Different users of financial statements have different informational needs
Disclaimer: This essay has been submitted by a student. This is not an example of the work written by our professional essay writers.
Any opinions, findings, conclusions or recommendations expressed in this material are those of the authors and do not necessarily reflect the views of UK Essays.
Financial statements form the backbone of communicating the information about the company to the members within and outside the organization. According to International Accounting Standards (IAS 1.9) "The objective of general purpose financial statements is to provide information about the financial position, financial performance, and cash flows of an entity that is useful to a wide range of users in making economic decisions." (Deloitte Global Services Limited, 2010).Owing to the wide variety of users of this information and that of the structure of business entities, there are different types of financial statements. Users refer to them from time to time in order to make correct economic decisions.
Depending upon the type of information provided by them, financial statements are categorized in 4 type's viz. balance sheets, income statement, statement of cash flow and the statement of equity. A Balance Sheet gives the financial position of the entity by considering its assets, liabilities and equity at a given time. It follows the accounting equation where assets equal capital plus liabilities. An Income Statement, also known as the Profit & Loss account of an entity, reports the income, expenses and profits of the entity over a period of time. Statement of Cash flow reports the changes in cash position. It informs about the operating activities like money received from customers or paid to suppliers, investment activities that include acquiring or selling different long-term assets that are not considered to be cash, interests or dividends that are paid or received or financial activities which change the capital of an entity. (Deloitte Global Services Limited, 2010).The Statement of Equity gives information about the total comprehensive income of the entity over a period while separately stating the amount attributable to the owner (Wheetman P, 2006). For large organizations, such statements are quite complex and it may be necessary to provide notes that explain the items on the financial statement. They also provide information about the basis on which financial statements are prepared and any other information that may be relevant but cannot be stated in the financial statements directly. Such notes form an integral part of the statement.
According to the International Financial Reporting Standards (IFRS) "Financial reports are prepared for users who have a reasonable knowledge of business and economic activities and who review and analyse the information with diligence."(Deloitte Global Services Limited, 2010).Depending upon their role in the organization, different type of information is used by different users. The users of financial statements include a wide range of people including owners, investors, creditors, management, employees, vendors, public as well as institutions like banks, government organizations etc. They can be briefly classified into two categories namely the Internal Users and External Users. The employees along with the managers and the owners form the Internal User group. Owners use financial statements to access the performance, efficiency of the management, also to measure the performance of the business entity. Management, being directly related with the day to day working of the business entity, enjoys unrestricted access to the wide range of information (much of which is confidential in nature). It is then utilised by managers to make analysis, judgements and decisions pertaining to their responsibilities. It makes proper utilization of resources in order to meet the objectives of the entity. A separate form of accounting called "Management Accounting" has come into existence due to broad nature of this group of users and the high quality of information that is available to them. Employees form the other part of this group. They use the information from financial statements to determine their job security. It is also helpful in analysing the ability of their employers to provide remunerations, pay rise, pension funds and retirement benefits etc to the employees. This information is sometimes provided in form of special reports to employees as the annual reports are published late. However such information provided may be verified by the employees using the financial statements.
The External Users of financial statements consist of investors, trade creditors, Government, financial institutions like Banks, customers etc. The financial statements are used by the existing investors to access the financial strength of the company, its economic stability, to make decisions whether to buy, sell or hold the stock depending upon the ability of the entity to pay dividends in future, to compare the performance of the entity over a period of time or with other entities in order to make investment decisions etc. It also helps investors to determine the risk factor and the investment returns over a particular period and compare the same with other entities. Institutional investors, for e.g. Insurance companies, pension funds or equity analysts that guide private investors make use of this information to ascertain the liquidity of the business and its ability to pay future dividends. Prospective investors may use the information to make valuable economic investment decisions.
