In addition to the basic financial statements, accountants must prepare notes to the financial statements. The purpose of the notes is to explain certain items or transactions to the reader. There is no comprehensive l ist of all information that should be disclosed in financial statements. The adequacy of disclosure is based on a combination of official rules, tradition, and accountants’ professional judgment. Two items always disclosed in the notes to financial statements are the accounting methods in use and the due dates of major liabilities. So, for example, JJ’s Lawn Care would disclose that straight-line depreciation was used to determine depreciation expense. The notes also explain any unusual or infrequent items that may be of interest to the reader. Almost all major corporations have a note disclosure about pending litigation.
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The Accounting Cycle Reporting Financial ResultsChapter 5Preparing Financial StatementsPublicly owned companies – those with shares listed on a stock exchange – have obligations to release annual and quarterly information to their stockholders and to the public.The annual report includes comparative financial statements and other information relating to the company’s financial position, business operations, and future prospects.The financial statements contained in the annual report must be audited by a firm of certified public accountants (CPAs).Business EarningsDividends Business LossesSummarizes the increases and decreases in Retained Earnings during the period.The Statement of Retained EarningsNotes to the Financial StatementsExamples of Items DisclosedLawsuits pendingScheduled plant closingsGovernmental investigationsSignificant events occurring after the balance sheet dateSpecific customers that account for a large portion of revenueUnusual transactions and related party transactionsDrafting the Notes that Accompany Financial StatementsClosing the Temporary AccountsClose Revenue accounts to Income Summary.Close Expense accounts to Income Summary.Close Income Summary account to Retained Earnings.Close Dividends to Retained Earnings.The closing process gets the temporary accounts ready for the next accounting period.Evaluating ProfitabilityEvaluating LiquidityEvaluating the BusinessNet Income PercentageNet Income Total Revenue=Return on EquityNet Income Avg. Stockholders’ Equity=Current RatioCurrent Assets Current Liabilities=Working CapitalCurrent Assets – Current Liabilities=MonthlyQuarterlyJan. 1Dec. 31AnnuallyMany companies prepare financial statements at various points throughout the year.Interim Financial StatementsPreparing Financial Statements Covering Different Periods of TimeEthics, Fraud, and Corporate GovernanceA company should disclose any facts that an intelligent person would consider necessary for the statements to be interpreted properly.Public companies are required to file annual reports with the Securities and Exchange Commission (SEC). The SEC requires that companies include a section labeled “Management Discussion and Analysis” (MD&A) because the financial statements and related notes may be inadequate for assessing the quantity and sustainability of a company’s earnings.Supplemental Topic: The WorksheetEnd of Chapter 5
