Investors pay attention to the financial statements in a corporation’s annual report. In addition, they closely review the disclosures in the note section as well. The detailed information recorded reveals the underpinnings of a corporation’s financial state as well as indicators of its future standing.
The company is required to disclose all commitments on the balance sheet. Some commitments directly affect the balance sheet at the time of their occurrence. Others may not have any current affect but with the company’s intentions revealed, it could significantly affect the company in the future.
Types of Commitments Disclosed
The most common types of commitments noted in financial statements are-
- the terms of outstanding loans
- long-term purchase plans
- arrangements to refinance existing debt
- lines of credit
- employee pension plan specifics
- lease terms
These disclosures are particularly valuable because they are indicative of the company’s future debt structure and need for cash to satisfy its current obligations.
The details of lease terms and arrangements greatly affect the definition of a company’s assets. Some noncancellable long-term leasing arrangements can be equated as alternative purchase and mortgage arrangements. With some leases, the risk of ownership is transferred to the lessee. Due to the variation in lease agreements, it is difficult to compare the financial statements of companies that lease with companies who do not lease. Therefore, the notes explaining the lease’s specific terms will assist investors in making a more equivalent comparison.
Contingencies are also communicated in the notes on commitments. Contingencies are in play when the company risks a gain or lose because of a past transaction or event. It must be classified as likely to occur, having a remote chance of occurring, or as may possibly occur. If it is determined a contingency is likely to result in a loss, it must be accrued, using the smallest amount estimated. If it is determined a contingency is likely to result in a gain, it is disclosed but not calculated.