Notes to the financial statements: what a small business must disclose

Notes to the financial statements: what a small business must disclose

The notes to the financial statements explain how each figure was reached: which policy was applied, which assumption was used and what sits inside a balance. They are an integral part of the statements, not a decorative annex. Without them, the statement of financial position is a list of numbers that every reader interprets differently.

In a small business the problem is almost never the absence of notes, but their quality. They are copied from the previous year, awkward balances take refuge in "other", and whatever compromises the owners is left out. Here is what a small or medium-sized company must disclose, in what order, with what support, and with a worked receivables example you can replicate.

The notes are not an annex: they are part of the statements

A financial statement without notes is incomplete. The notes explain the policies used to build the figures, the judgments that were applied and the detail of each line item. They are the bridge between the number and the decision that produced it.

That imposes two obligations. The first is that every line item in the statement must be cross-referenced to a note: the reader sees "trade receivables" and finds the note that breaks it down right beside it. The second is that the note must be consistent with the statement. If receivables in the statement read 773,400,000 and the note adds up to 820,000,000, the reader stops trusting the whole report, even when both figures are correct for different reasons.

It helps to think about who reads. A bank assessing a loan looks for debt, collateral and repayment capacity. An owner who does not manage the business looks for how profit was distributed. A buyer reviewing the company looks for contingencies and related parties. All three read the same notes, and all three reach different conclusions depending on what they find or fail to find.

Basis of preparation and compliance: the first note and the most copied

IFRS for SMEs requires disclosing the basis of preparation of the statements and compliance with the framework applied. It is the note that opens the document and the one most often inherited from one year to the next without review.

It must state, at a minimum: which framework was applied and under exactly what name, in which currency the information is presented, what the unit of measure is, which period the statements cover, and whether the comparative figures correspond to the same period of the previous year. "Statements prepared under IFRS" is not enough when several versions of the framework exist; the reader needs to know which one was used.

It must also assert compliance. If the company applied the full framework, it says so. If it applied the framework for SMEs, it says so. And if there was any departure, the note must name it and explain its effect on the figures, not hide it in a generic sentence.

The typical error is carrying over last year's note after a change of framework, functional currency or accounting period. The note ends up describing a set of statements that no longer exists.

Accounting policies: what to write and what to leave out

An accounting policy is not a list of intentions. It is the concrete rule used to recognise, measure and present an item. "Inventories are measured at the lower of cost and net realisable value, and cost is determined on a weighted average basis" is a policy. "IFRS are applied" is nothing.

In a trading SME there are four minimum policies: inventories; property, plant and equipment; revenue; and provisions. Each must answer three questions: when the item is recognised, how it is measured initially, and how it is measured afterwards.

Policies that are not used are not written. A catalogue of thirty policies copied from another report describes a company that does not exist: it talks about biological assets, construction contracts or financial instruments the company has never held. That excess carries a double cost, because it takes up space and because it pulls attention away from what actually matters.

If a policy changed from the previous year, the reader needs to know and needs to understand the effect. A change in costing method is not a wording detail: it moves cost of sales and closing inventory.

Judgments and estimates: where the figures rest on assumptions

Some balances cannot be computed from an invoice. The useful life of equipment, the impairment of receivables, provisions for legal proceedings and the fair value of an asset all rest on assumptions. The notes must explain those assumptions, not just the outcome.

The distinction between judgment and estimate helps structure the note. A judgment is the call of criteria: whether a lease is treated as an operating or a finance lease, whether an investment gives control. An estimate is the number that follows from that call: how many years the equipment lasts, what percentage of receivables will not be collected.

A simple example shows why it matters. Equipment bought for 120,000,000 with a ten-year useful life produces annual depreciation of 12,000,000. With a five-year useful life, depreciation rises to 24,000,000 and profit for the year falls by 12,000,000. The figure in the statement changes completely, and the only place where the reader can understand why is the note.

The note must state the assumption, the basis supporting it and, when the effect is material, what would happen if the assumption changed. An assumption without a basis is an opinion dressed up as accounting.

The detail of each item: break it down without drowning the reader

The breakdown is the heart of the notes. The statement shows a balance; the note shows what it is made of, which part carries restrictions and what risk it holds.

Cash and cash equivalents: composition by bank and by type of account, plus restrictions. An available balance of 404,000,000 that includes 80,000,000 pledged as collateral is not the same free cash, and the reader needs to know.

Inventories: composition by type of goods and costing method. Property, plant and equipment: the movement for the period, explained in three lines. Opening net balance 405,000,000, plus additions of 78,000,000, minus depreciation for the period of 53,000,000, equals a closing net balance of 430,000,000. With those three lines the reader reconstructs the year's investment.

Financial obligations: rates, terms and collateral. A debt with no term and no collateral is a figure with no visible risk. Trade receivables: composition and impairment, which is the subject of the next example.

Worked example: receivables by age and impairment

A trading SME closes with gross receivables of 820,000,000. The statement presents the net balance, after impairment. The note must show the path from one figure to the other.

