The role of financial accounting in aiding the decision making processes of different non-management stakeholder groups.
Introduction
Reliable, relevant financial statements present the best information about a company's economic history, current financial health, and prospect for the future (Johnson, 2004). The preparation and presentation of financial statements require the use of certain rules to ensure truth, fairness, and consistency.
Accounting employs a number of concepts. They underlie all traditional accounting in commercial organizations and are generally employed in non-commercial organizations as well (Bebbington et al, 2001). Although various concepts have been employed, few have found universal agreement. However, four are deemed to be important (Oxford, 2002). The four fundamental accounting concepts can be identified as going concern, accruals, consistency, and prudence concept.
As mentioned above, financial statements are a record used summarize and communicate financial information about a company and there are many groups of people who have an interest in these statements. In other words, financial statements are important a wide range of groups both internal and external to the organization. These different groups are known as stakeholders. They always have different purposes by looking at the company's financial statement.
This study is divided into two parts. Part one explains how the fundamental accounting concepts are used in preparing financial statements. In this part examples are also given to illustrate the application of the fundamental accounting concepts. Part two explains the four main users of financial statements and their interest. In this part it will also critically evaluate the role of financial accounting in aiding the decision making processes of the main users of accounts.
PART I
These topices are also helpful for you;
Reliable, relevant financial statements present the best information about a company's economic history, current financial health, and prospect for the future (Johnson, 2004). The preparation and presentation of financial statements require the use of certain rules to ensure truth, fairness, and consistency.
Accounting employs a number of concepts. They underlie all traditional accounting in commercial organizations and are generally employed in non-commercial organizations as well (Bebbington et al, 2001). Although various concepts have been employed, few have found universal agreement. However, four are deemed to be important (Oxford, 2002). The four fundamental accounting concepts can be identified as going concern, accruals, consistency, and prudence concept.
As mentioned above, financial statements are a record used summarize and communicate financial information about a company and there are many groups of people who have an interest in these statements. In other words, financial statements are important a wide range of groups both internal and external to the organization. These different groups are known as stakeholders. They always have different purposes by looking at the company's financial statement.
This study is divided into two parts. Part one explains how the fundamental accounting concepts are used in preparing financial statements. In this part examples are also given to illustrate the application of the fundamental accounting concepts. Part two explains the four main users of financial statements and their interest. In this part it will also critically evaluate the role of financial accounting in aiding the decision making processes of the main users of accounts.
PART I
These topices are also helpful for you;
Financial statements:
Financial statements are necessary sources of information about a company. They are used to analyse a company's past, present and future performance. A financial statement consists of the profit and lost account, the balance sheet, and the cash flow statement. Each of these statements summarizes specific information that has been identified, measured, recorded, and retained during the accounting process (Johnson, 2004).
As said earlier, financial accounting employs a number of concepts, because financial accounting seeks objectivity, and of course it must have rules which lay down the way in which the activities of the business are recorded. These rules have long been known as accounting concept (Wood et al, 1999). These concepts are used as guidelines for how the final accounts should be drawn up (Horner, 2000).
These basic concepts should be followed by accountants when producing financial statements. These concepts have evolved over time to deal with various practical problems that may arise in accounts. If accountants did not follow these rules then it would be impossible to evaluate the performance of the business or even compare it with one company's performance.
Going concern concept:
The first basic concept is going concern. This concept implies that the business will continue to operate for the foreseeable future. It means that it is considered sensible to keep to the use of the historic cost concept when arriving at the valuations of assets (Wood et al, 2004). Without this assumption, assets would to be valued at what they would realise if sold, and this amount is very different from their 'book value' or 'value to the business' (Pizzey, 1998).
Example:
Firm (A) is drawing up its final accounts at 31 December 2006. Normally, using the cost concept, the assets would be displayed at a total value of �0,000. It is known, however that Firm (A) will be forced to close down in April 2007, only four months later, and the assets are anticipated to be sold for only �,000. In this situation it would not make sense to keep to the going concern concept, and so we can refuse the historic cost concept for asset valuation purposes in situation such this. In the balance sheet at 31 December 2006 the assets will therefore be shown at the amount of �,000.
