# Notes to Accounts — Where Red Flags Hide

Series: Foundation Pillar 7 of the Stock Research Series | Based on Ind AS framework and Schedule III of Companies Act 2013 | Read all published pillars →

The most important investor information in an Annual Report is in the Notes — and almost nobody reads them. P&L is 1 page. Balance Sheet is 1 page. Cash Flow is 1-2 pages. Notes to Accounts can be 100-300 pages, in fine print, written in dense accounting language. Within those pages live every major risk a company faces — Related Party Transactions, Contingent Liabilities, Tax Disputes, Borrowing Covenants, Subsequent Events. This guide tells you exactly which notes to read and what to look for.

This article is an educational analytical framework. It does not constitute investment advice. Read the SEBI compliance disclaimer at the end.

# What Are Notes to Accounts and Why They Matter

Notes to Accounts (also called Notes to Financial Statements) provide the explanation, breakdown, and context for every line item on the P&L, Balance Sheet, and Cash Flow Statement.

If the financial statements are the headlines, Notes are the full article.

Under Ind AS, the typical Notes structure:

Numbering varies by company. The KEY notes for investors are: - Note 2: Significant Accounting Policies - Note on Related Party Transactions - Note on Contingent Liabilities - Note on Borrowings - Note on Subsequent Events

# Note 1: Significant Accounting Policies — The Foundation

This note explains the choices the company made in preparing financial statements. Different choices = different reported numbers.

Key policies to read:

### Revenue Recognition Policy - When is revenue recognized — on delivery, on collection, on percentage of completion? - For EPC/construction: Are revenue recognition criteria aggressive? - For software/SaaS: Are subscription revenues recognized correctly over time? - For real estate: Project completion method vs percentage completion method matters greatly.

### Depreciation Policy - Method: Straight Line (SLM) vs Written Down Value (WDV)? - Useful lives of various asset categories - Any changes from previous year?

### Inventory Valuation - FIFO vs Weighted Average vs Specific Identification - Net Realizable Value testing - Provision for obsolescence

### Foreign Exchange Translation - How are foreign operations consolidated? - Treatment of exchange gains/losses

### Lease Accounting (Ind AS 116) - Operating vs finance leases - Right-of-use assets

Red flag: Frequent changes in accounting policies. Companies sometimes change policies to flatter the bottom line in difficult years. Watch for notes saying "Change in Accounting Policy" or "Change in Estimate."

# Note on Related Party Transactions — The Most Important Single Note

Related Party Transactions (RPTs) are dealings between the company and its: - Promoters, promoter group entities - Subsidiaries, joint ventures, associates - Key Management Personnel (KMP) and their relatives - Other group companies

Under Ind AS 24 and SEBI LODR Regulation 23, all material RPTs must be disclosed.

# Why RPTs are critical

Most cases of promoter wealth extraction from listed companies happen through RPTs: - Sale of products/services to promoter entities at non-market prices - Loans extended to subsidiaries that don't get repaid - Purchase of services from promoter group at inflated prices - Royalty / brand fee payments to promoter entities - Real estate transactions at non-market prices

# What to look for in the RPT Note

The disclosure includes: - Name of related party - Nature of relationship - Nature of transaction - Amount of transaction - Outstanding balance as at year-end

# RPT Red Flag Framework

Famous Indian cases of RPT issues: - ICICI Bank-Videocon loan controversy (2018) - Sun Pharma promoter-related transactions - Various smaller companies with significant promoter-entity dealings

# Quantification check

Compute: (Total RPT Value / Total Revenue) ratio

• < 5%: Minimal RPT exposure
• 5-15%: Moderate — investigate specifics
• 15-30%: Significant — question quality of governance
• > 30%: Material — substantial governance risk

# Note on Contingent Liabilities — Off-Balance-Sheet Risks

Detailed treatment was in Pillar 6: Balance Sheet Analysis. The Note breaks down each component:

# Categories of Contingent Liabilities

# Tax Disputes — India's Specific Concern

Indian tax law is notoriously complex and litigation-heavy. Almost every large company has tax disputes pending at various levels: - Commissioner (Appeals) - ITAT (Income Tax Appellate Tribunal) - High Court - Supreme Court

Tax disputes can pend for 10-15 years in India. A ₹1,000 crore tax demand from 2015 may still be unresolved in 2026.

