Two codification topics set the frame for what a private company says about itself in the notes. ASC 275, Risks and Uncertainties, requires disclosures about the nature of operations, the use of estimates, significant estimates that could change soon, and concentrations that make the entity vulnerable. ASC 205, Presentation of Financial Statements, covers the general presentation framework, including comparative statements, going concern evaluation (ASC 205-40) and discontinued operations (ASC 205-20).
Lenders and other users read these notes closely. This guide explains each requirement and what auditors check.
ASC 275: the four disclosures
1. Nature of operations
The financial statements include a description of the major products or services, principal markets, and locations. For an entity operating in more than one business, describe the relative importance of operations and the basis for the description. This is usually the first note, and it should be specific. "The Company is engaged in various business activities" does not meet the requirement.
2. Use of estimates
The statements include an explanation that preparing financial statements in conformity with US GAAP requires management to make estimates and assumptions that affect reported amounts and disclosures, and that actual results could differ. Most entities include a standard paragraph, usually listing the items that involve significant estimates: allowance for credit losses, inventory reserves, useful lives, impairment, deferred taxes, and fair values.
The generic paragraph satisfies the explanation. It does not satisfy the next requirement.
3. Certain significant estimates
Disclosure is required for an estimate when both of the following conditions are met:
- it is at least reasonably possible that the estimate of the effect on the financial statements of a condition, situation or set of circumstances that existed at the date of the financial statements will change in the near term due to one or more future confirming events, and
- the effect of the change would be material to the financial statements.
"Near term" is a period of time not to exceed one year from the date of the financial statements. The disclosure describes the nature of the uncertainty and indicates that it is at least reasonably possible that the estimate will change in the near term. If the estimate involves a loss contingency covered by ASC 450, the disclosure also includes an estimate of the possible loss or range of loss, or a statement that an estimate cannot be made. See loss contingencies.
Typical candidates: a reserve for a dispute whose outcome is expected within months, a goodwill balance with headroom that is slim, inventory valued assuming a product launch, collectibility of a large receivable from a distressed customer, a self-insured claims reserve, a pending regulatory determination. The estimate-heavy items are the same ones auditors treat as significant risks under AU-C 540.
4. Current vulnerability due to certain concentrations
Disclosure is required when all of the following conditions are met:
- The concentration exists at the date of the financial statements.
- The concentration makes the entity vulnerable to the risk of a near-term severe impact.
- It is at least reasonably possible that the events that could cause the severe impact will occur in the near term.
Concentrations covered include:
- volume of business with a particular customer, supplier, lender, grantor or contributor
- revenue from particular products, services or fund-raising events
- available sources of supply of materials, labor or services, or of licenses or other rights used in operations
- a market or geographic area in which the entity conducts operations
"Severe impact" is a higher bar than "material." The codification glossary describes it as a significant, financially disruptive effect on the normal functioning of the entity; something can be material to a user's decisions without being severe. A client with one customer providing most of its revenue may state nothing because management considers the customer "stable." The test is vulnerability, not management's expectation.
A good concentration note states the nature of the concentration, the percentage of revenue or receivables or purchases, and the period. For example, two customers accounted for specified percentages of revenue and receivables at year end.
Related: concentrations of credit risk
A different requirement, in ASC 825-10-50, applies to concentrations of credit risk in financial instruments, such as cash balances above federally insured limits at one institution, or receivables concentrated in an industry or region. Many private companies disclose both and treat them in the same note. They have different triggers. Check the bank reconciliation guide for how cash at multiple institutions is evaluated.
ASC 205: presentation framework
Comparative statements
ASC 205-10 states that presentation of comparative financial statements is ordinarily more informative than single-period statements. Many private companies present two years. When comparatives are presented, the same principles apply across periods, and if the prior period was audited by another auditor or unaudited, that is addressed in the report. A client that presents a single year may still be asked for comparatives by lenders or other users.
Classified balance sheet
Most general-purpose statements present current and noncurrent assets and liabilities, though the codification does not mandate a classified balance sheet for all entities. Real estate, some financial institutions and others present unclassified balance sheets by industry practice. See debt classification for the effect on current liabilities.
Going concern (ASC 205-40)
Management evaluates, at each annual and interim reporting period, whether conditions and events, considered in the aggregate, raise substantial doubt about the entity's ability to continue as a going concern within one year after the date the financial statements are issued (or available to be issued). If substantial doubt exists, management considers its plans. Disclosure is required if substantial doubt exists, or if it is alleviated by management's plans. The auditor's responsibilities are in AU-C 570. See the going concern guide and the going concern checklist.