Accruals concept:
The second basic concept is accruals. It is also known as matching concept. This concept is based on the principle that revenues and costs are recognised as they are earned or incurred, are matched with one another, and are dealt with in the profit and loss account of the period to which they relate, irrespective of the period of receipt or payment (Davies et al, 2005). This means that revenues and costs are recognised when they are earned or incurred rather than when the related cash is received or paid.
Example:
Firm (A) which always sums up its finances according to fiscal year. If, by the end of 2005, gas bills had been received for the period up to 30 November only, the statement must include an estimate of gas used in December. Conversely, if in January 2005 rent had been paid in advance for the 16 months to 30 April 2006, the statement would include only the rent for the 12 months to 31 December 2005.
Consistency concept:
The third basic concept is consistency. By applying this concept it allows a firm to compare their account to a previous year's figures. This concept is based on the principle that accounting procedures used should be the same as those applied previously for similar items (Davies et al, 2005). This means that the same accounting method should be adopted every year and should not be changed form one financial year to another.
However, it is does not mean the business has to follow the method until the business closes down. A business can change the method used, but such a change is not made without a lot of consideration (Wood et al, 2004). Businesses are allowed to change procedures if there are good reasons for doing so, provided an explanation of the change is given (Black, 2005). Examples of areas where consistency is important include method deprecation, method of stock issue (Palan, 2006).
Example:
If one year Firm (A) decides to calculate an asset's depreciation using the straight-line method, then the next year it should also use this method. If Firm (A) does not and decide to calculate it using the reducing balance method, then the profit figures would fluctuate due to this change in technique.
Prudence concept:
The last basic concept is prudence. It is also known as conservatism concept. This concept is based on the principle that profits should never be anticipated before they have been earned and losses should always be recorded as soon as the organisation is aware of them. It is summarised by the well-known phrase 'anticipate no profit and provide for all possible losses'.
Example:
If Firm (A) was paid �,000 for a contract but the management are certain that final cost will be �,000, they should charge the �000 loss to this year's profit and loss account. However, if the management believe that the work will be completed for �,000 then the �000 profit must not be shown in the profit and loss account until it has been earned.
PART II
Users of Account:
Financial statements could be used by owners. For example, from time to time, owners want financial information to manage the business. Aside from the owners, there are many groups of people who require financial statements. That is to say, owners of businesses may not the only people to see financial statements.
The main users of financial information are investors, lenders, employees, suppliers and other trade creditors, customers and debtors, government and their agencies, and the general public (Britton et al, 2005). This study will only explain the four main users of financial information- investors, employees, lenders, and supplier, and their interests.
The economic decisions for which users need financial statements will not all be the same. Although different decisions usually require different information, all users are interested in the financial performance and financial position of the entity as a whole (Chopping et al, 2003).
Investors:
Both existing and potential shareholders are integrated in this group. Information will be required for them to consider whether to invest in the business or sell current investments. In addition, dividends and share price have to be taken into account by investors in their investment. Short-term for the investors are interest, and long-term view is future earnings. They might also concern profitability and its trend over a period of time.
Employees:
The employees would be interested in clear, simple and understand form of information about the stability and profitability of their employers together with a value-added approach rather than just a profit and loss account view of performance. They need the information on business performance generally for the wage and salary negotiation, assessment of current and forward opportunity in terms of employment.
Lenders:
The sort, medium and long term lenders of money are concluded in this group, this group usually referred to as loan creditor group. The most important thing that the loan creditors will be concerned which is "are they solvent?" For short term creditor, the cash flow statement will be considered at once. The bank would also have an interest in the net realizable value of the assets. Both medium and long-term creditors will review the future cash flow potential of the business. They would also be interested in current and future profitability and growth prospects of the entity in order to ensure that the debtors are able to return the money.
Suppliers:
The trade creditors are also included in this group since they are very important element in the supply of business's working capital. Suppliers would have interest in the company's ability to meet its short-term liabilities and the financial stability of the business in terms of cash flow. Current and future cash flow together with current profitability will also be taken into account. All these information enables them to determine whether amounts owing will be paid when due.