What to check in the Note: - Total amount of tax disputes - Aging — how old are they? - Major case-by-case breakdown - Whether company has paid under protest (deposit with department)

# Quantification framework

Compare Contingent Liabilities to Net Worth: - < 25% of Net Worth: Healthy - 25-50%: Moderate - 50-100%: Significant - > 100%: Material risk

# Note on Borrowings — The Debt Story Detail

The Balance Sheet shows total debt. The Note shows: - Composition: Term loans, NCDs, debentures, bonds, working capital - Lender names: Bank-by-bank breakdown - Interest rates: Floating vs fixed - Maturity profile: When does each loan come due? - Security: What assets are pledged as collateral? - Covenants: Conditions that must be met (Debt-Service-Coverage, Net-Debt-EBITDA, etc.)

# Why this matters

A company with ₹5,000 crore debt looks very different if: - 80% matures in next 12 months (refinancing risk) vs over 10 years (long-term cushion) - 70% is at floating rate (interest rate risk) vs fixed - Most loans have restrictive covenants (any small breach triggers acceleration) vs flexible terms

Refinancing risk check: List the maturity profile. If significant debt matures in next 12-24 months, the company depends on market conditions to refinance. Stress events can prevent rollover.

# Covenant Disclosures

Modern Annual Reports disclose key financial covenants. Watch for: - Debt Service Coverage Ratio (DSCR) covenants - Net Debt / EBITDA covenants - Interest Coverage covenants - Tangible Net Worth covenants

If the company is operating close to any covenant threshold, raise a flag — covenant breaches trigger lender actions.

# Note on Employee Benefits — The Hidden Liability

Under Ind AS 19, companies must disclose: - Gratuity obligations - Pension obligations - Provident fund commitments - Leave encashment liabilities - ESOP outstanding

Why this matters: These are real liabilities that will be paid in future. For employee-heavy businesses (IT services, banks, manufacturers), employee benefit liabilities can be substantial.

Actuarial assumptions to check: - Discount rate used - Salary escalation rate assumed - Mortality table

Aggressive assumptions can understate employee liabilities. Compare with prior year for consistency.

# Note on Subsequent Events — Post Year-End Disclosures

Events that occurred between the Balance Sheet date and the date of finalizing accounts: - Acquisitions or divestitures announced - Major contracts won or lost - Regulatory actions - Significant litigation outcomes - Capital raising activities

Why this matters: A profitable FY26 doesn't matter if April 2026 saw a major adverse event. Subsequent events note bridges the time gap.

# Note on Segment Reporting — Business Mix Truth

Detailed in Pillar 5: P&L Analysis.

Under Ind AS 108, multi-business companies disclose: - Revenue per segment - Result (operating profit/loss) per segment - Assets and capex per segment - Geographical breakdown

Use this to identify: - Which segment is driving consolidated growth - Which segment is loss-making - Which segment is capital-intensive - Concentration risks

# 10 Notes-Specific Red Flags

### 🚩 Red Flag 1: Frequent Auditor Change If a company has changed statutory auditors multiple times in last 5 years, investigate why. Auditor resignations are particularly concerning.

### 🚩 Red Flag 2: Significant Auditor Qualifications Read the Audit Report immediately after Notes. "Qualified Opinion" or "Emphasis of Matter" sections need deep investigation.

### 🚩 Red Flag 3: Related Party Transactions > 15% of Revenue High RPT proportion signals concentrated risk and potential governance issues.

### 🚩 Red Flag 4: Loans / Guarantees to Subsidiaries Without Clear Repayment Schedules Open-ended loans to subsidiaries can hide non-performing inter-company exposure.

### 🚩 Red Flag 5: Significant Tax Disputes vs Net Worth Pending tax disputes > 25% of Net Worth = material risk crystallization scenario.

### 🚩 Red Flag 6: Frequent Accounting Policy Changes Each policy change should be one-time. Multiple changes in 3-5 years = suspicious.

### 🚩 Red Flag 7: Aggressive Actuarial Assumptions for Employee Benefits Discount rates above market, low salary escalation assumptions = understated liabilities.

### 🚩 Red Flag 8: Large Capital Commitments Without Disclosed Funding Plan Pending capex obligations without clear funding source = future borrowing pressure.

### 🚩 Red Flag 9: Restated Numbers from Previous Year Restatements indicate prior reporting errors. Read why; check whether it materially affects valuation.

### 🚩 Red Flag 10: Material Subsequent Events Adverse subsequent events (litigation, contract loss, regulatory action) post Balance Sheet date.

