StudentShare
Contact Us
Sign In / Sign Up for FREE
Search
Go to advanced search...
Free

The Nature and Purpose of Financial Statements - Essay Example

Cite this document
Summary
This essay "The Nature and Purpose of Financial Statements" discusses the major financial statements which are the income statement, balance sheet, statement of retained earnings, and the statement of cash flow. The income statement shows how profitable a company has been during an accounting period…
Download full paper File format: .doc, available for editing
GRAB THE BEST PAPER94.4% of users find it useful
The Nature and Purpose of Financial Statements
Read Text Preview

Extract of sample "The Nature and Purpose of Financial Statements"

1. Explain the nature and purpose of financial ments The most useful reports that accountants and finance professionals use to analyze the financial performance of a company are the financial statements. The accounting staff of a corporation is responsible for the preparation of financial statements. The four major financial statements are the income statement, balance sheet, statement of retained earnings, and the statement of cash flow. The income statement shows how profitable a company has been during an accounting period. An accounting period typically is composed of one year in time. Within the income statement there is information regarding the revenues and expenses of a company. Sales or revenues are generated when a company sells a product or service. The revenue recognition principle dictates that revenue be recognized in the accounting period in which is earned (Accoutingtools, 2015). Two of the major expenses categories within the income statement are cost of goods sold and operating expenses. The figure at the bottom of the income statement is the net income or net loss of the company during an accounting period. The balance sheet is a statement that shows the financial position of a company at a specific point in time. The balance sheet follows the logic of the basic accounting equation. The basic accounting equation states that assets equal liabilities plus stockholders equity (Misscpa, 2011). The three major sections of the balance sheet are assets, liabilities, and equity. The preparation of the balance sheet must follow the historic cost principle. Historical cost is a measure of value used in accounting in which the price of an asset on the balance sheet is based on its nominal or original cost when acquired by the company (Investopedia, 2015). Assets in the balance sheet are subdivided into four subcategories: Current assets Long term investments Property, plant, and equipment Intangible assets Some examples of assets included in the balance sheet are cash, inventory, account receivables, short term investments, prepaid expenses, office equipment, and goodwill (Weygandt, Kieso, Kimmel, 2002). The liabilities section of the balance sheet is divided into current liabilities and long term liabilities. Current liabilities are liabilities that expire in less than one year. A few of the current liabilities included in the balance sheet are notes payables, account payable, current maturities of long-term obligations, unearned revenue, salaries and wages payable, taxes payable, and other current liabilities. A list of potential long-term liabilities are bank notes payable, mortgage payable, bonds payable, and other long term debt. The stockholder’s equity section shows how much capital the company has accumulated over time. The two main components of the stockholder’s equity section are common stocks and retained earnings. Some companies will also illustrate its preferred stocks within this section. The statement of retained earnings shows the changes in retained earnings that have occurred during a year. The preparation of financial statements occurs at the end of the accounting cycle. Companies provide information regarding its financial statements within the content of the annual report of the firm. Publicly traded companies often also release quarterly financial statements. Two accounting assumptions that accountants have to consider when preparing financial statements are monetary unit assumption and economic entity assumption. The monetary unit assumption requires that only transaction data that can be expressed in terms of money be included in the accounting records. Based on this accounting guideline the U.S. dollar is assumed to be constant or have no change in purchasing power over time (Averkamp, 2015). The economic entity assumption is another important accounting rule companies must follow. This accounting principle establishes a clear delineation between an economic entity and its stakeholders for the purpose of maintaining separate transactions records (Investorwords, 2015). In the process of preparing financial statements it is imperative for accountants to prepare them based on the generally accepted accounting principles (GAAP). 2. To what extend do the statement of financial position (or balance sheet) and the income statement provide useful information for an organization stakeholders. The information contained within the financial statements prepared by the accounting staff of a firm is used for both internal and external purposes. The stakeholders of a corporation are the users of the financial information prepared by companies. A stakeholder is a person, group or organization that has interest or concern in an organization (Businessdictionary, 2015). Some of the stakeholders groups of a corporation include its employees, unions, suppliers, governmental agencies, customers, investors, and the executive management team of an enterprise. Stakeholders utilize financial information for a variety of reasons. For example banks require companies to submit their latest financial statements whenever a company requests a loan or line of credit from the bank. The bank’s credit evaluation department analyzes the financial statements of companies to decipher if the firm has good profitability, efficiency, liquidity, and solvency. A technique that