December 6, 2017

3 key disclosure areas in your year-end financial statements

If you are a controller or CFO preparing your year-end financial statements for shareholders, regulators and lending institutions, there are several disclosure items you should carefully consider. Over the last several years, accounting and securities regulatory bodies have had a great deal to say about this subject. The following three areas are especially significant.

Management’s judgments, estimates and assumptions

The nature of financial statement preparation often includes many areas where management is required to make judgments, calculate estimates and use a number of assumptions to arrive at the financial account balance for the reporting period. For the users of financial statements to fully understand the nature of these judgments, estimates and assumptions, it is important to disclose any uncertainties or sensitivities that are significant to the balance. Uncertainties will include disclosures of key inputs such as discount rates, the basis for estimation and observable versus unobservable inputs used in fair value measurements.

Sensitivities are also very important, as they allow the user to understand the impact (positive or negative) if certain variables change. Keeping in mind disclosure overload, you only want to include material disclosures related to significant financial account balances, ensuring they stand out from the rest of the financial statement disclosures.

Areas to pay attention to for disclosure around management’s judgments, estimates and assumptions are:

  • business combinations (including the basis used to allocate the fair values of the net assets acquired, as well as the consideration given);
  • impairment of assets (including disclosure of the judgments used in determining whether an indicator of impairment or impairment reversal exists at the reporting period date, as well as details of method used to determine recoverable amounts);
  • compound financial instruments (including methods used to determine equity, liability and embedded derivative components); and
  • accounting for interest in other entities (including the facts used in the determination of control or significant influence).

Although your disclosures should be comparable to those of your peer group in your industry, it is also important to ensure your disclosures are tailored to the specific circumstances and business operations of your company.

Liquidity risk

Another important area for the users of financial statements to understand is whether your entity will be able to meet its short-term financial obligations. Financial statements should provide comprehensive insight into your entity regarding its liquidity risk, as well as a current analysis of the sources and uses of funding over the next year.

There are several questions to help financial statement preparers address liquidity risk in their year-end financial statement disclosure.

  • Are you going to pay your liabilities when they become due?
  • If you are experiencing difficulties right now because your revenues or operating cash flows have declined, where are you going to get additional funding and/or what is the specific course of action to reduce the overall liquidity risk?
  • Do you anticipate a breach of financial or non-financial covenants in the near future?
  • Are there any current or anticipated restrictions in your ability to access your credit facilities imposed by your lenders?

As noted above, it is important to ensure your disclosures surrounding liquidity risk are not boilerplate. They should make users aware of the specific risks facing your entity in the short term and the entity’s specific action plan to address these risks.

Credit risk

Another key area for financial statement users to understand is the exposure your financial assets (such as trade receivables and investments) have related to non-payment and/or impairment. Disclosure of the objectives for managing credit risk allows users to understand the policies and processes in place to reduce the entity’s overall credit risk exposure. Entity-specific (ie. non-boilerplate) disclosure should include a current analysis of the credit quality of its trade receivables and/or loan receivables, including amounts not past due, as well as amounts past due and impaired or not yet impaired.

In addition, disclosure surrounding concentrations of credit risk is important for a user attempting to understand the nature of the receivable amounts. In regard to investments, sensitivity disclosure should be included to allow users to understand how market price fluctuations (and foreign exchange fluctuations, if applicable) will impact the risk of investment gain or loss. If the investment is in shares that are not traded in the public market, additional disclosure should be included related to the judgments, estimates and assumptions that help determine fair value at each reporting date. 

Christin Giebelhaus, CPA, CA, is a partner at Collins Barrow Calgary LLP. Her primary focus is the energy, real estate and agriculture sectors.