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Purposes of Financial Statements

The main objective of financial statements is to endow 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 what are the main documents portrayed in the financial statements. The comprise the following: • Income Statement; • Balance Sheet; • Statement of Changes in Share Capital and Reserves; and • Cash Flow Statement; 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. 1. 2 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. 1. 3 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. 1. 4 Relationship between the financial reports The four main reports that build the financial statements mentioned in the opening paragraph of this assignment are highly interrelated with each other. Indeed there is a procedure how they are prepared. The first report computed is the Income Statement, which portrays the profitability of the organization. Once it is completed the statement of changes in share capital and reserves can be done.

This ought to be performed after the income statement because the net income, which is the resulting figure of the income statement, is a key ingredient in such financial report. Therefore the financial controller is required to first complete the income statement and then the statement of changes in share capital and reserves. The statement of changes in share capital and reserves mainly shows the equity of the company and mainly shows the growth in reserves and movement in share capital. The third financial report prepared is the Balance Sheet.

Again this have to be completed after the statement of changes in share capital and reserves since the equity showed in the latter part of the Balance Sheet have to be attained from such financial report. In this statement the financial position and stability of the company are shown. The preparation of the cash flow statement also necessitates that the income statement and balance sheet are prepared. This is due to the fact that a number of variables present in the cash flow statement like operating profit and changes in working capital are provided from such report.

In this latter financial report, emphasis is placed on the cash flow of the organization stemming from the management of cash and cash equivalents. References: Hendriksen S. E. ; Breda V. M. (1992). Accounting Theory. Fifth Edition. United State of America: McGraw-Hill Companies Incorporation. 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.