[MUSIC] Welcome everyone. In this module, we'll be spending time with some final elements of the financial statements that often get overlooked. In our first lesson, we'll discuss the notes of the financial statements, and then in the second lesson, we'll take a look at what's called the auditor's report on the financial statements. What I thought would be helpful is to introduce you to a few notes to the financial statements that are common across most companies. These notes accompany the financial statements, and usually appear after the statements of cash flows. Some notes are required to be reported by companies, while other notes are included to help users better interpret the financial statements, in order to answer the three measurement questions. What does the company own? What does it owe? And how did it perform? The first note we'll consider is often labeled as the Summary of Significant Accounting Policies. What accounting policies are worthy of noting? Well, we've discussed a few of these policies a company might note earlier in the course. For example, the company must make an assumption about the flow of inventory when determining cost of goods sold. Did the company adopt a FIFO assumption that suggests the oldest inventory was sold first, or did the company adopt a LIFO assumption that suggests the newest inventory was sold first? Users would want to know, and then note on significant accounting policies can give them that information. We might also recall a conversation about depreciation expense. Remember the company allocates the cost of a long-term asset, like equipment over the periods it intends to use the asset. While we allocated equal amounts of the equipment over those useful periods, the company can allocate in a number of different ways. For example, it can allocate more of the equipment cost to its earlier periods with smaller amounts being allocated to later periods. Again, the significant accounting policy note can clarify how the company allocated its equipments' costs. Let's take a break here to consider a question related to what we've discussed thus far. It's time to look at a second common note to the financial statements, but we'll use a scenario to set up the discussion. Let's say that Missy's Bakery has a fiscal year, or business year, that ends on December 31. After the end of the year, Missy's team must organize its records, make its calculations, and actually prepare its financial statements before making them public. That whole process takes two months to complete. Now what if on January 20, Missy completes an agreement to open a new bakery location. In this case, the event didn't occur during the fiscal year, so there's no place to report it on the balance sheet or income statement. But boy, an investor or a lender would sure like to know about it. So what does Missy do? She includes a note for what is called a Subsequent Event, much like this note from Barnes & Noble. Let's look at another scenario. Jed at Body and Sole sold a pair of running shoes to a customer, Tony. While Tony is running a marathon in the rain, he slips and severely breaks his leg. In great frustration, Tony decides to file a lawsuit against Jed's store seeking $100,000, claiming the shoes he was sold were faulty and caused his injury. At the end of the fiscal year, the lawsuit remains in court. Now the question for Jed is whether his financial statements at the end of the period should reflect his lawsuit as a liability. And the answer is, maybe. If Jed expects to owe Tony, as a result of the lawsuit and he can estimate the amount he will likely owe, then Jed should probably include a loss on the income statement and a liability on the balance sheet. On the other hand, if Jed can't estimate the loss or doesn't feel a loss is probable, then at most, Jed would only disclose the lawsuit and a note to the financial statements that we might call a contingency note, because the liability is contingent on, or depends on, the outcome of some future event. In this case, the settlement or verdict of the lawsuit. Barnes & Noble actually presents their disclosure in a separate note for legal proceedings. We've discussed just three common notes to the financial statements, but there are too many possible notes for me to try describing them all. What I'd like to do instead, is invite into the studio someone who has seen a number of financial statement notes during his illustrious accounting career. Tim Reierson has spent his career working for the global accounting firm, PricewaterhouseCoopers, where he served as a partner out of its Chicago office. But prior to his professional career, Tim was a student right here at the University of Illinois. So, we're thrilled to have you join us. >> I'm glad to be here Kevin, thanks for inviting me >> Yeah, absolutely. >> Yeah. >> So we've been discussing notes to the financial statements, and so where we been is, I've kind of introduced couple of key notes of the financial statements that readers might find common. >> Okay. >> But what I would want is your take on what you think are some of the, some notes of the financial statements that are particularly helpful. >> Great. Kevin, you know that consistency of financial statements is really important. And so, any note that talks to the comparability of financial statements is something that gets my attention. >> Okay. >> So, notes that highlights significant changes in accounting, significant changes in estimates, maybe significant corrections of errors, immediately get my attention, and I have a lot of interest in reading and understanding those numbers. >> Yes, I was going to say that when you say comparability, are you talking about