The Significance of Financial Statements - Assignment Example

The Significance of Financial ments Answer to Question Periodical financial reports are prepared by businesses at regular gaps (annual, half-yearly and quarterly) which mostly rely upon the needs of appropriate laws of the concerned nation. A company’s financial reports include financial statements, notes to various financial reports, supplemental dissemination, which is essential to evaluate the financial position of a company and its performance at periodic intervals. From the accounting recordkeeping process, which is just recording of various economic activities of a company, companies are preparing of their financial statements adhering to the appropriate accounting norms and principles. These financial statements offer the information on accounts of the company which is primarily for the stakeholders of the company like creditors, investors, lenders, regulators, employees, financial analysts and others. .Independent accountants audit the financial statements who offer their expert opinion on whether financial statements offer fair and true view of the financial position of that company and whether they are in accordance with a particular, applicable set of accounting norms and principles. (Robinson et al 2012:193). According to International Financial Reporting Standards (IFRS), there is a need to publish annually, a complete set of financial statements by the companies. Further, companies should also offer comparative information of the previous year along with the current year’s financial statements. Thus, two complete pairs of financial statements and associated notes thereon should be published every year. Thus, an exhaustive set of financial statements of a company would include the following: As at the end of the accounting period, a statement of financial position of the company. A comprehensive income statement for the relevant accounting period should be published. Changes in equity should be presented by a separate statement A cash flow statement for the relevant accounting period. A summary of the explanatory statements and significant accounting policies should be reported by way of notes. Capital Maintenance Capital maintenance is a concept where no income is given due recognisation until capital, whether it is net assets or equity has been retained in the business, and its associated costs are recovered. A return on invested capital means the incidence of income. If the amount invested in a business has been recovered or maintained, then it is said that the return on invested capital happens. As a result, the notion of capital maintenance is significant to differentiate between a return on invested capital and a return of capital and hence, to the determination of income of a business. Capital maintenance can be segregated into two elements namely physical capital maintenance and financial capital maintenance. If the value of the net assets at the fag end of the financial year is in excess over the value of net assets at the starting period of the financial year by excluding any transaction with the owners, then, it is referred as financial capital maintenance. However, if a return on capital happens when the physical productive capacity of the enterprise at the close of the accounting period surpasses the physical productive capacity at the start of the accounting period by excluding any transactions with owners is known as physical capital maintenance. This conception means that income is acknowledged only after the adequate provision has been made for the physical replacement of operating assets. Thus, physical productive capacity is analogues to the present value of the aggregate net assets used to earn revenues. Current value connotes anticipation as regards to earning power of the net assets in the future. The major difference between financial capital maintenance and the physical capital maintenance rests in the reporting of holding losses and profits. A holding revenue or loss happens when the value of the balance sheet item transforms during an accounting period. For instance, when there is an increase in the value of land, which is owned by a company, then, holding profit has happened. Advocates of physical capital maintenance concept treat the holding losses or gains as returns of capital and do not add them in revenues of the company. In its place, holding losses or gains are considered as direct fine tunings to equity. On the other hand, under the financial capital maintenance notion, holding losses or gains are regarded as returns on capital and are added to the income. (Schroeder, Clark & Cathey: 137). Answer to Question 2 Balance Sheet The present financial position of a company or business is being disclosed through its balance sheet, which disseminates the details about the resources which the company controls, which is also known as assets and its liabilities at a particular point of time . The excess of company’s assets over its liabilities is known as Owner’s equity as this amount is owed by the company to its investors or shareholders. A classified balance sheet of a company depicts the details of non-current and current assets and both current and non-current liabilities in an exhaustive manner. However, banks present their balance sheets on liquidity –based presentation instead of current and non-current presentation. A balance sheet which is presented in a vertical common-size form is the analysis of each item in the balance-sheet as a percentage of its total assets. (Robinson, Henry & Pirie 2012:193). The main objectives of a balance sheet are as follows: To understand the long-term and short-term financial status of the business; To evaluate the value of owner’s equity and to help to ascertain the relationship between the total assets and the proprietor’s equity; To help to arrive at the working capital and to know about the various financial ratios. (Siddiqui & Siddiqui 2010: 835). Income Statement From the income statement, the stakeholders can understand the following: to evaluate the cost of production, whether the company has earned gross profit or gross loss during the particular accounting period, and also net loss or net profit for the year. To evaluate the cost of goods sold and to interlink its connection with the sales; To correlate the connection between direct expenses with that of gross profit; To evaluate the operating cost and to determine operational efficiency of the business by correlating