The calculation is direct: each bracket is multiplied by its percentage and the results are added. 6,100,000 plus 6,500,000 plus 10,000,000 plus 24,000,000 gives 46,600,000. The net balance that goes into the statement is 773,400,000. The average rate of 5.7 % comes from dividing total impairment by gross receivables.

The note must also explain the movement of impairment during the period: opening balance 38,200,000, plus provision recognised 14,900,000, minus receivables written off 6,500,000, equals closing balance 46,600,000. Without that movement, the reader cannot tell whether impairment grew because receivables deteriorated or because old balances were written off. And it must explain where the percentages come from: collection history, customer behaviour, sector conditions.

Related parties: the note that is uncomfortable and therefore omitted

Transactions and balances with owners, directors and related companies are disclosed. This is not a gossip note: it is the one that lets profit be read without the distortion produced by dealing with someone who is not an independent third party.

For each relationship the note must identify who the party is, what the link is, the nature of the transaction, the amount, the balance still outstanding and the terms agreed. A sale to a company owned by the same person, rent charged by the owner or a loan granted to a director all change the reading of revenue, expenses and cash flow.

The frequent error is one of classification, not deliberate omission. The loan to the owner sits inside "other receivables", the rent sits inside "lease expenses", and the related-party note ends up stating that there were no transactions. The figure exists; the link is invisible.

Contingencies: what may happen and has not happened yet

Contingencies are disclosed, not recognised as if they were certain. The note must describe contingent liabilities and probable contingent assets: what matter exists, what stage it is at, what is being claimed and, when it can be estimated, what the financial effect would be.

An ongoing labour claim, a dispute with a customer over a warranty or a request from an authority are typical examples. The note does not settle the case; it reports that it exists and with what uncertainty. A statement without that note looks cleaner than it is.

The contingent asset follows a symmetrical and stricter rule: it is disclosed only when its realisation is probable. Announcing compensation that is not yet defined creates an expectation the figures do not support.

The note must also state what changed from the previous year. A contingency that closed, a provision that was released or a case that escalated is information for anyone comparing two periods.

Subsequent events: the window between closing and signing

Weeks or months pass between the closing date and the date the statements are approved. Things happen in that interval that can change how the report reads. Material subsequent events are disclosed.

It is worth separating two kinds, because the treatment is not the same. Those that confirm a condition that already existed at closing adjust the figures: the bankruptcy of a customer who was already past due confirms that impairment was higher. Those that report something new do not adjust the closed period, but they are disclosed: a fire at the warehouse, the sale of a business line, a change of owner.

The note must state the date up to which events were reviewed. That date is a promise to the reader and also a limit of responsibility for whoever signs.

Materiality: how much detail is enough

Materiality defines the level of detail. Irrelevant matters are not disclosed, and that decision has to be made against a written criterion, not the memory of whoever assembled the report.

A practical threshold rests on a stable base: total assets, equity or profit. If total assets are 2,480,000,000 and the company uses 1 % as a reference, the threshold is around 24,800,000. Items below that figure are grouped; items above it are broken down. It is not a universal rule, it is a starting point that must be revisited every year.

Materiality also has a qualitative dimension that the number does not capture. A small balance with an owner can be material by nature, even when it does not reach the threshold. A low-amount contingency with a large customer can be material because of the reputational and commercial risk it represents.

Both extremes fail. A threshold set too low produces eighty pages nobody reads and buries what matters. A threshold set too high leaves out precisely the balance the reader needed to see.

A note index for a trading SME

With those criteria, the minimum index for a trading SME comes to ten notes. It is not a mandatory format, it is a tested order: first the framework, then the rules, then the balances, and finally what surrounds the figures.

The order matters less than the cross-reference. Every note must carry the number that appears beside the line item in the statement, and every line item must have its note. A handsome index with no references is a document the reader walks through blind.

Frequent errors that leave the notes without substance

The errors are not about wording, they are about substance. Almost all of them surface when someone compares the note with the ledger, with the previous year or with the contract.

An honest close before signing

The notes do not fix badly kept accounting. If the balance is wrong, the note that explains it will be wrong too, and with more words. First the record is corrected; then the disclosure is written.

Nor do they replace the accountant. This text describes what a small business must disclose and the logic for ordering it; it is not accounting advice. The real scope depends on the framework the company has adopted, the sector, the size and, above all, who is going to read the statements. If the only reader is the owner, the note can be brief, but it must still cover the basis of preparation, the policies, related parties, contingencies and subsequent events.

Before signing, a three-step review helps: every line item has its note, every note reconciles against the ledger, and the index can be read in a minute. If your operation already runs on a system with perpetual inventory and electronic invoicing, much of that support comes from the same record rather than a parallel file; Kardex Tauro organises inventory, receivables and asset movement on that logic.

Keep reading

• Accounting policies: how to define and document them
• Statement of financial position under IFRS for SMEs: how to present it