Discontinued operations (ASC 205-20)
A disposal of a component or group of components is reported as discontinued operations if the disposal represents a strategic shift that has, or will have, a major effect on operations and financial results. Disclosures include the major classes of line items, the pretax profit or loss and the carrying amounts of assets and liabilities of the disposal group. Applying this to private companies often involves small divisions sold or closed, and the judgment is whether the shift is "strategic" and "major."
Other presentation points
Reclassifications of prior-period amounts to conform to current presentation are disclosed. The related policy note for accounting policies, required by ASC 235, sits alongside. For the cash flow presentation, see the statement of cash flows guide. Subsequent events disclosure is under ASC 855.
What auditors test
Disclosures are tested under AU-C 315 risk assessment, and presentation and disclosure are an assertion category. The risk is completeness: omitted notes rarely show up from tracing balances.
Concentrations
- Produce a customer sales and receivable listing and compute the percentages. Do the same for vendors, lenders, and grants or contributions at not-for-profits.
- Ask management about dependence on key suppliers, single-source materials, licenses, key personnel and geography.
- Read contracts, and consider termination clauses and renewal dates.
- Compare to disclosure, including percentages.
- Consider whether the matter is a going concern or risk assessment issue.
Significant estimates
- Identify estimates at the balance sheet date that could reasonably change within a year, using the results of testing under AU-C 540 and sensitivity analysis.
- Review subsequent events for resolution of uncertainties.
- Evaluate whether the disclosure describes the nature of the uncertainty.
Nature of operations and presentation
- Compare the description to the business as understood in planning.
- Check comparatives, reclassifications, going concern evaluation, and discontinued operations conclusions.
Use of a checklist
The GAAP disclosure checklist is a short-form prompt list for common private company topics, including basis of presentation, going concern, risks and concentrations and subsequent events. It is a prompt list, not a complete disclosure checklist. Do not complete it as a form. Use it to document an answer for each item that is applicable, and "not applicable" with a reason.
Document under AU-C 230, and include misstatements of disclosures in the summary of uncorrected misstatements for evaluation under AU-C 450.
Disclosure gaps to look for
- Concentration note missing for a customer representing a major share of revenue.
- Percentages stale from a prior year.
- Generic use-of-estimates paragraph only, with no near-term significant estimate disclosure.
- Nature of operations vague.
- Credit risk concentration omitted when cash exceeds insured limits.
- Going concern evaluation undocumented.
- Prior-year reclassifications unmentioned.
FAQ
What does ASC 275 require private companies to disclose?
The nature of operations, the use of estimates, certain significant estimates that could change in the near term, and current vulnerability due to certain concentrations. The last two apply only when specific conditions are met.
What does "near term" mean in ASC 275?
A period not exceeding one year from the date of the financial statements.
Do all customer concentrations need disclosure?
No. Disclosure is needed when the concentration exists at the balance sheet date, makes the entity vulnerable to a near-term severe impact, and it is at least reasonably possible that the events causing the impact will occur in the near term. Many entities disclose significant customers anyway.
Is a concentration of cash above FDIC limits an ASC 275 matter?
It is more directly a concentration of credit risk disclosure under ASC 825-10-50. Many entities cover both in one note.
Do private companies have to present comparative statements?
ASC 205-10 states that comparative presentation is ordinarily more informative than single-period statements. Whether comparatives are required in a given case depends on the framework, lenders and other users.
CORAA prepares ready-to-review audit files for US CPA firms from QuickBooks books; you review and sign. See /us.
Sources
- FASB ASC 275-10-50, Risks and Uncertainties (nature of operations, use of estimates, certain significant estimates, concentrations) and ASC 275-10 glossary (near term, severe impact)
- FASB ASC 205-10-45, Presentation of Financial Statements (comparative statements)
- FASB ASC 205-20, Discontinued Operations
- FASB ASC 205-40, Going Concern
- FASB ASC 210-10, Balance Sheet
- FASB ASC 235-10-50, Notes to Financial Statements (accounting policies)
- FASB ASC 450-20, Loss Contingencies
- FASB ASC 825-10-50, Financial Instruments (concentrations of credit risk)
- AICPA, AU-C Section 230, 315, 450, 540 and 570
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AU-C references are to AICPA Professional Standards, paraphrased here; read the standard itself before relying on a requirement. This page is guidance, not professional advice. Report an error