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June 28, 2022

Getting to the Bottom of Hidden Details in Financial Statement Footnotes

You only get part of the big picture if you only look at the numbers. Reading comprehensive footnote disclosures gives valuable insight into your company's operations. These disclosures are located at the bottom of financial statements that have been reviewed and audited.

Key details often get overlooked because most individuals just scan these notes instead of thoroughly reading them. Curious about what risk factors you may find within these disclosures? Below are just a few examples to look out for in your statements.  

Transactions between related parties

There are occasions when companies give or receive preferential treatment to or from related parties. This arrangement should be disclosed in the footnotes because of the potential risk associated with these relationships. 

A great example is if a bookstore rents retail space from the owner's brother at a rate well below market pricing. This price break saves the store approximately $95,000 in rent annually. However, the bookstore isn't disclosing the existence of this favorable party-related deal, which inflates its appearance as a profitable shop on its financial statements. 

One day, the brother sells his share of the building to a commercial investor, who then increases the rent to a more reasonable market rate. This sudden increase could put the bookstore into financial uncertainty. Its stakeholders, who had no idea of the previous party-related arrangement, are now blindsided and could face substantial losses.  

Changes in accounting rules and procedures

Financial statement footnotes also disclose changes to accounting principles and justification for these modifications. You will also find out what effect these adjustments had on the statements above. Keep in mind that a manager may be dishonest and use these changes to manipulate the reported results. This could occur when reporting depreciation, for example. However, there are legitimate reasons for changing accounting methods, such as when regulators impose modifications. 

Liabilities that are contingent and unreported

Disclosure footnotes often share details regarding specific risks that could impact a company's finances but are not reflected on a balance sheet. Examples of such liabilities include:

  • IRS audits
  • Lawsuits
  • Environmental claims

You can also learn about a company's loan agreement details, leases, contingent liabilities, and warranties within a financial statement's footnotes.

Events with long-term impacts

Stakeholders want to be fully informed of any business struggles ahead, such as new regulatory requirements taking effect in the coming year or a company losing a major client. Disclosure footnotes share these significant event details when there’s a likely material impact on business value or future earnings. 

Always strive for transparency

Today's marketplace is filled with uncertainty, causing stakeholders like investors and lenders to demand more supporting documentation and disclosures to answer their questions. They want to make informed decisions, so it's vital to work with experienced accountants to draft clear and concise footnotes and answer stakeholders' concerns. 

You can also work with our team to review your concerns regarding disclosures made by possible merger and acquisition targets or your publicly-traded competitors. 

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