11 types of important notes to financial statements
By Indeed Editorial Team
Published 10 October 2022
The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.
If you work in accounting management, you're responsible for ensuring that the organisation's financial records present a clear and accurate overview of its economic health. This helps potential investors to make informed decisions on whether to buy the business' stocks or bonds. Learning more about notes to financial statements can help you become more effective in your role and help the company where you work remain compliant with government accounting regulations. In this article, we define notes to financial statements and list 11 types of accounting notes and their purposes.
What are notes to financial statements?
Notes to financial statements are complementary documents attached to a firm's financial statements. Notes offer context to support the financial figures contained in corporate records, detail business strategies and justify current accounting policies. Depending on the health of the business' finances, such documents might either explain how current policies delivered commercial benefits or justify policy changes to increase growth. They may also discuss specific aspects of business finances, such as liabilities, inventory value or intangible assets. By attaching these notes to financial statements, organisations may remain compliant with the full disclosure principle during account audits.
11 types of accounting notes
Here is a list of 11 types of accounting notes:
1. Basis of presentation
These notes outline the legal basis on which you've prepared statistical data outlined by financial statements. You can refer to specific financial accounting regulations to justify the reporting methods used, such as the UK GAAP standards. You may also define the fiscal years covered by the financial statement. This note offers a legal disclaimer to reassure officials that the financial statement complies with relevant accounting practice standards.
2. Accounting policies
These notes disclose the standards, rules and internal processes that accounting managers may follow when preparing financial records for external assessment. Accounting policies provide guidance on how companies plan for future production, though the exact methods used can vary depending on the organisation's unique circumstances. By detailing these policies in notes, you help government auditors to appreciate the origin or reliability of figures used in financial statements. You can also explain if the business uses a conservative or aggressive approach to determine accounting policies.
These notes might briefly outline the varied types of accounting policy used to conduct different tasks, which you may clarify in more detail in later notes. For example, you might explain that your organisation uses the First In, First Out method to track inventory. The policy assumes that the first goods manufactured by companies become the first sold to customers. You may also use the straight-line method to calculate the depreciation of assets, which uses the below formula:
Depreciation = (Cost of the asset – estimated salvage value)/estimated useful life
3. Depreciation of assets
The depreciation of assets is the gradual decline in physical assets' productive value caused by weathering or breakdowns. Examples of physical assets include delivery vehicles, machinery or manual tools. This note may include more detail on the methods used to calculate asset depreciation before justifying their selection over other methods. For example, your organisation may use the accelerated depreciation method, which reports more depreciation in earlier usage years than in later years. In this situation, you can outline that this method allows you to account for early depreciation expenses during the appropriate tax year, increasing the reliability of accounts.
If the organisation changes the depreciation methods between tax years, you may also detail the reasons for this decision. Registering policy changes simplifies the auditing process and reduces the risk of non-compliance.
4. Valuation of inventory
The valuation of inventory is the total financial value of unsold inventory items. Organisations might use such figures to compare annual valuations changes when drafting a financial statement. Under FRS 102 - UK GAAP regulations, your organisation may use either the First In, First Out or average cost methods to calculate the value of inventory.
You might use valuation of inventory notes to justify usage of an inventory accounting policy, explaining how it benefits the organisation's finances. For example, you can use First In, First Out to give monetary value to identical items whose exact cost fluctuates with market demand. This method allows you to identify the effect of changing resource costs on production. In contrast, you can use the average cost method, which combines the individual costs of identical items before dividing them by the number of units available. Using this method, organisations can simplify the valuation process.
5. Subsequent events
Subsequent events are major events that take place after the balance sheet date but before the publishing of financial statements. These notes explain the nature of major events, their impact on the company's finances and business leaders' response to them. Examples of subsequent events include legal settlements, customer bankruptcy and discovering instances of fraud. Notes split events into two categories, additional information and new events. The former category provides updates on events whose earlier conditions exist on a balance sheet, whereas the latter category covers events not reflected in balance sheet data.
6. Intangible assets
Intangible assets have no physical form yet provide financial value to the owner. Examples of intangible assets include patents, trademarks and licensing agreements. These notes list the name, scope and functions of intangible assets before justifying their stated financial value.
In this situation, you can explain the method used to achieve valuations. For example, you can use the cost method, which calculates the amount another company might invest to design intangible assets of similar quality. Costs accounted for include labour, legal fees and copyright registration fees. Alternatively, you can use the market method, searching for assets owned by rival firms with an identical purpose as those created by the organisation where you work.
7. Consolidation of financial statements
Consolidation of financial statements concerns merging the financial records of the parent company and any subsidiaries into one statement. The note confirms that this process took place and identifies each business' revenue, assets, liabilities, equity and costs on a line-item basis. If subsidiaries operate across varied national markets, you can also explain that you've converted financial statement items into the currency of the parent company's home market. To make conversions, you may use average exchange rates from the relevant fiscal year.
8. Benefits for employees
This note lists the type, purpose and cost of benefits provided to some or all employees, such as occupational pension plans, health insurance or personal injury coverage. You may also outline the risk and liabilities accumulated in providing these benefits. For example, for occupational pensions, you may define the ratio of employee to employer contributions and discuss the types of asset-backed securities used to invest in such contributions. This evidence reassures auditors that you're making calculated investments rather than squandering money on high-risk assets. You can also define any conditions that employees may meet before receiving benefits.
Related: 20 common types of employee benefits
Contingencies are measures an organisation introduces to prepare for liabilities that might arise in the future, contingent on certain conditions. These notes outline the plans you've drafted to protect the firm against financial instability in case of sudden economic shocks. Contingent liabilities can include lawsuits by a rival business for copyright infringement, exchange rate fluctuations and corporation tax hikes. You may also offer evidence to describe the supposed impact of some contingent liabilities on the organisation's operating model.
10. Debt reporting
Debt reporting notes provide in-depth accounts of the company's individual debts, detailing both their values and format. Types of corporate debt include tradable bonds, hire purchases and business loans. These notes may also detail whether the organisation used assets as collateral to secure credit. If you attach debt reporting notes to financial statements, potential investors may effectively evaluate the business' current financial health and decide if it represents a worthwhile investment.
11. Fair value
In accounting, fair value represents the price that sellers receive after selling an asset, taking into account the associated liabilities. Fair value notes provide context for major commercial decisions, such as share issuance or corporate mergers. For example, if your organisation purchases a large stake in a small business, you may use fair value notes to justify the takeover based on the subsidiary's assets and liabilities at the point of sale. You can then provide an accurate valuation that accounts for price movement, which can lower the business' tax obligations and provide reference points to plan future growth.
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