Some information about an organization can’t be put into dollar terms, or easily captured in financial statements. As a result, organizations include footnotes to their financial statements to give additional context and details about themselves and their accounting policies. If you go through an audit, your auditors will review the notes as well to make sure they are presented clearly and accurately, and because the accounting policies you use factor into how transactions and balances are captured in your financial statements.
The first note will typically include general information about your organization. It will cover your name, country and/or state of incorporation, business structure (e.g. corporation, LLC, etc.), descriptions of your business activities or programs, nonprofit or for-profit status, etc.
There will also be a statement about significant accounting policies. This will cover a range of accounting functions, since some require management to make assumptions and some allow management to choose between multiple methods of presentation. A few examples are:
- Method of Accounting: Do you use the accrual basis or cash basis of accounting?
- Revenue Recognition: What conditions have to be met for revenue to be recognized? This may vary if you have multiple revenue streams. Also include when revenue is deferred.
- Inventory: If you sell products, describe how you value inventory (lower of cost or market) and which cost-flow assumption you use (FIFO/LIFO, specific identification, weighted average).
- Property, Plant and Equipment: At what dollar value do you capitalize and depreciate an asset versus expensing it at the time of purchase? When are significant repairs and improvements capitalized or expensed? List the useful lives you assume for different types of fixed assets, and what depreciation method you use (straight line, MACRS, 150% declining balance, double declining balance).
- Accounts Receivable: Describe how you value accounts receivable, how you determine an allowance for doubtful accounts, and when you write off receivables.
- Use of Estimates: List which items in your financial statements are valued in part or in whole based on estimates made by management, e.g. depreciation, the value of donated assets, inventory, accounts receivable.
- Fair Value Measurements: Financial instruments and investments are reported based on fair market value. There are 3 levels of how to measure the fair value based on how observable the market price is, and whether management needs to make judgments. Describe the criteria you use to value assets in the 3 levels.
- Method of Allocating Expenses Among Functions: On the statement of functional expenses, how do you allocate expenses between functions. Examples include on the basis of direct costs, full-time equivalents (FTEs), and square footage. You may use multiple methods based on the type of cost.
You should also disclose significant subsequent events that happen after the end of the accounting period that you’re reporting on. How you report an event is based on whether it’s a Type I or Type II event. A Type I event effects estimates you made in your financial statements. If a company who owes you money goes out of business, you should write off their account receivable as bad debt. If you were involved in a lawsuit during the accounting period that ended after the period and you are required to pay damages, you would accrue the expense and liability in your financial statements. Type I events should also be described in the notes. Type II statements should not be accounted for in your financial statements, but should be disclosed in the notes. If you sold, spun off, or closed a program after the accounting period ended, that wouldn’t impact your financial statements, but is relevant to stakeholders evaluating your future financial performance.
In the note about accounting policies, some of those items will also result in a freestanding note describing related transactions or balances. Examples include:
- Accounts Receivable: Report your gross receivables, allowance for doubtful accounts, and net receivables. If some are due more than a year after the accounting period ended, that balance should be adjusted based on the time value of money.
- Financial Instruments: The fair value of your financial instruments is best shown in a matrix. Have columns for values in Level 1, Level 2, and Level 3 of the fair value hierarchy, and the total value, and rows for different types of instruments, e.g. cash equivalents, foreign and domestic stocks, bonds and mutual funds, and real estate holdings.
- Property, Plant, and Equipment: List the categories of assets you own, e.g. land, buildings, vehicles, equipment, at the gross purchase price, followed by accumulated depreciation and amortization, and the net book value.
- Inventory: Reconcile the starting and ending balance, including purchases, sales, and lower of cost or market losses.
If you have a significant amount of notes, bonds, or leases, whether payable or receivable, include a note showing the dollar amount due in each of the following 5 fiscal years, and the total of what’s due after more than 5 years.
If you have investments, include a note about the related income. This should include unrealized gains and losses, realized gains and losses, and interest and dividend income.
Other notes that may be relevant for your organization are:
- Accounting Changes: Disclose if you changed an internal accounting policy, or a governing agency, such as FASB, issued new guidance that impacts you. Include how impact the current financial statements you’re issuing, and how future statements will be affected.
- Net Assets: What types of assets or income do you have that is temporarily and/or permanently restricted, if any?
- Employee Benefits: Disclose your expense and any unpaid liability for employees’ retirement and pension plans. This may include an obligation to pay for post-retirement health and medical costs.
- Contingencies: You may have a contingent liability if existing circumstances are likely to cause a loss in the future, such as a lawsuit or tax proceedings against your organization.
- Board Restricted Net Assets: List any money your governing board has designated for specific purposes, including the amount and purpose.