- Purposes of Financial Statements
The main purpose of financial statements is to provide financial information to interested users in order to aid them in their economic decisions. This point has been claimed by a number of accounting associations, highlighting its importance. For instance, the Accounting Principles Board stated that the function of accounting is to provide quantitative information, primarily financial in nature, about economic entities that is intended to be useful in making economic decisions.
The Financial Accounting Standards Board also asserted the same utility of accounting in different words. Indeed a number of qualitative characteristics like understandability, comparability and relevance had been set in the Framework for the Preparation and Presentation of Financial Statements to target the financial statements towards the aforesaid aim.
At this stage one would ask, who are the interested users, both internal and external to the organization. The interested external users recognized by the Financial Accounting Standards Board are the following:
- Suppliers and other trade creditors;
- Governments and their agencies;
Accounting information is not only targeted to external users. Indeed detailed managerial reports are frequently prepared to management in order to sustain them in their decisions.
- Use of Financial Accounting Information
We have already stressed out the importance of accounting information to aid in the decision making process. The different users identified above seek different information for diverse decisions. For instance, management who are the foremost users of accounting information needs such data in order to guide them in the day-to-day running of the business. Managers are employed in order to employ the resources of the corporation in the most efficient and effective manner.
By providing financial information such as the departmental profit and loss accounts, managers can examine the performance of each division and assert if the costs incurred in the production of the section’s income are excessive or not. If they are noted as high, proper cost control measures could be adopted in order to promote efficiency in the organization. Thus in this stance financial information act as a yardstick to identify areas where greater control is necessary.
External entities like lenders, suppliers and other trade creditors would devote their attention more to assessing the financial position and stability of the corporation rather than in the utilization of the firm’s resources. They would thus examine the financial statements to evaluate the firm’s ability in paying back the amount due.
Lenders may also demand detailed business plans, which are also prepared by accountants in order to attain more information specific to a particular project in which the firm has requested external finance from lenders. Again this is done in order to obtain more data for decision making purposes.
Governments and their agencies also utilize accounting information to aid them in their economic decisions. At first glance one may think that financial information is demanded by the government only to assess the tax liability that the corporation is required to pay. This is not entirely correct.
Other agencies employed by the government use such information to aid them in decisions. For instance the National Office of Statistics frequently gathers accounting information in order to set industry performance during a particular timeframe and thus aid the government in public decisions he will take.
1.2.1 Agency Problem
An important use that accounting information possess is in minimizing the agency problem that in organizations, especially large ones may occur. In practice, public limited companies are frequently managed by individuals who do not possess a financial investment in the corporation. There is thus the risk that such directors will adopt measures which are more in their best interests rather than the firm.
For example, luxury expensive cars are frequently purchased by directors with the funds of the firm, which by their acquisition will not provide any additional benefit to the firm’s operations. Financial statements help in mitigating such problem because the financial information provided in such reports will help interested external users, especially investors in assessing management stewardship. By knowing that their actions are monitored, executive management will pay more attention to adhere with the main interest of maximizing shareholders wealth.
- An ethical approach to business decisions
Ethical theorists have proposed two broad categories, known as the deontological and teleological approaches. The first system entails focusing on the motive to achieve the aimed target, such as lenders requesting a business plan on the project. The teleological model focuses solely on the end itself. For example, an investor may see the financial statements to examine the dividend return he will receive by looking at the profitability and earnings per share figures.
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International Accounting Standards (2000). Framework for the Preparation and Presentation of Financial Statements. London: International Accounting Standards Committee.
Lewis R.; Pendrill D. (1996). Advanced Financial Accounting. Fifth Edition. London: Pitman Publishing.
Weetman P. (2003). Financial and Management Accounting. Third Edition. Essex: Pearson Education Limited.