is often used to evaluate the information contained in the financial statements is ratio analysis. Ratio analysis uses financial basic financial formulas to create metrics that provide insight into the performance of a company. Some common financial ratios used to evaluate the financial performance of companies are the net ratio, return on assets (ROA), return on equity (ROE), current ratio, quick ratio, earnings per share, dividends per share, dividend payout ratio, debt ratio, working capital, inventory turnover ratio, average sale period. A stakeholder group that must follow the performance of a company is its employees. It is important for employees to know whether a company is doing good or bad financially. Companies that struggle financially often implement strategies that affect the employees such as downsizing. Some companies pay its employees with stock options or bonuses. Bonuses are often tied to the financial performance of the organization. Suppliers are another stakeholder group that has interest in the financial performance of a company. Based on the financial results of firm suppliers make decision of whether or not to extend credit to a firm. Employee unions closely follow the financial performance of an enterprise by analyzing financial statements. Unions pay close attention to the profitability of a firm in order to negotiate new collective bargaining agreements. If a company is doing well the union often asks for a raise for the employees. The government is another stakeholder that pays close attention to the financial performance of enterprises. Based on the net income displayed in the income statement the government taxes a company. Governments are also interested in the financial performance of private companies because there is a correlation between business success and job creation. The executive management of a firm which includes the CEO, president, and controller of a firm utilize the information contained within the financial statements to make business decisions. Based on the results of the financial statements business executives can make decisions such as expanding operations, closing down unprofitable business units, and investment decisions. The stakeholder group that probably pays most attention to the financial results of publicly traded companies is investors. Publicly traded companies are firm whose stocks are sold in the open market in marketplaces such as the New York Stock Exchange (NYSE). Some of the techniques used by investors to analyze financial statements are ratio analysis, horizontal analysis, and vertical analysis (Besley & Brigham, 2000). Customers also are interested in knowing the financial performance of companies. The use of financial statements is a great way to analyze the financial performance of enterprises, but despite its usefulness these reports also have its limitations. One limitation of financial statements is that it does not provide any qualitative information about the company. Important qualitative information such as the company’s expansion plans, size of the workforce, competitors, marketplace data, and future prospects of the industry are disregarded in the content of financial statements. A second limitation of financial statements is that its results are based on historical data. Financial statements do not provide forward looking information such as sales forecasts. Another limitation of financial statements is comparability of financial data between companies (Ahmed, 2014). The reason that often data between financial statements cannot be compared is due to differences in accounting methods used by different companies. A problem that exist regarding the information contained financial statements is that it does not consider industry trends, technological changes, changes in consumer tastes, changes in broad economic factors, and changes within the firm itself (Ahmed, 2014). Financial statements are a great resource that can be used to evaluate the financial performance of a firm. Companies that display poor financial performance are not good investment targets because bad financial performance is typically reflected in the price of the stock of the company. In contrast companies that perform well financially usually go up in price in the long run. The credibility of the accounting system is reinforced due to the use of the generally accepted accounting principles by accountants. It is important for business students to learn how to prepared and properly analyze financial statements. Knowledge about financial statements can help any professional or person because based on this knowledge people can make investments decisions in the stock market. References Accountingtools.com (2015). The Revenue Recognition Principle. Ahmed, S. (2014). Limitations of Financial Statement Analysis. Averkamp, H. (2015). Monetary unit Assumption. Besley, S., Brigham, E. (2000). Essentials of Managerial Finance (12th ed.). Forth Worth: The Dryden Press. Businessdictionary.com (2015). Stakeholder. Investopedia.com (2015). Historical Cost. Investorwords.com (2015). Economic Entity Assumption. Misscpa.com (2011). Basic Accounting Equation. Weygandt, J., Kieso, D., Kimmel, P. (2002). Accounting Principles (6th ed.). New York: John Wiley & Sons. Read More
Cite this document
  • APA
  • MLA
  • CHICAGO
(“Accounting For Organisations Essay Example | Topics and Well Written Essays - 1500 words”, n.d.)
Accounting For Organisations Essay Example | Topics and Well Written Essays - 1500 words. Retrieved from https://studentshare.org/finance-accounting/1681786-accounting-for-organisations
(Accounting For Organisations Essay Example | Topics and Well Written Essays - 1500 Words)
Accounting For Organisations Essay Example | Topics and Well Written Essays - 1500 Words. https://studentshare.org/finance-accounting/1681786-accounting-for-organisations.
“Accounting For Organisations Essay Example | Topics and Well Written Essays - 1500 Words”, n.d. https://studentshare.org/finance-accounting/1681786-accounting-for-organisations.
  • Cited: 0 times