# Notes Reading Workflow — How to Cover 200 Pages Efficiently

Reading every note in a 200-page Annual Report isn't practical. Use this priority workflow:

### Priority 1 (Always read — 30 minutes) 1. Auditor's Report (1-2 pages, read first) 2. Significant Accounting Policies (Note 2, scan for changes) 3. Related Party Transactions (the critical note) 4. Contingent Liabilities & Commitments (full reading)

### Priority 2 (Read if relevant — 20 minutes) 5. Borrowings detail (if D/E > 1.0x) 6. Tax disputes detail (always for older / litigation-heavy companies) 7. Segment reporting (for multi-business companies) 8. Subsequent events (always read — 1 page typically)

### Priority 3 (Reference as needed — 15 minutes) 9. Employee benefits (for service businesses) 10. Foreign currency exposure (for export/import heavy businesses) 11. Financial instruments / risk management

Total time per company: 60-90 minutes for thorough Notes review. This is institutional-grade analysis.

# Notes Quality Score Framework

☐ Auditor opinion clean (1) vs qualified (0)
☐ No frequent auditor changes (1) vs frequent changes (0)
☐ Related Party Transactions < 15% of Revenue (1) vs > 15% (0)
☐ Contingent Liabilities < 50% of Net Worth (1) vs > 50% (0)
☐ Tax disputes < 25% of Net Worth (1) vs > 25% (0)
☐ Borrowings maturity well-laddered (1) vs concentrated short-term (0)
☐ No covenant proximity concerns (1) vs near-breach (0)
☐ Employee benefit assumptions conservative (1) vs aggressive (0)
☐ No accounting policy changes (1) vs frequent changes (0)
☐ No material adverse subsequent events (1) vs material adverse events (0)

Score 8-10: Notes quality high
Score 5-7: Mixed — specific items need attention
Score < 5: Multiple concerns

# Frequently Asked Questions

Q1. Notes to Accounts kahan milte hain? Notes to Accounts are part of the company's Annual Report and Quarterly Results. Full Annual Report (with Notes) is filed on BSE/NSE within 60 days of fiscal year-end, also available on company's Investor Relations page.

Q2. Related Party Transactions ka kya regulation hai? Disclosed under Ind AS 24 and SEBI LODR Regulation 23. Material RPTs (above specified thresholds) require Audit Committee approval. Annual disclosure of all RPTs in Notes to Accounts. Listed companies must disclose RPTs >₹1,000 crore or 10% of turnover (whichever lower) on a half-yearly basis on stock exchanges.

Q3. Auditor's Report kya hota hai? Statement by the statutory auditor on whether the financial statements present a true and fair view. Four types: - Unqualified (Clean): No issues - Qualified: Specific items the auditor disagrees with - Adverse: Strongly disagrees with multiple items - Disclaimer: Cannot form an opinion (red flag)

Always read Auditor's Report before reading any financial statements.

Q4. "Emphasis of Matter" kya hota hai Auditor's Report mein? The auditor draws attention to specific matters that, while not affecting the audit opinion, are important for users. Often relates to going concern, significant uncertainty, or unusual events. Always read these carefully.

Q5. Contingent Liabilities ki note kab tak read karna chahiye? Always read in full. Most Indian corporate failures had clear warning signs in the Contingent Liabilities note years before collapse. The note is typically 1-2 pages — well worth the read.

Q6. Tax disputes ka outstanding amount kahan milta hai? In the Contingent Liabilities note, under sub-category "Tax disputes." Typically broken down by tax type (Income Tax, GST, Excise) and amount. May include status (which forum the case is pending at).

Q7. Significant Accounting Policies note me kya check karna chahiye? - Revenue recognition policy (especially for EPC, real estate, software) - Depreciation method and useful lives - Inventory valuation method - Treatment of foreign currency transactions - Treatment of leases (Ind AS 116) - Any changes from previous year

Q8. Subsequent Events note kya hota hai? Events between Balance Sheet date and date of approval of financial statements. Examples: acquisitions, divestitures, major contracts, litigation outcomes, capital raising. Critical for understanding any material changes post the reporting period.

Q9. ESOP-related disclosures kahan milte hain? Under "Share-Based Payments" note (typically Note 30+). Discloses: - Number of options outstanding - Vesting schedule - Exercise price - Expected dilution impact on EPS

Important for assessing future share dilution.