The role of financial accounting and its limitations:
Financial accounting is the branch of accounting concerned with classifying, measuring, and recording the transactions of a business (Oxford, 2002). At the end of the period, usually a year but sometimes less, financial statements are prepared. These statements show the performance and position of the company or the business. For example, a balance sheet gives a snapshot of the company's financial position, a profit and loss account says how profitable a company is and a statement of cash flow tells how much cash a company made, and where it went.
However, financial statements have their limitations. For instance: (a) they cover financial effects of transactions and other events only. They do not cover non-financial effects such as investment in technology, marketing or human resources. But what is not covered may be more important that what is (Marcause et al, 2003). (b) They provide information that has happened in the past.
Besides these, either for honest or for more devious reasons, the number presented in accounts can be misleading. This might be done in order to provide an unfair advantage to one group of people within the firm or the business as a whole (Horner, 2000). Furthermore, it is impossible to sensibly compare two businesses which are completely unlike one another.
As a result of these, users of accounts mentioned above have to be careful with assessment of the performance of a company or a business before making decisions.
CONCLUSION:
Financial statements are a record used summarize and communicate financial information about a company, and they are vital to assess the performance of a company or a business. To ensure truth, fairness, objectivity and consistency, it is necessary to use of certain rules when preparing and presenting of financial statements. These rules have long been known as accounting concept. Although various concepts have been used as guidelines for financial statements, few are considered to be important. These are going concern, accruals, consistency and prudence concept.
There are many groups of people who are interested in financial statements. These different groups are known as users of accounts. They always have different purposes by looking at the financial statements of a company or a business. There is no doubt that financial statements are a good vehicle to assess the performance of a company or a business. However they have various inherent limitations that make them an imperfect vehicle for reflecting the full effects of transactions and other events on a reporting entity's financial performance and financial position (Chopping et al, 2003). It is therefore vital that users of accounts have to be careful with assessment of the performance of a company or a business and should always try to use other sources of information as well to make decisions.
Financial statements are necessary sources of information about a company. They are used to analyse a company's past, present and future performance. A financial statement consists of the profit and lost account, the balance sheet, and the cash flow statement. Each of these statements summarizes specific information that has been identified, measured, recorded, and retained during the accounting process (Johnson, 2004).
As said earlier, financial accounting employs a number of concepts, because financial accounting seeks objectivity, and of course it must have rules which lay down the way in which the activities of the business are recorded. These rules have long been known as accounting concept (Wood et al, 1999). These concepts are used as guidelines for how the final accounts should be drawn up (Horner, 2000).
These basic concepts should be followed by accountants when producing financial statements. These concepts have evolved over time to deal with various practical problems that may arise in accounts. If accountants did not follow these rules then it would be impossible to evaluate the performance of the business or even compare it with one company's performance.
Going concern concept:
The first basic concept is going concern. This concept implies that the business will continue to operate for the foreseeable future. It means that it is considered sensible to keep to the use of the historic cost concept when arriving at the valuations of assets (Wood et al, 2004). Without this assumption, assets would to be valued at what they would realise if sold, and this amount is very different from their 'book value' or 'value to the business' (Pizzey, 1998).
Example:
Firm (A) is drawing up its final accounts at 31 December 2006. Normally, using the cost concept, the assets would be displayed at a total value of �0,000. It is known, however that Firm (A) will be forced to close down in April 2007, only four months later, and the assets are anticipated to be sold for only �,000. In this situation it would not make sense to keep to the going concern concept, and so we can refuse the historic cost concept for asset valuation purposes in situation such this. In the balance sheet at 31 December 2006 the assets will therefore be shown at the amount of �,000.
Accruals concept:
The second basic concept is accruals. It is also known as matching concept. This concept is based on the principle that revenues and costs are recognised as they are earned or incurred, are matched with one another, and are dealt with in the profit and loss account of the period to which they relate, irrespective of the period of receipt or payment (Davies et al, 2005). This means that revenues and costs are recognised when they are earned or incurred rather than when the related cash is received or paid.
Example:
Firm (A) which always sums up its finances according to fiscal year. If, by the end of 2005, gas bills had been received for the period up to 30 November only, the statement must include an estimate of gas used in December. Conversely, if in January 2005 rent had been paid in advance for the 16 months to 30 April 2006, the statement would include only the rent for the 12 months to 31 December 2005.
