Financial Statement Footnotes Explained

Financial statement footnotes are supplemental notes that provide context for a company’s primary financial statements, such as the balance sheet and income statement. Both U.S. Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS) mandate these disclosures. Their purpose is to clarify the numbers and help readers understand a company’s financial position and performance.

Significant Accounting Policies and Estimates

A footnote, often appearing first, outlines the accounting policies and estimates chosen by a company’s management. This disclosure details the specific methods and assumptions used to prepare the financial statements, informing users about judgments that could affect the financial figures. This section allows for the comparison of financial information across different companies, as choices in accounting methods can lead to different reported outcomes.

One policy detailed is revenue recognition, governed by ASC 606, which explains when a company records revenue from customer contracts. Revenue is recognized when control of goods or services is transferred to the customer for an expected amount. For example, a software company might recognize revenue over the life of a subscription, whereas a retailer recognizes it at the point of sale.

Another policy involves inventory valuation. Companies must disclose their method, such as First-In, First-Out (FIFO), Last-In, First-Out (LIFO), or weighted-average cost. While U.S. GAAP permits LIFO, IFRS prohibits it. Under FIFO, the first units purchased are considered the first sold; under LIFO, the last units purchased are sold first. In periods of rising costs, LIFO results in a higher cost of goods sold and lower reported profit.

The method for depreciating property, plant, and equipment (PP&E) is also disclosed. Depreciation allocates a tangible asset’s cost over its useful life. A company may use the straight-line method, spreading the cost evenly, or an accelerated method that expenses more of the value in earlier years. This choice affects the asset’s book value and the depreciation expense on the income statement.

This footnote also addresses accounting estimates, which are areas requiring management judgment. This includes estimating the allowance for doubtful accounts (uncollectible receivables) and determining the useful lives of assets for depreciation. These estimates are based on historical experience and future expectations, and changes can impact reported earnings.

Detailed Breakdown of Financial Statement Line Items

Footnotes provide detail that unpacks the summary figures on the financial statements. These disclosures break down complex line items into their parts, offering a deeper understanding of a company’s assets, liabilities, and equity.

Debt

The footnotes disaggregate long-term debt, showing sources like bank loans and public bonds. For each instrument, the notes list the principal amount, interest rate, and maturity date. This section also details any debt covenants, which are restrictions lenders place on the company, such as requiring a certain debt-to-equity ratio.

Property, Plant, and Equipment (PP&E)

For PP&E, the footnotes provide a detailed schedule. This disclosure breaks down PP&E into classes like land, buildings, and machinery. It also presents a reconciliation of the carrying amount from the beginning to the end of the period, showing additions, disposals, and depreciation.

Leases

Leases are another obligation detailed in the footnotes, guided by ASC 842. This standard requires companies to recognize most leases on the balance sheet as a right-of-use (ROU) asset and a lease liability. The footnotes provide specifics on operating and finance leases, including a maturity analysis of future lease payments for the next five years and a total amount thereafter.

Investments

The footnotes elaborate on a company’s investments, following guidance from ASC 320. These disclosures detail the types of investments held, such as corporate bonds or government securities. The notes specify the classification of these securities—as held-to-maturity, available-for-sale, or trading—and report their cost basis and fair market value.

Shareholders’ Equity

Footnote disclosures clarify shareholders’ equity. These notes provide information on stock classes, like common and preferred, including the number of shares authorized, issued, and outstanding. Details on stock-based compensation plans, governed by ASC 718, are also included. This covers stock options and restricted stock units (RSUs) granted to employees, the number of awards, their fair value, and the associated compensation expense.

Disclosure of Risks and Future Obligations

Footnotes are the location for disclosing risks and obligations not yet on the balance sheet but that could impact the company’s future financial condition. These forward-looking disclosures cover commitments that could affect future cash flows and help stakeholders assess potential vulnerabilities.

One disclosure relates to contingencies and legal proceedings, governed by ASC 450. A contingency is a potential gain or loss dependent on a future event. The footnotes must describe pending litigation, the nature of the claim, and an estimate of potential loss if possible. If a loss is probable and can be estimated, a liability is recorded. If reasonably possible, it is disclosed in the footnotes; if remote, disclosure is not required.

The footnotes also reveal commitments that are not yet liabilities but represent future obligations. These can include long-term contracts to purchase raw materials, agreements for capital expenditures, or other non-cancelable obligations. Disclosing these commitments provides a picture of a company’s future cash requirements.

Other Disclosures

Other disclosures are presented in the footnotes to provide a complete financial picture. These address events and relationships for understanding the company’s status and governance.

Subsequent events are material events occurring after the balance sheet date but before the financial statements are issued. Governed by ASC 855, these are categorized into two types. The first provides evidence of conditions existing at the balance sheet date and may require adjusting the financial statements. The second relates to conditions that did not exist at the balance sheet date but are disclosed to avoid being misleading. Examples include a major business acquisition, issuing a large amount of debt, or settling a lawsuit after year-end.

For large, diversified companies, segment reporting is a footnote required by ASC 280 for public companies. This footnote breaks down metrics like revenue, profit or loss, and total assets by each business line and geographic area. This allows investors to see which parts of the company are driving performance and assess the risks and growth prospects of each segment.

Related-party transactions are disclosed to ensure transparency and highlight potential conflicts of interest. ASC 850 defines related parties to include executives, principal owners, their families, and other entities they control. The footnote must describe the relationship, the transactions, and the dollar amounts involved. While not inherently improper, this disclosure allows stakeholders to assess if the dealings were on an arm’s-length basis.