Q10. Promoter loans ko company se ka data kahan milega? Related Party Transactions note. Look specifically for: - "Loans to KMP and their relatives" - "Loans to entities controlled by KMP" - "Loans to promoter group entities"

Outstanding balances at year-end show inter-company / promoter loan exposures.

Q11. Multiple subsidiaries hain — consolidated notes mein kya cover hota hai? Consolidated Notes cover all subsidiaries on a combined basis. For specific subsidiary detail, look at: - List of Subsidiaries (typically in early notes) - Form AOC-1 (subsidiary financial summary) - Segment Reporting (for material subsidiaries)

Q12. Foreign currency exposure ka data Notes mein kaha hota hai? Under "Financial Instruments and Risk Management" note. Discloses: - Currency-wise outstanding receivables / payables - Hedged vs unhedged exposure - Sensitivity analysis (impact of 10% currency move)

Critical for export/import-heavy businesses (IT, pharma, oil refining).

Q13. Auditor change kab problematic hota hai? Concerning if: - Auditor resigns mid-year - Auditor changed 2-3 times in 5 years - Auditor cites disagreement with management - New auditor immediately makes large adjustments

Audit firm rotation (post-Companies Act 2013) is mandatory after 10 years — that's normal.

Q14. "Going concern" warning kya hota hai? Auditor's note expressing doubt that the company can continue operations for the next 12 months. Triggered by: - Significant losses - Cash flow problems - Loan defaults - Loss of major customers - Regulatory issues

Going concern warning = serious red flag.

Q15. Notes section padhne mein time bahut lagta hai — kaise efficient karein? Follow priority workflow: 1. Always (30 min): Auditor's Report, Significant Accounting Policies, RPT, Contingent Liabilities 2. If relevant (20 min): Borrowings, Tax Disputes, Segment Reporting, Subsequent Events 3. As needed (15 min): Employee Benefits, Foreign Currency, Risk Management

Total 60-90 minutes for institutional-grade analysis per company.

# Series — All Published & Upcoming

1. Pillar 1: Cash Flow Statement Analysis — Published
2. Pillar 2: Promoter Pledge Analysis — Published
3. Pillar 3: DuPont ROE Decomposition — Published
4. Pillar 4: Valuation Multiples — Published
5. Pillar 5: P&L Statement Analysis — Published
6. Pillar 6: Balance Sheet Analysis — Published
7. Pillar 7: Notes to Accounts — You are reading this
8. Article 8: MD&A Reading Framework — Coming
9. Article 9: Auditor's Report Decoded — Coming
10. Article 10: Sector-Specific Analysis Frameworks — Coming

# Official References

1. Ind AS 24 — Related Party Disclosures
2. Ind AS 37 — Provisions, Contingent Liabilities and Contingent Assets
3. Ind AS 108 — Operating Segments
4. Companies Act, 2013 — Schedule III (Financial Statement Format)
5. SEBI LODR Regulations, 2015 — Regulation 23 (RPT framework)
6. BSE/NSE Corporate Filings — Annual Reports availability

# Bottom Line

Notes to Accounts is the longest, most-skipped section of any Annual Report — and the most valuable for risk identification.

Three takeaways:

1. Always read Auditor's Report first. It's a one-page summary of whether the financial statements are reliable. Qualified opinions and Emphasis of Matter notes are early warnings.

1. Master the Related Party Transactions note. Most promoter-extraction patterns hide here. RPTs > 15% of revenue = governance risk.

1. Don't skip Contingent Liabilities. Off-balance-sheet obligations have killed more Indian companies than on-balance-sheet debt. Always quantify against Net Worth.

The 60-90 minutes spent reading priority Notes per company is the highest-ROI activity in fundamental analysis.

For automated Notes parsing and red-flag detection, explore VittSphere ONE. For institutional-style equity research, reach out via Prabhakar Kumar & Co..

Author: Prabhakar Kumar is a practising Chartered Accountant (ICAI, Nov 2019).

IMPORTANT DISCLAIMER (Mandatory under SEBI Regulations): This article is for educational purposes only and does not constitute investment advice or stock recommendation. The author is NOT a SEBI-registered Research Analyst. Past performance is not indicative of future results. Markets subject to risks. Consult a SEBI-registered Investment Adviser for personalized advice.

Written by

Prabhakar Kumar

Chartered Accountant (ICAI, Nov 2019)

Founder of VittSphere Technologies. Practicing CA serving 200+ MSME clients across Pune. 86% win-rate at AO and CIT(A) level tax appeals. Writes on Indian taxation, capital gains, and personal finance.