Financial institutions like Banks make use cash flow statements to determine whether to help them with working capital by issuing loans or if their loans would be paid along with the interest. Financial lenders use this information to determine the economic vulnerability of the business and its results. They may impose restrictions to limit overall borrowing limits called loan covenants. These are then verified through financial statements. Trade creditors provide services or goods on credit. They are called as unsecured creditors as they come last in the payments in case of failure of the business. They therefore make use of the information to ensure the repayment of services and calculate the non-payment risks. Government makes use of the financial statements to keep a tab on the taxes paid by the business entity and make sure that they are in accordance with the profits earned. They have a right to demand more information than that which appears in public statements. Other government agencies also use accounting information to ascertain that the consumers are charged properly by organizations for their services.eg: OFGEM (the Office of Gas and Electricity Markets).Customers need information about the current and future supply of goods and services. Financial statements in form of fixed assets, working capital confirm the ability of the business to meet the current and future obligations like guarantees or warrantees. (Weetman P, 2006).
Accounting statements provide financial information for the user which is to be used for decision making. International Financial Reporting Standards (IFRS) Framework identifies comparability, verifiability, timeliness and understandability as the qualitative characteristics that enhance the usefulness of information provided in the financial statements. (Deloitte Global Services Limited, 2010). According to this Framework general purpose financial statements are prepared which can help all users. However it is evident that different users require different kind of information to make decisions. Also the general financial statements and reports are prepared keeping in focus the interests of the owners or investors. Moreover management tends to modify the information keeping in mind the behaviour of the investors. This often results in the entity being over or under-priced and thus information loses its reliability and trustworthiness.
To increase the decision useful financial information, the International Accounting Standards Board and the US Financial Accounting Standards Board (hereafter the Boards) are undertaking a joint project to develop a common conceptual framework with new and revised accounting standards that both the boards can use. The Boards have proposed to reconfigure the financial statements by partitioning each financial statement in five categories viz. business activities, financing activities, income taxes, discontinued operations, and equity. The allocations of these transactions would be done by management. They propose that the objective of financial reporting should be on decision useful information. The management approach would then subsume stewardship. The allocation of the transaction within the above stated partitions would be based on the assessment of the management. There is no doubt that objective of segregating the financial statement would help the investors and creditors in judgements and decision making. (Bradshaw, M., Callahan, C. et al June 2010).However the objective of a financial statement should not be merely influencing the buying, selling and holding company's securities. The role of stewardship also has to be considered as it informs about the financial positions of the past and the current dates. It would not only keep the performance of management under vigil but the past records would also help in identifying the similar re-occurrences of such circumstances. Also importance is given to management approach whereas the very same managers are believed to report biased accruals. (Bradshaw, M., Callahan, C. et al June 2010).
Hence financial reporting should not only be done with the management approach but also keeping in mind the importance of the objective of stewardship. Also guidance is to be specified about the level of details to be given in financial statements which would unlikely be provided by the managers. The framework and standards should be based to provide unbiased, faithful information to the users in order to make cost-effective economic decisions.
Bradshaw, M., Callahan, C. et al (June 2010). The American Accounting Association's Financial Reporting Policy Committee's Response to the Preliminary Views on Financial Statement Presentation. Accounting Horizons. 24 (2), pp 279-296. Business Source Premier. Available at http://search.ebscohost.com/login.aspx?direct=true&db=buh&AN=51362791&site=bsi-live (Accessed: 11 November 2010).
Deloitte Global Services Limited. (2010). Summaries of International Financial Reporting Standards. CONCEPTUAL FRAMEWORK FOR FINANCIAL REPORTING Available: http://www.iasplus.com/standard/framewk.htm. (Accessed: 11 November 2010).
Deloitte Global Services Limited. (2010). Summaries of International Financial Reporting Standards.IAS 7 STATEMENT OF CASH FLOWS. Available at http://www.iasplus.com/standard/ias07.htm. (Accessed: 14 November, 2010).
Weetman, P (2006). Financial and Management Accounting-An Introduction. 4th ed. Harlow: Prentice Hall. 12-16.