Notes to the financial statements refer to additional information provided in the financial statement of the company. It provides the details of the information which is left out of the main documents, such as the income statement and the balance sheet. The main purpose of notes to financial statements is to provide necessary information of essential facts about the company, which may not be completely revealed by simply analyzing the financial statements.
This approach is followed, so as to provide clarity because, if these notes were to be included in the reporting document, it could become very lengthy as they can be very long.
Income statements of the company provide important information of a specific entity or business which helps in making judgments, such as whether more capital needs to be infused into the business or not, funds can be invested or not, money should be lent to the creditors or not, or for even judging whether the company is stable to continue working or to find a new employer.
Balance sheet of the financial statement gives the information about the financial condition of the company. Profit and loss statement shows the performance of the business. The cash flow statement specifies information about cash flows from financing activities like lending and investing. The changes in equity statement throws light on the impact of company’s performance, its transactions and other factors related to equity from the beginning to the end of accounting period.
However, these four constituents of financial statement are not entirely sufficient to provide with clear understanding, that is required by the readers, to make economic and financial assessments. Thus, the notes to financial statements are necessary as it essentially accompanies the information disclosed on the financial statements.
The requirements of notes to financial statement, which have become necessary part of audit include:
- Specification of changes made to accounting policies.
- Reporting important accounting policies, such as inventory assessment methods.
- Specification about the operating leases.
- Disclosure of comments regarding any possible liabilities and their impact on the company.
- Comments related to effects taking place in demand for organization’s goods and services, loss of important clients, and focus of business on limited number of customers.
- Notes about off balance sheet financing.
- Specification about pension liabilities, including funded and unfunded.
Notes to the financial statements are considered to be very important for the investors. These notes can consist of vital information about the company on things like, accounting methods used for documenting and reporting transactions, details of pension plan and information about the stock option compensation.