As an experienced accountant, who reads, reviews and audits financial statements on a daily basis, there are certain terms and concepts, which become embedded in your vocabulary. For everyone else, here are some of the key terms and assumptions that are used to prepare financial statements, which are critical to reading and understanding the information that is being presented by your organization’s finance team.
Going concern assumption:
‘Going concern’ refers to the fact that the organization will continue to be in operation for the foreseeable future, and does not have the intention or need to liquidate or curtail operations. Unless it is otherwise noted in the organization’s accounting policies, the preparation of the financial statements assumes that the organization is a going concern. If the organization is not a going concern, another basis of accounting must be applied.
Although you typically won’t find the word ‘materiality’ directly within the financial statements, the concept is engrained in the preparation of the statements you are reading. Accountants preparing the statements and auditors reviewing the statements consider an item to be ‘material’ if its misstatement or omission could be reasonably expected to influence the economic decision of the users of the financial statements. A simple example helps illustrate the concept:
As a potential donor to a not-for-profit organization, I’m reviewing their most recent annual report; total revenues are $2.6M for the year in question. When I look at expenses, I note that fundraising expenses are stated as $100K. If in reality these expenses are $102K, the difference would likely not cause me to change my mind about my donation; the misstatement is not material. However, if in reality these expenses are $1.2M, I might reconsider my donation given fundraising expenses represent a much larger portion of revenues; this is a material misstatement.
Consolidated financial statements:
You will often note that in front of the name of each financial statement, the word “consolidated” appears. This means you are reading financial statements which comprise the assets, liabilities, equity, income, expenses and cash flows of the group of entities, including the parent and its subsidiaries. The elements of the financials are amalgamated to present a single set of statements for the full group of entities. If the statements are not preceded by the word consolidated, you are reading a financial statement for only a single entity.
Accompanying any set of financial statements, are the notes to the financial statements, which provide the reader with more information about the organization’s operations and more details on the figures within the face of the financials. You’ll typically see the second note describes the organization’s accounting policies. These policies refer to the specific principles, practices, and rules applied by an entity in preparing and presenting financial statements.
As a reader, it’s important to understand the significant policies, as these may differ organization to organization.
Using the same example to illustrate this point, if I am comparing NPO A vs. NPO B for my donation, depending on the judgments or assumptions employed, I may not be able to directly compare the financial statements of the two organizations.
You will often see a letter like page, typically directly following the table of contents for the financial statements, titled the Auditor’s Report. The auditor’s report is a formal opinion, or disclaimer of opinion, issued by an auditor after performing an audit. To provide an audit opinion, the independent auditor must obtain sufficient, appropriate evidence to confirm that the financial statements are free from material error or omission. Essentially this report tells the reader that an independent expert did not find any errors or omissions that could reasonably impact the reader’s decisions.
The five terms above are just a few of the key concepts that are embedded in financial statements. As best practice, whenever reviewing financial statements, if a term or expression comes up that you are not comfortable with, ask your accountant for an explanation, you are likely not the only person with the same question!