Financial Statements and Accounting Concepts

Introduction

There are many users of business information who do not work for companies but are associated with them directly or indirectly. These users are considered as external users, and they do not have access to the financial information generated by different departments of a company. Therefore, they have to rely on the qualitative and quantitative information prepared by the company’s accountants and verified by its auditors. This information is periodically prepared, and it is available to its users after some time. There are different financial statements prepared by companies, which are identified and discussed along with their purpose in this paper. There are different accounting concepts related to the information prepared and reported by companies, which are also covered in this paper.

Importance of the Study

The study of the accounting cycle and financial statements is important as it could help users to understand the purpose of financial reporting and assist them in making their decisions. The disclosures by companies are assessed for their relevance, reliability, completeness, and timeliness. For example, shareholders would be interested in determining the return on their investment in the company’s stocks. Therefore, they would consult the financial information provided by the company to estimate their return. Furthermore, such a study can help in understanding how financial reporting affects different stakeholders.

Accounting Cycle

The seventh step of the accounting cycle is the preparation of financial statements. There are different financial statements that are prepared by publicly listed companies. These financial statements summarize the financial performance of the company in the last reporting year. Therefore, it could be stated that they are prepared and reported at the year-end. A company’s year-end is the last working day of the accounting period. Moreover, companies can change their reporting period to reconcile with their tax period (Rich et al. 132). In addition to year-end financial statements, companies also prepare financial statements on a quarterly basis. These statements are important as they provide timely information to users as compared to year-end financial statements. Furthermore, companies provide comparative financial statements of the previous financial period. It allows users to compare and evaluate the financial performance of companies in the last two accounting periods.

Basic Financial Statements

There are four different financial statements that are prepared by companies. These include “statement of income (income statement), statement of financial position (balance sheet), statement of changes in equity, and statement of cash flows” (Whittington 148). The statement of income is prepared for the entire financial period. It indicates the company’s revenue, cost of sales, selling and administrative expenses, and other expenses to determine its gross profit and operating profit. Furthermore, the statement includes interest expenses and tax paid by the company to determine its net profit. In addition to these, the statement also indicates the income attributable to the company’s equity holders and minority shareholders along with the basic and diluted earnings per share. The statement of financial position provides information about the company’s assets, liabilities, and equity on the last working day of the accounting period. It implies that the information provided in the statement is for a particular day and not for the entire period. The statement of cash flows is the most useful financial statement as it provides information about cash receipts and cash payments made by the company during the accounting period. The statement is structured in three different sections including cash flow from operating activities, cash flow from investing activities, and cash flow from financing activities. The sum of cash flows from all these activities determines the ending cash position of the company on the last working day of the accounting period. The statement of changes in equity provides details of changes in the owner’s equity during the year. The changes in equity are due to the company’s earnings, dividends paid, revaluation of assets and liabilities, and equity withdrawals, etc. (Yona 117).

Users of Financial Statements and Their Purpose of Using Such Statements

There are different users of financial statements including customers, creditors, shareholders, investors, financiers, tax authorities, government, and the general public. They all have different interests, and their requirements of information also vary significantly. For example, creditors would be interested in determining whether the company can settle its accounts payable. They assign a credit limit to a company based on its previous dealing with them. On the other hand, customers would assess the company’s financial worth and ability to manage their orders. Most importantly, shareholders, who provide finance to the company, would be interested in determining if their investment in its equity would generate a sufficient return for them. Managers act as agents of shareholders (Porter and Norton 11). Therefore, they need to make decisions that are favorable and generate value for shareholders. The regulators and tax authorities would assess the company’s compliance with regulations and policies to ensure that it is fulfilling its corporate obligations. Moreover, the general public would be interested in the information about the company’s actions and investments for its corporate social responsibility. Therefore, it could be argued that all users of financial information have different information needs that must be satisfied by the company through its reporting.

Accounting Concepts

There are different accounting concepts that relate to the preparation of financial statements. Some important concepts are going concern concept, accrual concept, matching concept, consistency concept, and materiality concept. The accrual concept requires companies to “recognize revenues when they are earned and expenses when assets are consumed” (Pingle 33). The going concern concept is based on the assumption that the company will continue to use its assets in the coming periods. The matching concept requires companies to “recognize expenses in the same period when revenue is recognized” (Pingle 95). The materiality concept implies that companies should record all those transactions that are likely to affect the users of financial information and their omission would result in wrong decisions (Flood 16). The consistency concept requires companies to follow accounting principles and policies on a consistent basis. They should not change their accounting methods without adjusting the previous period’s financial information based on the new methods. In addition to these concepts, there are other concepts including conservatism and economic entity concept that should also be considered by companies when preparing their financial statements.

Conclusion

The discussion provided in this paper concludes that preparation of financial statements by companies is a key step in the accounting cycle. There are different types of financial statements, and they serve various objectives of users. These financial statements are prepared on a regular basis and their frequency varies. Finally, companies are expected to adhere to the concepts and principles of accounting when preparing their financial statements.

Works Cited

Flood, Joanne M. Wiley GAAP 2015: Interpretation and Application of Generally Accepted Accounting Principles. John Wiley & Sons, 2014.

Pingle, Michael. Basic accounting concepts: A Beginner’s Guide to Understanding Accounting. Xlibris Corporation, 2013.

Porter, Gary A., and Curtis L. Norton. Financial Accounting: The Impact on Decision Makers. Cengage Learning, 2012.

Rich, ‎Jay, et al. Cornerstones of Financial Accounting. Cengage Learning, 2012.

Whittington, O. Ray. Wiley CPA Exam Review 2013, Financial Accounting and Reporting. John Wiley & Sons, 2012.

Yona, Lucky. Financial Accounting for Executive MBA. AuthorHouse, 2013.