent to the date of the financial statements that may have a material impact on the financial statements, then it should be disclosed in the footnotes. The accountant should consider issuing pro forma statements to include a monetary presentation of this information in cases where the amount of the subsequent event significantly changes the organization’s financial position. Some examples of subsequent events that should be disclosed are:

  • Gains or losses on foreign exchange transactions of a substantial nature.
  • Gains or losses on investments of a substantial nature.
  • Loans to related parties.
  • Loss contingencies.
  • Loss of assets to natural disasters.
  • Merger or acquisition.
  • Receipt of new funds from debt or equity issuances.
  • Sale of major assets.
  • Settlement of litigation, including the amount of any prospective payments or receipts.

 

Read also:

29 Most Common Accounting Footnote Disclosures [Part I]

 

Author: Lie Dharma Putra

Putra is a CPA. His last position, in the corporate world, was a controller for a corporation in Costa Mesa, CA. After spending 15 years as a nine-to-five employee, he decided to serve more companies, families and even individuals, as a trusted business advisor. He blogs about accounting, finance and tax, during his spare time, and helps accounting students (around the globe) to understand the subject matter easier , faster. Follow him on twitter @LieDharmaPutra or add him to your circle at Google Plus Lie+

One thought on “Accounting Footnote Disclosures Part II [Accountant Must Used]”

Leave a Reply

Your email address will not be published. Required fields are marked *