News

Notes to the Financial Statements – Tips How to Make Them Simpler

Notes to the financial statements are an integral part of the financial statement that explain and complement the information disclosed in the financial statements. Mandatory information to be provided in the notes to the financial statements is defined by Act No. 563/1991 Coll. and Regulation No. 500/2002 Coll. (Section 39).

We, auditors, see an enormous amount of various notes to the financial statements and, thus, we are able to provide a critical appraisal of the document. In numerous cases, the notes to the financial statements do not provide sufficient information to fully comply with the statutory requirements, or, on the other hand, they include a vast number of disclosures that are utterly irrelevant as they provide information that the user is able to deduct from the financial statements. This article describes a few tips or suggestions for simplifying the notes to the financial statements that you may want to use in preparing the notes to the financial statements or when reviewing them, in which case you might like to propose some of our tips for simplification to the authors of the notes to the financial statements.

How to simplify the notes to the financial statements?

The notes to the financial statements should include only material balances, transactions and information. It is not necessary to include low value assets not reported in the balance sheet, if the amount is not material.

You may ask how the materiality of such information is to be assessed. The Accounting Act (Section 19 (6)) stipulates that “information is considered material if the omission or incorrect presentation thereof would result in an erroneous judgment or decision made by the person relying upon such information”. International Standards on Auditing define the concept of materiality as follows: “Misstatements, including omissions, are considered to be material if they, individually or in the aggregate, could reasonably be expected to influence the economic decisions of users taken on the basis of the financial statements.”

In practice, the level of materiality is defined as a percentage of turnover, profit, shareholder’s equity or the company’s net assets.

The information included in the notes should be explanatory and complementary. It is not necessary to include sentences with no added value, such as: “The Company made provisions against inventory amounting to CZK XXX thousand.” Such information is clearly evident from the statements as such. Further, it is not necessary to quote numbers from the financial statements, eg. “estimated payables amounting to CZK XXX thousand represent….”, it is sufficient to say: “estimated payables represent…”.

Additionally, the notes need not include tables where one number is added up horizontally and vertically, or as the case may be, two numbers, of which one is immaterial, are added up. In such situations it is preferable to use a sentence such as: “Estimated payables represent (mainly)…”

Sentences stating that the company does not have certain items do not have to be included in the notes if such information is clearly evident from the financial statements. For instance, “the company does not make provisions against…” On the other hand, negative assurance commonly expressed at the end of the financial statements represents information relevant for the users of the financial statements, eg: “the Company was not involved in any legal dispute, the outcome of which would have a material impact on the Company.”

Below are tips for specific items listed in the notes that we have selected based on what we have encountered most often in our work:

Provisions

It is not necessary to itemise annual provisioning and the use of provisions. Such information must be included only if it is an outstanding matter.

Tables summarising asset movements

Tables providing a detailed overview of asset movements divided by opening balance, additions, disposals and closing balance are not required by law. It suffices to list significant items in terms of material additions and disposals.

Leases

It is sufficient to state the total lease payable and significant items, ie item groups that the company leases. It is important to present lease payables that are overdue and significant operational leases. No further information needs to be included in the notes.

Payables and receivables

It is compulsory to present only the total amount of receivables and payables past their due date and with maturity greater than 5 years. Detailed aging of receivables and payables does not need to be included. We would like to point out that there is often confusion between receivables or payables with maturity greater than 5 years and receivables and payables past due for longer than 5 years. The former is a statutory piece of information, whereas the latter is not required by law. On the other hand, if a significant amount of receivables and payables of a company is past due, it is advisable to comment on such a situation by stating eg that the majority of such receivables or payables are only 30 days overdue rather than several years.

Outstanding payments on social security and health insurance

Outstanding payments of social security and health insurance may be presented in total; they must be presented separately only if the amounts are material.

Staff costs

The total amount of staff costs must be presented in a way separating the company’s management and other employees. Nevertheless, individual items of staff costs, such as wages and salaries, social security and health insurance costs, and social costs do not have to be disclosed separately.

Sales

It is rather ineffective to divide sales in the same manner as presented in the statements, ie by sales of goods and sales of products and services. On the contrary, it is advisable to divide sales by eg individual groups of products or services provided.

The division of sales by geographical markets must state only entities of a certain size, namely the ones that meet at least two of the following three criteria:

a. Total assets exceeding CZK 350 million (gross value)

b. The total annual turnover over CZK 700 million (revenues less sales discounts)

c. The average number of employees during the reporting period exceeds 250 Even if the above criteria are met,      the obligation to report sales based on geographical markets prevails only if the markets differ considerably.

Reserves

Statutory requirements in terms of reserves require that the balances of reserves are itemised based on how they arise as opposed to being divided by the manner of their creation and use. Further information, comments and amounts must be included only if a significant change to the balances has occurred.

Related party transactions

The law only requires the reporting of payables to group entities. Other related party transactions are to be reported only if the reporting entity meets at least two of the three criteria stated in the Sales section above.

Nevertheless, we recommend that the list of related party transactions always be disclosed in the notes to the financial statements, as such information provides added value for the user of the financial statements. The list may be simplified to a certain degree, if, instead of giving a detailed list of all transactions with related parties, only the most significant transactions are itemised and the remaining transactions are given as a total under other sales from related parties or other purchases from related parties, etc.

Similar lists of related party transactions are often presented in both the notes to the financial statements and the report on relations. In such a case, it is necessary to ensure the consistency of the presented data.

What must not be left out from the notes to the financial statements?

In conclusion, we would like to add a list of statutory information that is frequently omitted in the notes to the financial statements:

• Description of the organisational structure and significant changes occurring during the most recent reporting period (Section 39 (1) of the Regulation)

• Other commitments not presented in the balance sheet, if such information is material in terms of assessing the reporting entity’s financial situation (Section 39 (9) of the Regulation)

• Payables and receivables the maturity of which is greater than 5 years at the balance sheet date (Section 39 (7) of the Regulation)

• Additional assessment of due income tax payables for the past reporting periods (Section 39 (6) of the Regulation)

• An itemised list of long-term loans including interest rates and the description of loan collateralisation (Section 39 (6) of the Regulation)

• Subsidiaries or associates of the reporting entity (Section 39 (2) of the Regulation)

• Derivatives (Section 39 (5) (c) of the Regulation)

• Received investment and operating grants (Section 39 (6) of the Regulation)

• Description of significant events that occurred after the balance sheet date (Section 39 (7) of the Regulation)

• Conditions for registrations in the real estate cadastre to become legally effective (Section 56 (8) of the Regulation)

• Explanation of the start-up costs item (Section 39 (13) of the Regulation)

• Information on leased assets (Section 39 (7) of the Regulation)

• Explanation of amortisation of goodwill for a period greater than 60 months (Section 6 (3) (d) of the Regulation)

• Explanation of amortisation of the valuation difference on acquired assets for a period shorter than 180 months (Section 7 (10) of the Regulation)

• Average number of members of the managing bodies and management costs (Section 39 (3) of the Regulation)

• Remuneration to the members of the statutory body (in aggregate) and remuneration to the members of the supervisory body (in aggregate) (Section 39 (3) of the Regulation)

• The amount of existing or newly concluded pension debts of the former members of the supervisory and statutory bodies (Section 39 (3) of the Regulation)

WeI hope that you will find at least some of the tips in this article helpful and that you will make use of them when you start preparing financial statements.