8 ASC 235 NOTES TO FINANCIAL STATEMENTS
Commonly disclosed accounting policies
Valuation allowances (sometimes referred to as “contra” amounts)
PERSPECTIVE AND ISSUES
ASC 235, Notes to Financial Statements, contains one Subtopic:
- ASC 235-10, Overall, which addresses “the content and usefulness of the accounting policies judged by management to be most appropriate to fairly present the entity's financial statement.”
The topic does not address specific disclosures. Those are addressed in the related topics. The topic does, however, list accounting policy disclosures commonly required:
- Basis of consolidation
- Depreciation methods
- Amortization of intangibles
- Inventory pricing
- Accounting for recognition of profit on long-term construction-type contracts
- Recognition of revenue from franchising and leasing operations.
(ASC 235-10-50-4)
DEFINITIONS OF TERMS
There is no glossary in ASC 235.
CONCEPTS, RULES, AND EXAMPLES
Accounting Policies
The reporting entity's management is responsible for adopting and adhering to the highest quality accounting policies possible. ASC 235 requires management, in discharging this responsibility, to adopt accounting principles and methods of applying them that are “the most appropriate in the circumstances to present fairly financial position, results of operations, and cash flows in accordance with generally accepted accounting principles.”
There are many different methods of valuing assets, recognizing revenues, and assigning costs. Financial statement users must be aware of the accounting policies used by an entity so that sound economic decisions can be made. Per ASC 235, financial statement disclosures are to identify and describe
- All significant accounting policies followed by the entity and
- Methods of applying those principles that materially affect the determination of financial position, changes in cash flows, or results of operations.
This requirement applies even in reporting situations where one or more of the basic financial statements have been omitted. However, it does not apply to unaudited interim statements where the accounting policies have not changed since the issuance of the last annual statements. (ASC 275-1050-2)
The accounting policies disclosure is to encompass those accounting principles and methods that involve the following:
- Selection from acceptable alternatives
- Principles and methods peculiar to the industry
- Unique applications of GAAP.
In theory, if only one method of accounting for a type of transaction is acceptable under GAAP, it is not necessary to explicitly cite it in the accounting policies note, although many entities do routinely identify all accounting policies affecting the major financial statement captions.
It is not necessary to repeat details provided elsewhere in the disclosures in the accounting policy disclosure. Many preparers simply cross-reference accounting policy disclosures to relevant details provided in other notes to the financial statements.
The “summary of significant accounting policies” is customarily, but not necessarily, the first note disclosure included in the financial statements. A more all-encompassing title such as “Nature of business and summary of significant accounting policies” is frequently used.
Commonly disclosed accounting policies.
A listing of accounting policies commonly disclosed by reporting entities follows (the listing is not intended to be all-inclusive):
- Advertising costs
- Advertising, direct response arrangements
- Cash equivalents
- Changes in accounting policies
- Combined financial statements, principles of combination
- Concentrations of credit risk, major customers and/or suppliers
- Consolidated financial statements, principles of consolidation
- Consolidated financial statements, variable interest entities
- Deferred income taxes
- Deferred income taxes, undistributed earnings of subsidiaries and/or joint ventures
- Derivatives and hedging activities
- Fair value elections, methods, assumptions, inputs used
- Financial instruments
- Fiscal year, 52-53 week year
- Fiscal year, difference between fiscal year used for financial reporting and for income tax purposes
- Foreign currency translation
- Foreign sales corporations
- Goodwill
- Guarantees
- Impairment of long-lived assets, goodwill, other intangibles, investments, etc.
- Income taxes, deposit to retain fiscal year
- Income taxes, nonaccrual by flow-through entity
- Income taxes, liability for unrecognized income tax positions
- Intangibles, amortizable and/or nonamortizable
- Interest capitalization
- Internal-use software
- Inventories
- Investments, cost method
- Investments, debt and marketable equity securities including reclassifications between portfolios
- Investments, equity method
- Long-term contracts
- Nature of operations
- Not-for-profits; restrictions that are satisfied in the year they originate
- Operating cycle
- Out-of-pocket costs (typically for service businesses)
- Pension and other postretirement or postemployment plans
- Property and equipment, depreciation and amortization
- Property and equipment, changes from held-and-used to held-for-sale
- Rebates
- Receivables, past due, interest and late charges, determination of allowance for bad debts
- Reclassifications
- Revenue recognition, lessor leasing activities
- Revenue recognition, long-term contract accounting
- Revenue recognition, methods for each significant product or service
- Revenue recognition, multiple-element arrangements
- Revenue recognition, product returns
- Revenue recognition, real estate (time-sharing) sales (e.g., installment cost recovery, full accrual)
- Revenue recognition, software sold or otherwise marketed
- Share-based payment arrangements
- Shipping and handling costs
- Start-up costs
- Syndication costs
- Use of estimates
- Warranties.
Initial adoption decisions.
Upon formation of a business or nonprofit organization, management makes decisions regarding the adoption of accounting policies, based on the types of activities in which the entity engages and the industry and environment in which it operates. Certain ASC Topics permit choices to be made from among alternative, acceptable accounting treatments. The principles selected from among the available alternatives and the methods of applying those principles constitute the reporting entity's accounting policies.
Management initially adopts accounting principles at two distinct times:
- Upon formation of the reporting entity
- Upon the occurrence of a new type of event or transaction that had either not happened in the past or had previously been judged to be immaterial.
Once the initial adoption decisions are made, the users of the financial statements expect a reporting entity's financial statements to be prepared consistently over time. This facilitates comparisons across periods and among different reporting entities.
Disclosure Techniques
The following five disclosure techniques are used in varying degrees in contemporary financial statements:
- Parenthetical explanations
- Notes to the financial statements
- Cross-references
- Valuation allowances (sometimes referred to as “contra” amounts)
- Supporting schedules.
Parenthetical explanations.
Information is sometimes disclosed by means of parenthetical explanations appended to the appropriate statement of financial position caption. For example
Common stock ($10 par value, 200,000 shares authorized, 150,000 issued) $1,500,000
Parenthetical explanations have an advantage over both notes to the financial statements and supporting schedules. Parenthetical explanations place the disclosure prominently in the body of the statement instead of in a note or schedule where it is more likely to be overlooked.
Notes to financial statements.
If the information cannot be disclosed in a relatively short and concise parenthetical explanation, a note disclosure is used. For example
Inventories (see note 1) $2,550,000
The notes to the financial statements would contain the following:
Note 1: Inventories are stated at the lower of cost or market. Cost is determined using the first-in, first-out (FIFO) method.
Cross-references.
Cross-referencing is used when there is a direct relationship between two accounts on the statement of financial position. For example, among the current assets, the following might be shown if $1,500,000 of accounts receivable were pledged as collateral for a $1,200,000 bank loan:
Accounts receivable pledged as collateral on bank loan payable $1,500,000
Included in the current liabilities would be the following:
Bank loan payable—collateralized by accounts receivable $1,200,000
Valuation allowances.
Valuation allowances are used to reduce or increase the carrying amounts of certain assets and liabilities. Accumulated depreciation reduces the carrying value of property, plant, and equipment, and a bond premium (discount) increases (decreases) the face value of a bond payable as shown in the following illustrations:
