There are a variety of reasons for the numerous required footnote disclosures under Generally Accepted Accounting Principles (GAAP). One reason is that the footnotes to your company’s financial statements give investors and lenders an insight into account balances, accounting practices and potential risk factors. This knowledge is extremely important when making sound investment decisions as the numbers within the balance sheet, income statement and statement of cash flows may not tell the entire story. Additionally, financial statements are generally thought of as reporting historical data, however, there could also be unrecorded amounts that are required to be disclosed under GAAP. Below are a few examples of required disclosures that are oftentimes not considered, but are required for financial statements to be in accordance with GAAP.
A company’s balance sheet might not reflect all future obligations depending on the nature of the transaction and the criteria for recognition that must be met. One example of this relates to contingent liabilities. A few examples of contingent liabilities are potentially damaging lawsuits, IRS inquiries and/or tax audits and environmental claims. An additional item to consider is that it is very common for contingent liabilities to meet the criteria for recognition when there is still uncertainty on the amount to be paid. In these cases, there is often a range of expected outcomes and a qualitative disclosure about the range of outcomes required under GAAP.
2. Related-party transactions
Related parties may take many forms. The most usual that we see are common ownership entities and affiliates that are not required to be consolidated into the financial statements. Significant related party transactions, including a description of the transaction(s) as well as any quantitative totals, are required to be disclosed under GAAP. A few examples of typical related party transactions requiring disclosure are related party leases, guarantees of related party debt and transactions with key employees.
3. Accounting changes
Footnotes are required to disclose the nature and justification for a change in accounting principle, including any impact of that change on the financial statements. This has become especially important and very common in recent years with the adoption of Accounting Standard Codification (ASC) 606 – Revenue from Contracts with Customers and the upcoming adoption of ASC 842 – Leases for private companies beginning in 2022.
4. Risks and uncertainties
A final qualitative disclosure that has become extremely common within the past twelve months is the disclosure of risks and uncertainties of the business. GAAP requires disclosure of any uncertainties where it is at least reasonably possible that estimates may change within one year of the date of the financial statements and that the change could be material. Risks and uncertainties regarding the COVID-19 pandemic are being disclosed in almost all instances due to this requirement and the related uncertainty surrounding the business landscape that COVID has brought.
Too much, too little or just right?
Recently, the Financial Accounting Standards Board has been eliminating and simplifying footnote disclosures, especially for private companies. Questions may arise with these simplification initiatives, such as, “Do I need this disclosure?” and “How much do I need to disclose?” Transparency is key to effective corporate governance as well as the preparation of financial statements that are in accordance with GAAP.
We at GBQ are always willing and available to help answer any questions you may have. Please contact your GBQ representative if you have questions, or if you would like to discuss any of this information in further detail.
Article written by:
Tobin Perrill, CPA
Senior Manager, Assurance & Business Advisory Services