Consistency concept:
The third basic concept is consistency. By applying this concept it allows a firm to compare their account to a previous year's figures. This concept is based on the principle that accounting procedures used should be the same as those applied previously for similar items (Davies et al, 2005). This means that the same accounting method should be adopted every year and should not be changed form one financial year to another.
However, it is does not mean the business has to follow the method until the business closes down. A business can change the method used, but such a change is not made without a lot of consideration (Wood et al, 2004). Businesses are allowed to change procedures if there are good reasons for doing so, provided an explanation of the change is given (Black, 2005). Examples of areas where consistency is important include method deprecation, method of stock issue (Palan, 2006).
Example:
If one year Firm (A) decides to calculate an asset's depreciation using the straight-line method, then the next year it should also use this method. If Firm (A) does not and decide to calculate it using the reducing balance method, then the profit figures would fluctuate due to this change in technique.
Prudence concept:
The last basic concept is prudence. It is also known as conservatism concept. This concept is based on the principle that profits should never be anticipated before they have been earned and losses should always be recorded as soon as the organisation is aware of them. It is summarised by the well-known phrase 'anticipate no profit and provide for all possible losses'.
Example:
If Firm (A) was paid �,000 for a contract but the management are certain that final cost will be �,000, they should charge the �000 loss to this year's profit and loss account. However, if the management believe that the work will be completed for �,000 then the �000 profit must not be shown in the profit and loss account until it has been earned.
PART II
Users of Account:
Financial statements could be used by owners. For example, from time to time, owners want financial information to manage the business. Aside from the owners, there are many groups of people who require financial statements. That is to say, owners of businesses may not the only people to see financial statements.
The main users of financial information are investors, lenders, employees, suppliers and other trade creditors, customers and debtors, government and their agencies, and the general public (Britton et al, 2005). This study will only explain the four main users of financial information- investors, employees, lenders, and supplier, and their interests.
The economic decisions for which users need financial statements will not all be the same. Although different decisions usually require different information, all users are interested in the financial performance and financial position of the entity as a whole (Chopping et al, 2003).
Investors:
Both existing and potential shareholders are integrated in this group. Information will be required for them to consider whether to invest in the business or sell current investments. In addition, dividends and share price have to be taken into account by investors in their investment. Short-term for the investors are interest, and long-term view is future earnings. They might also concern profitability and its trend over a period of time.
Employees:
The employees would be interested in clear, simple and understand form of information about the stability and profitability of their employers together with a value-added approach rather than just a profit and loss account view of performance. They need the information on business performance generally for the wage and salary negotiation, assessment of current and forward opportunity in terms of employment.
Lenders:
The sort, medium and long term lenders of money are concluded in this group, this group usually referred to as loan creditor group. The most important thing that the loan creditors will be concerned which is "are they solvent?" For short term creditor, the cash flow statement will be considered at once. The bank would also have an interest in the net realizable value of the assets. Both medium and long-term creditors will review the future cash flow potential of the business. They would also be interested in current and future profitability and growth prospects of the entity in order to ensure that the debtors are able to return the money.
Suppliers:
The trade creditors are also included in this group since they are very important element in the supply of business's working capital. Suppliers would have interest in the company's ability to meet its short-term liabilities and the financial stability of the business in terms of cash flow. Current and future cash flow together with current profitability will also be taken into account. All these information enables them to determine whether amounts owing will be paid when due.
The role of financial accounting and its limitations:
Financial accounting is the branch of accounting concerned with classifying, measuring, and recording the transactions of a business (Oxford, 2002). At the end of the period, usually a year but sometimes less, financial statements are prepared. These statements show the performance and position of the company or the business. For example, a balance sheet gives a snapshot of the company's financial position, a profit and loss account says how profitable a company is and a statement of cash flow tells how much cash a company made, and where it went.
However, financial statements have their limitations. For instance: (a) they cover financial effects of transactions and other events only. They do not cover non-financial effects such as investment in technology, marketing or human resources. But what is not covered may be more important that what is (Marcause et al, 2003). (b) They provide information that has happened in the past.
Besides these, either for honest or for more devious reasons, the number presented in accounts can be misleading. This might be done in order to provide an unfair advantage to one group of people within the firm or the business as a whole (Horner, 2000). Furthermore, it is impossible to sensibly compare two businesses which are completely unlike one another.
