Financial Statements - Management Discussion and Analysis & Financial Statement Footnotes

I. Management Discussion and Analysis
The Securities Exchange Commission (SEC) requires this section to be included with the financial statements of a public company and is prepared by management

This narrative section usually includes the following;

  • A description of the company's primary business segments and future trends
  • A review of the company's revenues and expenses
  • Discussions pertaining to the sales and expense trends
  • Review of cash flow statements and future cash flow needs including current and future capital expenditures
  • A review of current significant balance sheet items and future trends, such as differed tax liabilities, among others
  • A discussion and review of major transactions (acquisitions, divestitures) that may affect the business from an operational and cash flow point of view
  • A discussion and review of discontinued operations, extraordinary items and other unusual or infrequent events

Financial Statement Footnotes
These footnotes are additional information provided to the reader in an effort to further explain what is displayed on the consolidated financial statements.

Generally accepted accounting principles (GAAP) and the SEC require these footnotes. The information contained in these footnotes help the reader understand the amounts, timing and uncertainty of the estimates reported in the consolidated financial statements.

Included in the footnotes are the following:

  • A summary of significant accounting policies such as:
    • The revenues-recognition method used
    • Depreciation methods and rates
  • Balance sheet and income statement breakdown of items such as:
    • Marketable securities
    • Significant customers (percentage of customers that represent a significant portion of revenues)
    • Sales per regions
    • Inventory
    • Fixed assets and Liabilities (including depreciation, inventory, accounts receivable, income taxes, credit facility and long-term debt, pension liabilities or assets, contingent losses (lawsuits), hedging policy, stock option plans and capital structure.

Supplemental schedules often detail disclosures required by audited statements, as well as the accounting methods and assumptions used by management. Supplemental schedules can include information such as natural resources reserves, an overview of specific business lines, or the segmentation of income or other line items by geographical area or customer distribution.

Management's Discussion and Analysis (MD&A) presents management's perspective on the financial performance and business condition of the firm. U.S. publicly-held companies must provide MD&As that include a discussion of the operations of the company in detail by usually comparing the current period versus prior period

Analyst Interpretation
As reporting standards continue to change and evolve, analysts must be aware of new accounting approaches and innovations that can affect how businesses treat certain transactions, especially those that have a material impact on the financial statements. Analysts should use the financial reporting framework to guide them on how to determine the financial statement impact of new types of products and business operations.

One way to keep up to date on evolving standards and accounting methods is to monitor the standard setting bodies and professional organizations like the CFA Institute that publish position papers on the subject.

Companies that prepare financial statements under IFRS or US GAAP must disclose their accounting policies and estimates in the footnotes, as well as any policies requiring management's judgment in the management's discussion and analysis. Public companies must also disclose their estimates for the impact of newly adopted policies and standards on the financial statements.

The Auditor and Audit Opinion
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