By J. Gregory Kashella, CPA

CPAs who help small businesses with financial reporting are in a position to assist in drafting the financial statement disclosures. CPAs will do this because small businesses do not have staff familiar with disclosure requirements. Their bookkeepers or financial managers may be good at getting the numbers correct, but they are generally unfamiliar with preparing notes to the financial statements.

The purpose of this article is to provide a few tips for preparing disclosures that not only meet professional standards, but also are helpful to the client and the client’s banker. All of us rely on disclosure checklists, but when we assist the client we want to have an attitude of doing something beyond being able to clear an item on a checklist.

Some items here will seem obvious, but in my years as a practitioner I have found the obvious can be missed when working in a vacuum. First and foremost, be sure the client is not under the mistaken impression that the financial statements are your responsibility. The accounting literature has been adapted over the years to eliminate this misunderstanding, especially in the area of SSARS engagements. Compilation and review reports have had wording added to make clear management is responsible for the financial statements.

Here are a few areas of financial statement disclosures with enhancement suggestions.

Nature-of-Business Disclosures

Disclosing the nature of the client’s business has been a requirement for a long time. Over time, various enhancements to this disclosure have been added. These include locations, markets served, product lines, and others. In today’s interconnected world, obtaining information concerning a client’s business is easier than in years past. Businesses have websites and other promotional materials. Another way to gather this information is by having a face-to-face conversation with the client. Clients love to talk about their businesses. I like to have these discussions at the client location when possible, and actually look at the client’s facilities. Touring the facilities gives us a look at the operations and possibly spot other areas where we can assist the client in addition to financial statement reporting.

After touring the facilities and obtaining information from the client’s website and promotional materials, we are in a position to assist the client in the Nature of Business disclosure that will not only meet the professional standards, but also describe the business in the most full, complete, and enlightening way.

The Bank’s Disclosure Area

When a client has bank loans, it is important that the disclosures be correct. According to the disclosure requirements, some of the major items of disclosure for bank loans are the interest rate, collateral, term of loan, and if there are restrictive covenants and if the client is within covenant.

One area of concern is covenant ratio calculations. Some banks have their own calculation formulas for certain ratios that may be different from textbook formulas, or the bank may permit certain variations or allowances in the calculation. In one situation where I was involved, a new client was a recently purchased business. The seller financed some of the purchase, and additional funds were obtained through a bank loan that had covenant ratio requirements. In the debt-to-net-worth calculation, the bank’s formula permitted the debt to the seller to be considered equity instead of debt in the calculation. With client permission, I will sometimes provide the bank with advance drafts of the statements (usually without the notes) so the bank can verify the covenant calculations. This way, the client and bank agree with the results of the covenant calculations.

Another area to be careful is the bank’s use of the term “prime rate.” Some banks have their own prime rate instead of using the general prime rate listed in the Wall Street Journal. A number of years ago, I was involved in financial statement disclosures where I was informed that the rate on a certain loan was not the prime rate, but XYZ Bank’s prime – which was different from the general prime rate at that time.

I will often talk to the client’s bank loan officer to go over the various disclosures before the statements are issued to ensure that the disclosures are correct. I commonly tell the loan officer that when he or she gets the finalized statements, he or she – after checking the general financial condition of the company – should go to the notes to the financial statements.

Clearly this is not an exhaustive list, but I hope this article gives practitioners something to think about when assisting clients with financial statement disclosures in order to make them meaningful to the client and the intended financial statement users. Making financial statements meaningful also goes a long way toward enhancing the value of a CPA’s services.

J. Gregory Kashella, CPA, is the financial statement technical review manager for Smoker, Smith & Associates PC in Hershey, Pa. He can be reached GKashella@SmokerSmith.com.

Financial statement presentation and disclosure best practices will be a topic of discussion at PICPA's 2021 Accounting & Auditing Conference. The fully virtual event will be held Dec. 9-10.

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