POSSIBLE USES OF THE FINANCIAL STATEMENTS BY DIFFERENT USERS:

Equity Investor group: Assessing their investment

Loan Creditor group: Assessing the ability to make repayment of loan

Employee group: Assessing security of employment

Analyst-adviser group: Assessing their investment

Business contact group: For the suppliers: likelihood of future supply and for the customers: reliability of future supply

Government: Collection of tax and for economic statistics

Public: Assessing impact on local economy.

THE LIMITATIONS OF FINANCIAL STATEMENTS:-

• As the historical costs and money measurement concepts govern the preparation of the balance sheet and income statements, hence these financial statements are essentially statements reflecting historical facts. It ignore inflationary trend and does not reflect the true current worth of the enterprise,

• Certain important qualitative elements are omitted from the financial statements because they are incapable of being measured in monetary terms like the quality and reputation of the management team, employee and other,
• There are still items in the assets side of the balance sheet which has no real value and are merely deferred charges to future incomes like preliminary / pre-incorporation expenses and other.

• There are still the following issues or challenges in preparing the financial statements which may amount to overstatement of the accounting profit of an entity:

ISSUES OR CHALLENGES

• When to and how much to recognize revenue in the Income statement,

• The constant challenge of when to expense or to capitalize the expenses. It is important to determine definitely what is revenue expenditure and capital expenditure otherwise the accounting profit will be overstated or understated – for example, capitalization of borrowing costs,etc

• Method of depreciations and the rates to depreciate into the income statement are selected by management to suit their business needs. Are the rates intentionally been made lower or the depreciation rates are higher to accelerate the depreciation of the fixed assets,

• Adequacy of provisions and method of providing for doubtful debts. Are the trade debtors recoverable and to what extent the accounting method for provision for doubtful debts shows the realistic picture,

• Basis of valuation of assets -when can costs change to reflect current values? Using replacement or current costs?

• Consolidation challenges-what to eliminates to reflects the overall group performance. Some items might be omitted to show a higher accounting profits.

PURPOSE OF READING FINANCIAL STATEMENTS?

Assess the stewardship of management on the use of the economic resources controlled by the enterprise.

Assess the stewardship of management as a basis for assessing past and anticipated performance.

Assess the enterprise’s capacity to generate cash flows from its existing resource base and in forming judgments on the effectiveness the enterprise employed its resources and might employ additional resources.

Assess how future cash flows will be distributed, its ability to raise further finance and its requirement for future finance.

Assess the business liquidity and solvency to meet its financial commitments as they fall due.

Assess its risk profile and risk management approach.

Evaluate its current performance, financial adaptability and its ability to generate cash in future.

Provides investors information on the enterprise’s capacity to adapt to changes in the environment in which it operates – to raise new capital, repay capital or debt at short notice, mitigate the risks associated with operations.

UNDERSTANDABLE & USEFUL

• Accounting information should be readily understandable to the intended users of the information.

• This is a function of both the intended users and the intended uses of the information. Accounting systems that define either the users or uses narrowly may justify more complex information requirements and standards. Accounting systems that envision a broad body of users and/or uses would tend towards less complexity in published information and standards.

• Typically the belief that, for information to be understandable, information contained in the various financial disclosures and reporting must be transparent (i.e., clearly disclosed and readily discernable).

RELEVANT

The information should be relevant to the decision-making users of the information. It should make a difference in their decisions. Typically, this means the information must

be:

• Timely
• Have predictive value
• Provide useful feedback on past decisions

RELIABLE

The information should be reliable and dependable. This usually includes the concepts of:

• Representational faithfulness – the information represents what it claims to represent. For example, if the reported value of a common stock holding purports to be the current market value, that value should be approximately what the stock could be sold for by the company holding it.

• Verifiability – another person or entity should be able to recreate the reported value using the same information that the reporting entity had.

• Completeness – the reported information should not be missing a material fact or consideration that would make the reported information misleading.

• The concept of neutrality is sometimes incorporated into the concept of reliability.

COMPARABLE AND CONSISTENT

• For accounting information to be usable, it must allow for comparisons across time and across competing interests (such as competing companies or industries).

• This leads to a need for some consistency, wherever such comparisons are to be expected. For example, comparisons of two companies would be very difficult and potentially misleading if one discounts all its liabilities while the other discounts none of its liabilities.

UNBIASED

• Information that is biased can be misleading.

• Biased information is not useful unless the users understand the bias, any bias is consistently applied across years/firms/industries, and the users can adjust the reported results to reflect their own desired bias.

• When faced with uncertainty, there is a need to either require reporting of unbiased values accompanied with sufficient disclosure, or require the reporting of biased (prudent or œconservative) values with the bias determined in a predictable, consistent fashion.

COST-BENEFIT EFFECTIVE

• General understanding that the development of accounting information consumes resources.

• As such, the cost of producing such information should be reasonable in relation to the expected benefit.

• Use the materiality accounting rule – may not have to be fully followed for immaterial items if full compliance would result in unwarranted higher costs.