As a result of these, users of accounts mentioned above have to be careful with assessment of the performance of a company or a business before making decisions.
CONCLUSION:
Financial statements are a record used summarize and communicate financial information about a company, and they are vital to assess the performance of a company or a business. To ensure truth, fairness, objectivity and consistency, it is necessary to use of certain rules when preparing and presenting of financial statements. These rules have long been known as accounting concept. Although various concepts have been used as guidelines for financial statements, few are considered to be important. These are going concern, accruals, consistency and prudence concept.
There are many groups of people who are interested in financial statements. These different groups are known as users of accounts. They always have different purposes by looking at the financial statements of a company or a business. There is no doubt that financial statements are a good vehicle to assess the performance of a company or a business. However they have various inherent limitations that make them an imperfect vehicle for reflecting the full effects of transactions and other events on a reporting entity's financial performance and financial position (Chopping et al, 2003). It is therefore vital that users of accounts have to be careful with assessment of the performance of a company or a business and should always try to use other sources of information as well to make decisions.
You
are required to suggest:
REFERENCES:
Bebbington J., Gray, R., and Laughlin, R. (2001), "Financial Accounting Practice and Principles", 3rd Edition, Thomson, p.11-13 and 137-143
Black, G. (2005), "Introduction to Accounting and Finance", Pearson Education, p.1-5
Britton, A., and Waterston, C. (2005), "Financial Accounting", 4th Edition, Pearson Education, p.9-11, and 51-68
Chopping, D., and Stephens, M. (2003), "Accounting Standards 2003/2004", CCH Group Ltd., p.17-38
Davies, T., and Boczko, T. (2005), "Financial Accounting", McGraw-Hill Education, p.5-11
Horner, D. (2000), "Accounting & Finance", 1st Edition, Hodder Education, p.8-12
Johnson, R.C. (2004), "Financial Reporting and Analysis", 3rd Edition, Pearson Education, p.1-7
Marcouse, I, Gillespie, A., Martin, B., Surridge, M., and Wall, N. (2003), "Business Studies", 2nd Edition, Hodder Education, p.171-175
Oxford (2002), "Dictionary of Business", 3rd Edition, Oxford University Press
Palan, S. (2006), "Lecture Notes"
Pizzey, A. (1998), "Finance and Accounting", 1st Edition, Financial Times-Pitman Publishing, p.8-12
Wood, F., and Sangster, A. (1999), "Business Accounting 1", 8th Edition, Financial Times-Pitman Publishing, p.86-94
Wood, F, and Sangster, A. (2004), "A-Level Accounting", 4th Edition, Pearson Education, p.524-527
Bebbington J., Gray, R., and Laughlin, R. (2001), "Financial Accounting Practice and Principles", 3rd Edition, Thomson, p.11-13 and 137-143
Black, G. (2005), "Introduction to Accounting and Finance", Pearson Education, p.1-5
Britton, A., and Waterston, C. (2005), "Financial Accounting", 4th Edition, Pearson Education, p.9-11, and 51-68
Chopping, D., and Stephens, M. (2003), "Accounting Standards 2003/2004", CCH Group Ltd., p.17-38
Davies, T., and Boczko, T. (2005), "Financial Accounting", McGraw-Hill Education, p.5-11
Horner, D. (2000), "Accounting & Finance", 1st Edition, Hodder Education, p.8-12
Johnson, R.C. (2004), "Financial Reporting and Analysis", 3rd Edition, Pearson Education, p.1-7
Marcouse, I, Gillespie, A., Martin, B., Surridge, M., and Wall, N. (2003), "Business Studies", 2nd Edition, Hodder Education, p.171-175
Oxford (2002), "Dictionary of Business", 3rd Edition, Oxford University Press
Palan, S. (2006), "Lecture Notes"
Pizzey, A. (1998), "Finance and Accounting", 1st Edition, Financial Times-Pitman Publishing, p.8-12
Wood, F., and Sangster, A. (1999), "Business Accounting 1", 8th Edition, Financial Times-Pitman Publishing, p.86-94
Wood, F, and Sangster, A. (2004), "A-Level Accounting", 4th Edition, Pearson Education, p.524-527
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