Accounting footnotes are the numbered notes attached to a set of financial statements that carry the accounting policies the entity applied and the detail the face of the statements cannot hold. They are not commentary about the statements. Under US GAAP a description of all significant accounting policies is part of the statements themselves, so a reader who skips the notes has read an incomplete set rather than a shorter one.
Footnotes and notes to the financial statements name the same thing. Notes is the term the standards and the filings use.
The Notes Are Inside the Statements, Not Beside Them
The rule is stated as a matter of status, not of etiquette. When financial statements are issued purporting to present fairly financial position, cash flows, and results of operations in accordance with generally accepted accounting principles, a description of all significant accounting policies of the reporting entity should be included as an integral part of the financial statements (APB Opinion No. 22, paragraph 8). Where one basic statement is issued without the others, it carries the pertinent policies too, and the same conclusion applies to not-for-profit entities (APB Opinion No. 22, paragraphs 8 and 9).
Integral part is the phrase that does the work. A balance sheet handed to a lender with the notes stripped off is not the financial statements, and a missing note is a reporting defect rather than a stylistic one.
The First Note Names the Policies
Format is left flexible, with one strong preference expressed. The Board believes the disclosure is particularly useful if given in a separate Summary of Significant Accounting Policies preceding the notes to financial statements or as the initial note, and it expresses its preference for that format under the same or a similar title (APB Opinion No. 22, paragraph 15). That preference is why a statement set usually opens on a note carrying that title.
What belongs in it is defined rather than left to taste. Disclosure of accounting policies should identify and describe the accounting principles followed by the reporting entity and the methods of applying those principles that materially affect the determination of financial position, cash flows, or results of operations, and in general the disclosure should encompass important judgments as to appropriateness of principles relating to recognition of revenue and allocation of asset costs to current and future periods (APB Opinion No. 22, paragraph 12).
The same paragraph then names three cases the disclosure has to reach in particular:
- A selection from existing acceptable alternatives.
- Principles and methods peculiar to the industry in which the reporting entity operates, even where those principles and methods are predominantly followed in that industry.
- Unusual or innovative applications of generally accepted accounting principles, and as applicable of principles and methods peculiar to that industry.
The second one is the one preparers skip. An industry convention still gets described, precisely because it is a convention the reader outside that industry does not know.
The Opinion also gives examples of the disclosures commonly required, including those relating to basis of consolidation, depreciation methods, amortization of intangibles, inventory pricing, accounting for recognition of profit on long-term construction-type contracts, and recognition of revenue from franchising and leasing operations, and says the list of examples is not all-inclusive (APB Opinion No. 22, paragraph 13).
The Policies Note Is Not a Second Copy of the Detail
There is an explicit instruction against padding it. Financial statement disclosure of accounting policies should not duplicate details, such as the composition of inventories or of plant assets, presented elsewhere as part of the financial statements, and in some cases the disclosure should refer to those related details instead (APB Opinion No. 22, paragraph 14).
The same paragraph handles one case by cross-reference rather than by repetition: changes in accounting policies during the period are described with cross-reference to the disclosure required by FASB Statement No. 154, Accounting Changes and Error Corrections (APB Opinion No. 22, paragraph 14). Where that change is the correction of an earlier period, the mechanics land on the opening balance, which is worked through in statement of retained earnings.
So a policies note that runs for pages is usually carrying detail that belongs in the notes that follow it, or on the face of a statement.
Interim Statements Get an Exception
The requirement is written for the annual set. The provisions requiring the policies disclosure are not intended to apply to unaudited financial statements issued as of a date between annual reporting dates, for example each quarter, where the reporting entity has not changed its accounting policies since the end of its preceding fiscal year (APB Opinion No. 22, paragraph 10).
Two conditions sit inside that sentence and both have to hold: the statements are interim, and the policies have not changed. A quarter in which a policy did change carries the disclosure. What the SEC’s own interim rule permits a registrant to omit is set out in Form 10-Q.
What Else the Note Set Carries
Past the policies note, the notes hold the families a preparer works every close: subsequent events, loss contingencies, related party transactions, going concern, and the terms and maturities behind a single debt caption. Why each of them is reported at all, rather than left out because no figure required it, is the subject of the full disclosure principle.
What Accounting Footnotes Are Not
- Management’s commentary. A discussion of results written by management is a separate document with its own rules. The notes are part of the statements and are covered by whatever level of service the accountant performed on them.
- Optional detail. All significant accounting policies are required, and the word in the Opinion is all.
- The auditor’s report. That report is the accountant’s own statement about the statements, including the notes. It is not one of them.
- A place to explain away a number. The notes describe the principles applied and the detail behind the captions. A result the entity dislikes is still the result.
Common Questions
The notes attached to a set of financial statements, carrying the significant accounting policies applied and the detail supporting the captions. They are an integral part of the statements rather than an addition to them.
Because the policies chosen change what the figures mean. The usefulness of financial statements for making economic decisions depends significantly on the user’s understanding of the accounting policies the entity followed, which is the reasoning the Opinion sets out before it states the requirement (APB Opinion No. 22, paragraph 7).
The note that identifies and describes the accounting principles the entity followed and how it applied them. The Opinion prefers it as a separate summary preceding the other notes, or as the initial note.
Not where the entity has not changed its policies since the end of the preceding fiscal year. Change a policy and the disclosure comes back.
Accountably places trained offshore accountants inside US CPA and EA firms, and a firm can grade a real block of its own note preparation work through a trial task before any client file moves.
