Financial statements are produced periodically by businesses to provide information about the financial position and performance of a company over a given period. Companies produce a number of financial statements. Each intended to express information differently to different users, both internally and externally which is analysed and interpreted to assist in their individual economic decision-making.
With so many users of financial statements each requiring different information, How do these information needs affect the accuracy of financial statements. With such great emphasis on decision makers as a user of these financial statements other users could be neglected and mislead in the representation of the figures, and information provided. The more scandals that occur the less reliance and confidence decision makers will have on these statements.
Different users look at financial statements in different ways, however, the main purpose of analysis for most users is for assisting in decision making at different levels both internally and externally, such as investment, lending and internal investment decisions. With the outcomes of these decisions predictable, companies may emphasis their results towards a particular group of users they would like to impress at that particular time. This emphasis would suggest that a large amount of pressure is put on companies to ensure there figures are absolutely correct and are interpreted in a way to meet and excel expectations to fulfill the required outcome.
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In the UK there are certain standards and accounting practices that are adopted and an international framework that is used each time a large company produces their financial statements. These accounting practices such as UK Generally Accepted Accounting Principles (UK GAPP) and reporting standards such as International Financial Reporting Standards (IFRS) are designed to make companies produce statements that show a true, fair and accurate view of there financial position at the time of reporting.
However even with rules in place companies still find 'creative' ways around certain aspects of accounting practices such as accruals and stock valuation to make figures look more favorable than they actually are and they focus them more towards a particular group of users.
There are two groups into which users of financial statements can be classified, Internal users and external users. Primarily the most common and important user of the financial statement would be the external user who in many cases will have little or no direct financial communication with the company except through the publication of the financial statement periodically. There are again two types of user in the external group, firstly those who have a direct interest in the company and secondly those who have an indirect interest such as customers and suppliers. Most importantly the direct users include the investors and creditors who rely upon the information produced to make investment and lending decisions which hold an element of risk which they hope to reduce to as little as possible from analysis of the financial statements.
Investors are looking at a company to provide growth and ultimately return on there investment for this they look at particular parts of the financial statements such as assessing the growth potential and profitability of the company. While other users such as creditors will focus on the level of debt the company can support and repay in the agreed terms and will like to see a fluid short term cash flow and low debt to equity ratio.
Other external users have a much more general interest in the company and do not require the information for making any decisions such as customers, suppliers and the press. However they can see signs that the company is healthy, stable and growing through expansion.
Internal users are grouped together as directly associated to the operation of the business which includes employees, management and the business owners. These users will have had a continuous outlook on the company through there day to day working, however, they will, as in the case of employees, be interested to see the performance of there hard work or perhaps the prospects of a future pay rise. The important internal users are at management level who are similar to investors and creditors required to make decision from these statements such as investment in new resources, whether or not to produce a new product, expansion of production facilities and whether or not to increase employee resources.
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It can be seen that different users are looking for different types of information to make their decisions however the information they use come from the same financial statements. It would be impossible to expect every users need to be fulfilled from the same information when in some cases different users are looking at contrasting elements. For example employees and management are looking at the profitability of the company, a large profit would result in employees feeling undervalued and underpaid and could cause employees to feel they have right to ask for a pay rise, while management would want to see this money distributed in more productive areas such as asset buying or business expansion. In a similar way investors like to see a large profit growth to indicate further potential growth to increase there investment, while banks and creditors would be looking for a more conservative approach.
These examples of the specific elements of information users are looking for in financial statements is the reason behind companies feeling the need to gloss up particular areas of the financial statements in order to impress particular group of users either externally and internally. These example have recently been seen most famously the Enron accounting scandal.
Enron was one of the most famous situations in which accounting practices not necessarily illegal were used to hide certain assets and liabilities, over a period of years Enron used certain accounting methods such as mark to market pricing to price assets at higher values than there current value, hence pricing them into the future inflating the price and increasing the profitability reported, consistently doing this meant that once these practices had begun Enron had to continue to find new ways to inflate there balance sheet through unusual and complicated accounting methods, to keep continually impressing investors, and key stakeholders to drive up there share price artificially on overinflated assets. This method cannot be sustained and resulted in the bankruptcy of the firm in 2001.
As mentioned previously in the UK and Internationally there are certain accounting practices and reporting standards, which are adopted to help keep the many different accounting practices similar, and help to keep the final statements as comparable between companies and industry and prevent companies such as Enron reporting inaccurate figures through accounting practice loopholes.
The most widely used reporting standards known as the International Financial Reporting Standards (IFRS) provide a series of 37 standards which provide a principle based standard for reporting company results, Interestingly IFRS regards statements as requiring one particular primary user and in that circumstance the IFRS regards capital investors as the main primary user of financial statements, and all other stakeholder groups needs should be meet by reporting in this way. Under all standards because of the complexity and varied method of accounting practices is it required for companies to accompany there financial statements with a series of notes detailing any particular accounting practices and specific issues that should be considered while reading there statements.
In conclusion, Companies do feel a great deal of pressure after all they are in business and competitiveness is key to their continued success. Some companies don't break the rules of accounting standards however there accounting practices don't show a true, fair and accurate view of the company. To show this companies would have to be completely un-bias in there reporting and when they are produced under the control of the company directors and top management they are most likely, given the opportunity, to overstate any performance rather than understate, creating a bias element in the financial statements.
IFRS standards are constantly updated and reviewed however they seem to fail in preventing the sorts of accounting practices that lead to such dramatic consequences similar to Enron.
Accounting bodies need to start recognising the fact that no rules or standards can ever stop companies finding ways of manipulating data to look more favorable than it is. There are too many ways of expressing the same thing. Instead the accounting bodies and government should look at auditing financial statements at a more public level rather that allowing private auditors to complete the task as again they are being paid to complete the audit and so will be bias toward the people paying them.
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We know that there are a number of users all with different information needs, which are required to help them make there economic decisions. Working through loopholes in the accounting system, certain companies have been proved to exploit the standards set up to help protect them, and the users of these statements, time after time companies are found to be misleading investors, misleading one user has a consequence for every other user. Scandal after scandal users will loose confidence in using the statements to make critical decisions in fear of being misled by the very company they are trying to help.