comparability from year-to-year or from across different companies? >> It could be both. >> Okay. >> Certainly, it could be, you know, looking at trend analysis, looking at how things have changed year over year. But it could also be looking at and comparing results of a company with competitors or across an industry. >> Okay, so what would be an example, a particular example? >> In a manufacturing environment, it could be a change in depreciation policy or a change in the methodology that a company used in developing its estimate for bad debts. >> For accounts receivable, it would be an example of a change in accounting that I would have an interest in, if it was significant. >> So what other, do you have any other examples of notes that you find particularly helpful? >> I always like to make sure that I read the note on significant accounting policies. >> Okay. >> because I think it's important for you to understand how a company is accounting for certain accounts, or for certain transactions. I think it's important to understand if the way that they're accounting for a particular transaction differs as it relates to their industry or to other companies. And I particularly look at that footnote, in comparison to the same footnote in the prior year, to see if there's been any additional disclosures, or possibly if some of those accounting policies have been removed. Because that may be an indication that something of significant has changed within the organization that I might have an interest in, as well. >> Okay, okay, so do you have any other examples? >> I do. I also am very interested in any note that highlights significant accounting estimates. >> Okay. >> You know, as you know, the development of an accounting estimate can require significant judgement, and as a result of that judgement, you know, readers could have different points of view as to what they think the ultimate valuation or balance of an account should be. So, the footnote that highlights one, the nature of the estimate, if it's changed, how significant that change was year over year, And more importantly, the method that was used to develop the estimate, as well as maybe some of the key inputs and assumptions, such that I, as a reader, can then evaluate whether I believe those inputs or assumptions are appropriate and if not, I can make adjustments in my own analysis. >> No, that's awesome that you bring up significant estimates. I mentioned earlier in the course, the role that estimates play and how sometimes they can be kind of sneaky. >> Yes. >> Yeah. So, just out of a curiosity, looking at the notes in the financial statements, has that evolved, as far as the volume of notes that you see? Is it comparable to the way it was, say, maybe 20 years ago? >> It's changed significantly in my experience. As a matter of fact, I think the volume of notes has significantly increased. >> Okay. >> I think, as I reflect on that, I think there's a number of reasons for that. >> Yeah, what's some of those reasons? >> Well, one is, there's been a significant increase in accounting standards. >> Yeah. >> And normally, in my experience, when a accounting standard is issued, in most cases, it requires some kind of a disclosure. Two is I just think the complexity of business and transactions has increased, and I think with complexity comes more disclosure. >> Right. >> I also feel that there has been a greater demand for transparency by the readers, particularly investors, to provide them with the information that they need, and companies have complied with their requests. >> And before you, and that demand would be driven by? Who do you think drives that demand? >> I think it's, you know, investors, sophisticated investors that have an interest or a need for additional information to help them in making the investment decision that they need to make, and I think because of the confidence that management has in the information that they're providing, the improvement in systems, the improvement in controls, and more importantly, the confidence that management has in the quality of the information. And investors understanding those changes and improvements. I think that that's led to an increase in more information being disclosed. And management's willingness to do that because they have more confidence in the quality of the information they're providing. >> Yeah, yeah, so you were going to say, I'm sorry, what was it? >> And I think the other driving reason for the increase in footnotes is, I think, management has discovered disclosure as a means to help manage their own risk. >> Okay. >> Particularly, as it relates to informing readers, investors, of particular risks that might result as it relates to an account or transaction, thus when an adverse situation arises down the road, and let's say that performance is not what an investor expected, and they want to place responsibility for that change. >> As we all do. >> I understand that, as well. On the heads of management, management can go back and say, by the way, we disclosed this risk. We tried to inform you, we tried to warn you that this was a possibility. And therefore, I feel like it helps them manage their exposure in situations like that, as well. >> Fantastic. Well, Tim, thank you for your insight. That was very helpful. In fact, you're so helpful, I'm going to ask you to stay in the studio and help us with the next lesson. >> Great. I'd be happy to help you Kevin, thank you. >> For you students, that's going to wrap up our time on this lesson. But make sure you come back for the next lesson because I'll be asking Tim some additional things about something else he knows a whole lot about. But until then, be well. [MUSIC]
