Question

Contracts or agreements can sometimes create financial contingencies for companies. Discuss what types of contractual obligations must be disclosed in great detail in the notes to the balance sheet and why you think these details should be disclosed.

Answer 1

General debt obligations, lease contracts, pension arrangements, and stock option plans are four items for which disclosure is mandatory in the financial statements. The reason for disclosing these contractual situations is that these commitments are of a long-term nature, are often significant in amount, and are very important to the company's well-being.

The rule requires public companies to discuss their "off-balance sheet arrangements" that have or are reasonably likely to have a current or future effect on their financial condition, changes in financial condition, revenues, expenses, results of operations, liquidity, capital expenditures, or capital resources that is material to investors.

All those contractual obligations which likely lead to an outflow of financial resources in the future must be disclosed in the notes to the balance sheet.

The final rule defines the term "off-balance sheet arrangement" to mean any transaction, agreement, or another contractual arrangement to which an entity that is not consolidated with the company is a party, under which the company has:

• a retained or contingent interest in assets transferred to an unconsolidated entity or a similar arrangement that serves as credit, liquidity, or market risk support to that entity for those assets;
• any contingent or other obligation under a contract that would be accounted for as a derivative instrument except that it is both indexed to the company's own stock and classified in stockholders' equity in the company's statement of financial position.
• any contingent or other obligation arising out of variable interest, in an unconsolidated entity that is held by and is material to the company, where that entity provides financing, liquidity, market risk or credit risk support to, or engages in leasing, hedging or research and development services with, the company.

  For an off-balance sheet arrangement to exist a contractual relationship must be in place. No disclosure of an arrangement is required until a definitive agreement that is unconditionally binding or subject only to customary closing conditions exists or if there is no such agreement when the transaction closes.

While a company’s financial statements contain all the relevant financial data about the company, that data is often in need of further explanation. That is where the disclosures on the financial statement come into play.

A financial statement disclosure will communicate relevant information not captured in the statement itself to a company’s stakeholders. The disclosures can be required by generally accepted accounting principles or voluntary per management decisions.