As important as the four main financial statements are, the required notes to the statements are equally important. They provide essential information for understanding the financial statements. The notes to Apple’s 2020 financial statements run more than 20 pages, and include a variety of important information such as:
- Its fiscal year ends on the last Saturday in September, resulting in a 52/53 week fiscal year. Therefore, in some periods there will be either one more or one fewer week of results compared to the prior period. This can affect comparisons over time.
- It reports in accordance with US GAAP.
- It recently effected a 4-for-1 stock split, and adjusted prior results accordingly.
The notes describe the accounting policies, methods, and estimates used to prepare the statements. Both US GAAP and IFRS allow management some discretion when reporting certain transactions. Two companies buying similar pieces of equipment or inventory may have differing strategies that are better reflected by different ways of accounting for the asset. However, this flexibility can create challenges for analysts comparing the performance of the two firms. By understanding and adjusting for these differences, the analyst can better compare performance.
Another important source of information included with financial reports is the management commentary, or management discussion and analysis. In this section, company management provides insight on how and why certain things occurred. It may also provide forward-looking statements that will be useful in forecasting future performance.
According to the US Securities and Exchange Commission, the objectives of MD&A are:
- To provide a narrative explanation of a company’s financial statements that enables investors to see the company through the eyes of management;
- To enhance the overall financial disclosure and provide the context within which financial information should be analyzed; and
- To provide information about the quality of, and potential variability of, a company’s earnings and cash flow so that investors can ascertain the likelihood that past performance is indicative of future performance.
According to IFRS Practice Statement 1:
Management commentary should provide users of financial statements with integrated information providing a context for the related financial statements, including the entity’s resources and the claims against the entity and its resources, and the transactions and other events that change them. It also provides management with an opportunity to explain its objectives and its strategies for achieving those objectives.
The Practice Statement makes clear that management commentary should be consistent with the following principles:
Provide management’s view of the entity’s performance, position and progress (including forward looking information)
Supplement and complement information presented in the financial statements (and possess the qualitative characteristics described in the Conceptual Framework for Financial Reporting).