USCPA (FAR) – (7) Note to Financial Statements

I would like to record about the key points of the US CPA exam content.

<Create and note the points based on mainly Becker’s workbook>

The disclosure of accounting policies

• Information presented in notes to the financial statements have the purpose of providing disclosures required by GAAP. SFAC 5 page 7.
• Disclosure of accounting policies (and all other disclosure also) is an integral part of the financial statements.
• The disclosure of accounting policies is not fixed in terms of format or location. Typically, disclosures regarding accounting policies are usually placed in ‘Note 1,’ but this is a widely adopted practice rather than a strict rule.
• The first or second note of the financial statements is the Summary of Significant Accounting Policies and includes information regarding measurement bases used in preparing financial statements. The company will not duplicate the information provided in this note in later footnotes. Instead, the company will present calculations of the inventory and plant asset amounts that reflect the new policies.”
• (example) The method of determining which assets are considered to be cash equivalents is a significant accounting policy.

Adjusting Subsequent Events vs Non-adjusting Subsequent Events

<Adjusting Subsequent Event>

• Definition and Explanation: Adjusting subsequent events are events that provide additional information about conditions that existed at the balance sheet date. These types of events bring significant information that affects the financial statements, necessitating adjustments to the figures reported.
• Example: If a refinancing was confirmed before the date of the financial statements issuance, this refinancing qualifies as an adjusting subsequent event. For instance, if a company’s refinancing, which was uncertain at the end of the period, was completed before the financial statements were issued, this refinancing needs to be reflected in the financial statements as a non-current liability because it directly impacts the company’s financial position. This adjustment is crucial for the financial statements to accurately reflect the company’s financial situation.

<Non-adjusting Subsequent Events>

• Definition and Explanation: Non-adjusting subsequent events are events that occur after the balance sheet date and do not affect the condition of the company at that point. These events do not alter the figures in the financial statements but are usually disclosed in the notes as they provide useful information for investors and other stakeholders to understand the company’s future condition.
• Example: If a refinancing is confirmed after the issuance of the financial statements, it is treated as a non-adjusting subsequent event. For example, if a company completes refinancing after the end of the period, but it was not confirmed before the financial statements were issued, this event does not affect the financial figures directly. However, the fact of refinancing should be disclosed in the notes to the financial statements, providing information to investors and other stakeholders to better understand the company’s financial condition.
• For entities that do not file financial statements with the Securities and Exchange Commission, the subsequent event evaluation period runs through the date the financial statements are available to be issued, and that date is defined as the date when the financial statements are in a form and format that comply with GAAP and by which all approvals for issuance have been obtained. It is not necessary that the financial statements have actually been issued.
•  For entities that file financial statements with the Securities and Exchange Commission, the subsequent event evaluation period runs through the date the financial statements are issued. Financial statements are considered issued on the date when the financial statements are in a form and format that comply with GAAP and by which the financial statements have been widely distributed to financial statement users. There is no requirement for any shareholders to have acknowledged receipt of the financial statements.

Disclosure of Account receivable

Trade accounts receivable must be presented separately from non-trade receivables such as dividends receivable and interest receivable.

Disclosure of Restricted cash

• Account Name: Restricted cash is typically recorded on the balance sheet under the account name “Restricted Cash”. This categorization makes it clear that this cash is separate from general operating funds and has specific restrictions.
• Classification as a Long-Term Asset: If restricted cash is related to long-term obligations, it may be classified as part of “Other Long-Term Assets”. This classification indicates that the funds will be utilized in subsequent fiscal years.
• Note Content: The notes to the balance sheet will include the amount of restricted cash and the specific reasons or conditions for the restriction. For example, the cash may be reserved for the payment of a specific debt or designated as funding for a particular project.
• Relation to Liabilities: When restricted cash corresponds to related liabilities, it is important to explain this relationship in the notes. This helps clarify how the presence of restricted cash affects the company’s ability to pay those liabilities.
• Practical Handling: In practice, such information is usually explained in separate notes for each account. However, for information with high relevance, it is recommended to illustrate the relationships through cross-references or additional explanations.

Disclosure of Fiscal Year Timeframe

• Disclosure of Fiscal Year Timeframe: The disclosure of the fiscal year timeframe in the financial statements specifies the exact period when the year starts and ends, commonly stated as from “January 1st to December 31st”. This information provides a temporal context for analyzing the financial statements, enabling comparative analysis across different years.
• Appropriate Use of Timeframe: In certain industries, such as retail, it is common to set the fiscal year according to seasonal trends or specific sales cycles inherent to the industry. This approach allows for a more accurate reflection of performance. When a company selects such an industry-specific timeframe, it is advisable to explain the reasons for this choice in the notes to the financial statements.

Disclosure of Property, plant, and equipment

This note presents the net amount of equipment. The accumulated depreciation amount should be presented separately, reducing the historical cost of the equipment to net book value.

Disclosure of Investment in bonds

Investment in bonds that are held to maturity should be reported at amortized cost, not fair value.

Disclosure of use of estimates

The preparation of financial statements in conformity with generally accepted accounting principles (GAAP) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Disclosure of Loss contingencies

The Company determines to be both probable and reasonably estimable in accordance with GAAP. Legal costs are expensed as incurred.

Disclosure of vulnerability to concentration

Disclosure of vulnerability to concentration is required if all of the following criteria are met:

• The concentration exists as of the financial statement date.
• The concentration makes the entity vulnerable to the risk of a near-term severe impact.
• It is at least reasonably possible that the events that could cause a severe impact from the vulnerability will occur in the near term.

the likelihood of an event

• In US GAAP, the requirement that “the likelihood of an event is high” is used as a criterion for recording related expenses and liabilities in the financial statements when there is a high probability of occurrence and the amount can be reasonably estimated. The evaluation of this likelihood is generally considered in the following classifications:
• Probable (high likelihood, likely to occur) Definition: An event is judged likely to occur. In this classification, the likelihood of the event occurring is generally interpreted to be 75% or higher. Accounting Treatment: If an event is assessed as “Probable,” the resulting expenses and liabilities are recognized in the financial statements. If the amount can be reasonably estimated, it is recognized; if a reasonable estimate cannot be made, disclosure is required.
• Reasonably Possible (some likelihood, possible occurrence) Definition: An event is possible but not as likely as “Probable.” This classification interprets the probability of occurrence to be between 20% and 75%. Accounting Treatment: If an event is rated as “Reasonably Possible,” related expenses and liabilities are not recorded in the financial statements, but disclosure of the nature and amount of information is required in the notes.
• Remote (low likelihood, unlikely to occur) Definition: An event is very unlikely to occur. In this classification, the probability of occurrence is interpreted as less than 20%. Accounting Treatment: If an event is assessed as “Remote,” there is no need to record related expenses and liabilities in the financial statements, and disclosure is usually not required. However, disclosure may be required under certain circumstances based on the principle of materiality.
• Based on this classification, the recognition and disclosure of expenses and liabilities under US GAAP are determined. Companies use these classifications to perform appropriate accounting treatments depending on specific cases and circumstances.