Financial Statement Disclosures Explained: Why Footnotes Are Essential in a Review
When you hear the term financial statement disclosures, you might assume it’s something reserved only for big corporations with complex audited financials. But the truth is, even if your business is only preparing reviewed financial statements, these disclosures—commonly referred to as footnotes—are not optional. They’re a critical part of presenting a transparent and accurate financial picture.
This article explores why financial statement disclosures matter in a review engagement, what they typically include, and how they impact the trust and decisions of lenders, investors, and other stakeholders.
What Are Financial Statement Disclosures?
Financial statement disclosures are explanatory notes that accompany your financial statements. These footnotes go beyond the numbers to provide essential context, explaining the accounting methods, key assumptions, unique transactions, and relevant events that influence your financial data.
Here are a few examples of commonly required disclosures:
Accounting Policies: Disclose how your business recognizes revenue, values inventory, depreciates assets, and applies other significant accounting methods.
Related-Party Transactions: Include any dealings with entities owned or influenced by company insiders, such as contracts with a family-owned vendor or rent paid to a business affiliate.
Subsequent Events: Report material events that occurred after the balance sheet date but before the financial statements were issued—such as legal disputes, mergers, or significant asset purchases.
These disclosures are vital to ensure that the financial statements are interpreted correctly by anyone who reads them.
Why Financial Statement Disclosures Matter in a Review
Even in a review engagement, where the CPA provides only limited assurance, financial statement disclosures remain a fundamental component of the reporting process. Here’s why:
1. They Enhance Lender Confidence
Lenders evaluating your business for financing rely on clear and complete financials. Footnotes help them understand not only your current numbers but also the underlying context—such as contractual obligations or risks—that could affect your ability to repay.
2. They Influence Investor Decision-Making
Investors use disclosures to uncover hidden risks, like pending litigation or dependency on a few major customers. This insight is often a deciding factor in whether they choose to invest.
3. They Improve Industry Comparability
Disclosures reveal how your accounting estimates or methods differ from others in your field, allowing more accurate benchmarking against competitors or industry standards.
4. They Protect the CPA’s Review Conclusion
If key disclosures are missing, your CPA may have to modify their report to reflect that the financials could be misleading. In some cases, they may even withdraw from the engagement if the issues are severe enough.
Management’s Role in Financial Statement Disclosures
While your CPA can offer guidance, it is management’s responsibility to ensure that financial statement disclosures are accurate, complete, and clearly presented.
You’ll need to disclose items such as:
Unusual or Significant Transactions: This includes anything outside normal business operations, such as the sale of a major asset or restructuring of debt.
Changes in Accounting Methods: If your business shifts from one method to another—for example, changing how revenue is recognized—this must be disclosed.
Contractual Obligations and Long-Term Commitments: Detail any leases, long-term loans, or service agreements that affect your financial obligations.
Uncertainties or Legal Issues: Mention any pending lawsuits, regulatory investigations, or concerns about the business continuing as a going concern.
Your CPA may recommend disclosures to avoid misleading users of the financial statements, but the final decision to include or exclude them rests with you as the business owner or financial officer.
Common Types of Financial Statement Disclosures in a Review
While not as exhaustive as in an audit, financial statement disclosures in a review should still cover the most relevant and material areas. Common disclosures include:
Significant Accounting Policies: Provide a summary of the accounting framework used (such as U.S. GAAP) and highlight any key judgments, such as how estimates are determined.
Debt and Liabilities: Clearly outline the terms, interest rates, repayment schedules, and any collateral associated with major loans or credit agreements.
Revenue Recognition Practices: If your business earns revenue in multiple ways (e.g., subscriptions, product sales, service contracts), explain how and when revenue is recognized for each stream.
Owner or Related-Party Transactions: Disclose any business conducted with related parties, including services purchased from a company owned by a shareholder or rent paid to a related entity.
Subsequent Events After the Reporting Date: Detail any impactful occurrences after year-end that could influence how stakeholders interpret your financial position.
What Happens If You Omit Required Disclosures?
Neglecting proper financial statement disclosures can lead to consequences that extend far beyond a simple revision request:
Modified or Adverse CPA Report: Your CPA may have to alter their conclusion if the omission results in financial statements that are potentially misleading.
Stakeholder Mistrust: Lenders, investors, or partners may become suspicious of your financial transparency, raising doubts about your business practices.
Future Compliance Issues: If your business later undergoes an audit or applies for financing, missing disclosures can create delays, increased costs, or compliance setbacks.
Conclusion
Financial statement disclosures are not just a formal add-on—they’re a key part of ensuring your reviewed financial statements provide a fair and reliable representation of your business’s financial health. At Hudson & Empire, we help businesses navigate the disclosure requirements with clarity and precision, offering practical guidance so you can meet expectations without overwhelming your audience.
If you’re preparing for a financial review or unsure about what needs to be disclosed, our team is here to assist. Together, we can make sure your statements are complete, compliant, and trusted by everyone who reads them.
Need help crafting clear, complete disclosures? Reach out to Hudson & Empire to ensure your reviewed financials reflect the full story.
Frequently Asked Questions (FAQs)
Do smaller businesses really need formal footnotes in a review?
Yes. If your financial statements are prepared in accordance with GAAP, footnotes are typically required—even for smaller entities. The length and complexity may vary, but the principle of transparency remains the same.
Is it ever okay to complete a review engagement without any disclosures?
Only in rare circumstances. Some special-purpose frameworks may allow reduced disclosures, but omitting them altogether usually limits the financial statements to internal or management-only use. Always check with your CPA to determine what’s appropriate.
What if I’m unsure which disclosures are required for my business?
Hudson & Empire can provide a custom disclosure checklist tailored to your business. We’ll ask the right questions and guide you through the process to ensure your disclosures are accurate, relevant, and complete.
