The User's Perspective
Touring the Financial Statements, Part IV: Note Disclosures
“The accompanying notes are an integral part of the financial statements.” How often have you seen this phrase, or something very like it, at the bottom of one of a government’s financial statements? Perhaps enough that you do not even notice it anymore. But it is a crucial matter for the users of governmental financial reports. The financial statements do not consist solely of the numbers presented in rows and columns in financial statements like the government-wide statement of activities or the governmental funds balance sheet. Although found following the statements, the notes are considered an essential part of the financial statements, a component without which the statements cannot fully be understood.
The Relationship between Financial Statements and Notes
The GASB’s conceptual framework defines financial statements as tabular presentations of words and dollars describing either (a) a government’s financial position (the status on a given date of its assets, liabilities, deferred amounts, and residual balances) or (b) its inflows and outflows of resources. Assets, liabilities, inflows, outflows, and deferred inflows and outflows that are “measurable with sufficient reliability” are recognized (recorded and presented) in the financial statements.
The notes to the financial statements present both quantitative and narrative information that is essential to a financial statement user’s understanding of financial position or inflows and outflows of resources. In other words, the notes are necessary to comprehending what the financial statements are trying to communicate.
There are generally three types of note disclosures:
Methods, Policies, and Choices
An intrepid financial statement user does not merely accept the amounts presented at face value. The user asks, “How did the government come up with these numbers?” This is a key question, because accounting and financial reporting standards sometimes offer governments choices among methods for measuring and reporting certain transactions and events. For example:
In general, a government discloses its methods, policies, and choices in the summary of significant accounting policies, which is typically the first note disclosure. Some of the required contents of the summary of significant accounting policies are:
Details and Explanations
The amounts presented in the financial statements tend to be aggregations of similar elements. For instance, a government may recognize a single amount for capital assets net of accumulated depreciation in the government-wide statement of net assets. But the government is required to present a detailed note disclosure that, among other things: (a) disaggregates the amount by type of capital asset, distinguishing between those that are depreciated and those that are not; (b) shows the amounts added to and subtracted from capital assets during the year; and (c) allocates depreciation expense to the functional and programmatic categories reported in the statement of activities (for example, general government, social services, public works, public safety, and so on).
Likewise, long-term liabilities—outstanding bonds, net pension obligations, compensated absences, pollution remediation obligations, and such—may be reported in the aggregate in the statement of net assets. The required note disclosure for long-term liabilities might look like this:
The disclosure also would have a section pertaining to the government’s business-type activities, and would identify the funds in which the liabilities are to be liquidated.
Amounts Not Recognized
A primary example of this type of note disclosure is construction and other significant commitments. Governments are required to disclose significant commitments they have made that are not reflected in the financial statements, because they have not yet occurred. For example, a government may have signed a contract to begin a major construction project, but work on the project will not begin until after the fiscal year-end. Users find disclosures of commitments useful because they signal potentially significant impacts on a government’s financial situation going forward.
What Information Should Be Disclosed in the Notes?
Generally accepted accounting principles (GAAP) identify the summary of significant accounting policies and 17 other areas of disclosure as being “essential to fair presentation” (in shorthand, required in order not to be misleading), including:
There are another 53 areas of disclosure that are required, if applicable, by GAAP, including:
As they say in informercials, “But that’s not all…” GASB standards make clear that the lists of specific disclosures are “neither all-inclusive nor intended to replace professional judgment” regarding what is necessary to achieve fair presentation. In other words, if a government believes that not disclosing a particular piece of information would cause the financial statements to be misleading, then it should disclose that information, even if it is not specifically required in the standards.
There is no required order for the note disclosures, but the standards say that notes are more informative when arranged logically. A suggested order has been in existence for 30 years (and is presented in the nonauthoritative section of the GASB’s Codification), and most governments follow it. Many of the easier-to-read notes section also begin with a table of contents that makes it simpler to find a particular topic.