connection between sales and the operating cost. It also helps to contrast the budgeted performance with that of actual performance, thereby divulging the disadvantages or positive features of the business. (Siddiqui & Siddiqui 2010: 835). Cash Flow Statement A cash flow statement offers a business’s cash outflows and inflows of economic resources during the financial year. This is significant since business must have adequate cash flows to cater its commitments when they fall due. Thus, a cash flow statement reveals the stakeholders to know whether the business has generated cash or not. Rather of a snapshot of a point in time, cash flow statements depict changes over time in its cash flow pattern. The cash flow statement employs the information from the business’s income statement and balance sheet and any changes that have occurred in funding equity or net assets of the company. The cash flow statement offers information about cash flow in four activities namely operating activities, investing activities, cash flows from capital financing functions and cash flows from non-capital financing functions. (Bogui 2008:271). Notes to Financial Statements Notes to accounts can be described as a fundamental part of reporting of financial statement information. Notes can describe in qualitative terms’ details about the particular items in the financial statements. Notes also include the bar inflicted by fundamental contractual arrangements or by financial agreements. In some cases, though notes to accounts may be too technical and arduous to comprehend, they offer valuable and meaningful details for the stakeholders and to the financial analysts. (Kieso, Weygandt & Warfield 2010: 213). Advantages of Financial Statements The general purpose of financial statements while considering the information provided in the key components of financial statements, which offer meaningful information and data to the various stakeholders of the company like shareholders, lenders, creditors, investors, employees, financial analysts, regulators and managers. By analysing the financial statements of a company, one can understand the present economic status of the company. One can analyse the future of a company with the help of the data offered by the financial statements of a company. Financial statements help to find out the individual company’s performance by comparing the performance of the similar industries and also can be compared with the industry as a whole. Thus, this helps to find out how a company is performing as compared to the particular industry as a whole. (Sinha 2009:8). Disadvantages However, financial statements are not without demerits and some of its disadvantages are as follows; it disregards the qualitative features of the business. Since financial statements are prepared on the basis of the historical cost, they are footed upon conventions and traditions and may not be true view of the financial position of the company. It disregards the efficacy of human resources in the business and also not taking into account the price-level changes. (Siddiqui & Siddiqui 2010: 835). How Financial Statements are Useful to various Stakeholders? The general purpose of financial statements is that while considering the information provided in the key components of financial statements, which offer meaningful information and data to the various stakeholders of the company. Stakeholders of the company are shareholders, lenders, creditors, investors, employees, financial analysts, regulators and managers. Whether a business is having the capability of repaying both principal and interest amount is being analysed with the help of financial statements of a company by the lenders. Long-term profitability of a company is being analysed by the equity investors of the company. Whether the business is able to repay their dues on time is being analysed by the suppliers. Customers are more worried over the business continuing feasibility, both to maintain those products already in existence and the capability of supplying new products. Employees analyse the financial reports so as to know whether company’s financial health is good or not as their job security foot upon its immediate solvency, repaying capacity of its long-run debts and likelihood of earning profitability in the long-run and to meet their retirement obligations. When making important policy decisions like financing, investment and working capital policy decisions, managers methodologically evaluate the financial information from the financial statements of the company. Further, managers of the company use the financial statement information to make capital investment decisions. (Baker & Powell 2009:19). Conclusion Thus, to sum-up, the balance sheet can be referred as a picture of the various liabilities, equity accounts and assets of a company. It mirrors the financial status of a company at a specified point of time. The excess of revenues’ minus expenses of a company is being reported through the income statement. The statement of cash flows is the indirect method of showing how changes in cash monitored on the balance sheet which can reconcile to the reported revenues of a company. Thus, cash flow statement offers a reconciliation of the cash balances at the start date of the balance sheet till the end date of the balance sheet of a company. (Robinson, Henry & Pirie 2012:855). Without the financial statements, it will be very difficult for the various stakeholders of the company to know about its performance, its future growth and its viability. Hence, we can conclude that the financial statements are like a lighthouse which offers insight to the stakeholders of the company to know about its current and future performance, future growth and viability. List of References Baker HK & Powell G. (2009). Understanding Financial Management: A Practical Guide. London: John Wiley & Sons. Bogui, F. (2008). Accounting. Hong Kong: CRC Press. Kieso D E, Weygandt JJ & Warfield, D. (2010). Intermediate Accounting IFRS Edition, Volume 1. New York: John Wiley & Sons. Robinson TR, Henry E & Pirie WL (2012). International Financial Statement Analysis. New York: John Wiley & Sons. Schroeder RG, Clark MW & Cathey JM. (2011). Financial Accounting Theory and Analysis: Text and Cases. London: John Wiley & Sons. Siddiqui SA & Siddiqui AS. (2010). Comprehensive Financial Accounting XII. New Delhi: Laxmi Publications. Sinha. (2009). Financial Statement Analysis. New Delhi: PHI Learning Pvt Ltd. Read More