CHECK THESE SAMPLES OF The Nature and Purpose of Financial Statements

Practical Aspects of Financial Statements

Introduction This paper focuses on the practical aspects of financial statements.... This will be aided by critical analysis an explanations of components and importance of financial statements to relevant stakeholders identified above.... The GAAP and other legal statutes require businesses to prepare financial statements once every 12 months.... Tracey (2009) identifies that the main purpose of the income statement is to identify the profit or loss made by a business in a given period of time (p13)....
9 Pages (2250 words) Essay

Financial Performance of a Business

The author of this assignment "Financial Performance of a Business" casts light on the main financial statements.... It is stated that in order to understand the financial strength and financial status of the business, every enterprise should prepare certain statements known as financial statements.... financial statements give complete information about equity, assets, liabilities, expenses, reserves and profit and loss of concern.... The following constitute the basic financial statements: Balance sheet; Income statement and; Cash flow statement....
6 Pages (1500 words) Assignment

Financial Statements

This essay focuses on the four types of financial statements identified above and their importance to internal users such as managers and employee as well to the external users such as investors and creditors.... financial statements 8th, January, 2013 Introduction A financial statement can be defined as a record that shows the financial activities of a business, individual, or other entity.... financial statements act as indicators of the financial position of a company and are useful to different users wishing to make financial decisions....
4 Pages (1000 words) Essay

An Insight into Financial Statements and Management

In the analysis of financial statements, the analyst has a variety of tools available from which he can choose those best suited to his specific purpose.... This paper "An Insight into financial statements and Management" focuses on the fact that a financial statement is a compilation of data, which is logically and consistently organized according to accounting principles.... financial statements show a position at a moment in time, as in the case of a balance sheet, or may reveal a series of activities over a given period of time, as in the case of an income statement....
8 Pages (2000 words) Case Study

Financial Statements as an Important Part of Business

financial statements are an important part of any business because they help to determine how a company is currently doing financially and thus what business decisions need to be made for the future of the company. ... Comparative statements can be completed for any of the above financial statements.... The key purpose of an income statement is to find out the net income of the business.... Comparative statements are useful for determining how well a company is doing financially compared to a previous time period....
2 Pages (500 words) Essay

Demonstrate an understanding of financial statement analysis

This is particularly important as it guarantees Financial ment Analysis Financial ment Analysis Introduction Financial ment Analysis refers to the checks carried out on the financial figures of a company's financial statements.... It is for this purpose that the information gathered from the financial statements is important.... It is for this reason that they should analyse financial statements in order to measure the effectiveness of the policies and the decisions they make in the day-to-day running of a firm....
2 Pages (500 words) Essay

Critically analyse financial statemebt

Introduction: of the financial ments To better understand the distinctive features of financial statements, it would be necessary to define the functions of a certain type of financial statement in a business organization.... Conclusion The three types of financial statements differ in their features because of the nature of their operations and the consideration of the different audience which these financial statements serve.... In preparing the financial statements of a limited company however, such financial statement has to adhere to International Financial Reporting Standards (IFRS) and Generally Accepted Accounting Principle (GAAP) unlike in sole trader business where it is not necessary because the financial statements are primarily for use by the owner and need not be compared and harmonised with other organizations (Bouwman 1995)....
1 Pages (250 words) Essay

The Role of Financial Statements and Financial Analysis for Organizations

The paper 'The Role of financial statements and Financial Analysis for Organizations' is a well-turned example of a finance & accounting case study.... However, issues arise regarding the preparation of financial statements and eventual financial analysis.... The paper 'The Role of financial statements and Financial Analysis for Organizations' is a well-turned example of a finance & accounting case study.... However, issues arise regarding the preparation of financial statements and eventual financial analysis....
12 Pages (3000 words) Case Study
sponsored ads
We use cookies to create the best experience for you. Keep on browsing if you are OK with that, or find out how to manage cookies.
Contact Us