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The following essay examines the fair presentation of financial statements. The essay also examines the objectives of financial reporting, components of financial statements, Principles of Presentation, qualitative characteristics of financial statements and Fundamental Accounting Assumptions.
It is important to first determine the meaning of financial statements before examining the fair presentation of financial statements. Financial statements entail the end products which are prepared from the adjusted trial balance. Financial statements play an important role of communicating key accounting information concerning a business organization to those people who are interested in the business.
The financial statements act as a model of a business enterprise by showing the business organization in financial terms (Berger, 2007, 47). The major financial statements includes income statements or profit and loss account, the balance sheet or statement of financial position, the cash flow statement and changes in owner’s equity.
The income statement or the profit and loss account summarizes the expenses and revenues that a business incurs in a particular accounting period. Income statement is an important financial statement as it enables people to determine as to whether the business has attained its profitability objectives or not. The balance sheet main purpose is to explain the position of a firm at a particular date i.e. either at the end of year or month. Cash flow statement usually focuses on the liquidity of a business .
Thus cash flows refers to the inflows as well as outflows of money. Changes in owner’s equity or the statement of retained earnings explain the changes that occur in the retained earnings in a particular accounting period. The main propose of financial statements according to IAS 1 is to provide the users with information concerning the financial performance of a business entity. In addition, the financial statements help to show the management’s results (Nikolai et.al. 2009, 79).
Objectives of Financial Reporting
The main purpose of financial reporting it to provide the users of information so as to enable them makes well-versed decisions. Various users require information so as to come up with sound decisions regarding a business entity. The users includes the
stockholders,bankers,bondholders,suplliesr,employees,lenders,cerditoirs,government,customers among others (Porter, & Norton,2010,58).
The investors provide risk capital and therefore they are concerned with the firm’s risk inherent as well as the returns for their investments. They thus need the financial information so as to enable them to know as to whether or not they should sell, buy or hold shares. The investors also require the information so as to determine the capability of the firm to pay dividends. The employees together with their representative unions require the information so as to determine their profitability and stability of their company.
The employees also require knowing the firm’s ability to remunerate them well, to provide them with employment opportunities and also to provide them with the retirement benefits.
The lenders provide the firm with the required funding and therefore, they are interested in financial information so as to enable them to know as top whether or not the firm is able to pay their loans plus interests when due. The suppliers requires the information so as to enable them to know as to whether or not the firm is capable of paying them the amounts unsettled.
Customers are mainly interested with the continuity of a firm and so, they requires information so as to enable them to know as to whether or not the firm will continue meeting their needs. The government regulates the business entities and therefore, they require the financial information in order to know which activities require to be regulated and also to determine the taxation policies (Needles, Powers & Crosson, 2010, 210).
These users have to make such decisions as whether or not to invest in a particular firm e.t.c.The external users usually relies on the financial statements i.e. balance sheet, profit and loss account and the cash flow statement so as to obtain information. The statement of financial position enables the users to know the obligations that are due soon and also the kind of assets that are available in the firm. The profit and loss account enables the users to determine the expenses and revenues of a business entity in a given time period.
The cash flow statement provides the users with information concerning the sources of cash and also how the cash was utilized in a certain period. Another important tool that is used for providing the external users is the notes. Notes plays an important role of providing key details concerning a firm’s accounting practices as well as other important factors that can affect the firm’s financial performance.
The users have to clearly understand the accounting policies that a firm adopts in preparation of the financial statements and therefore, the accountants considers the following ;the purpose of financial reporting, the salient features that make the information useful, the most ideal manner of displaying the information obtained in the cash flow statements, balance sheet and profit and loss account.
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Apart form providing the users with financial information, financial reporting serves other purposes i.e. financial reporting helps to reflect the potential cash receipts to creditors and investors, financial reporting reflects the cash flows that a company is likely to obtain in near future and also, financial reporting reflects s the resources of a firm (Needles, & Powers,2007,226).
Qualitative characteristics of financial statements
Qualitative characteristics of financial statements refer to the aspects that enhance the usefulness of financial information. Qualitative characteristics of financial statements include reliability, relevance, comparability and understandability.
Information is deemed to be relevance if it is capable of influencing the users’ decisions. According to the International Accounting Standards, information should be predictive, timely and also have feedback value for it to be regarded as relevance. Predictive value entails the ability of information to predict past, present and future outcomes. Feedback value entails the capacity of information to enable the users to confirm with the prior expectations.
The relevance of financial information is mainly determined by its materiality. Materiality basically involves the importance and relative size of a financial transaction to business entity. An item thus is considered as material if it is capable of influencing the decisions of the users of financial statements (International Accounting Standards Committee Foundation & International Accounting Standards Board, 2008, 22).
With regards to reliability, information is considered to be reliable if it is free from any bias or error and also represents faithfully what it purports to present or what it is expected to present. According to the International Accounting Standards, information must be able to meet the following three conditions for it to be considered as reliable i.e. information should be verifiable, the information should have faithful representation and also, the information should be neutral.
Faithful representation entails that the information should not have any error or bias. In order for the information to be deemed as reliable, information is required to faithfully represent the transactions it purports to represent. This implies that the balance sheet is required to faithfully represent the transactions in assets and liabilities of a business entity at the reporting time.
Verifiability entails that the information should be easy to confirm. Neutrality implies that the information should not intend to obtain predetermined outcomes. Another aspect that helps to ensure that the information is true and fair is the substance over form. In order for the information to faithfully represent what it purports to stand for, it is important that it is presented and accounted for with regards to their economic and substance reality rather than its legal form (Stolowy, H, & Lebas, 2006, 160).
With regards to comparability, the information should be easy to compare with other firms in the industry.Also; the financial statement should be easily comparable form one accounting period to another (International Accounting Standards Committee Foundation & International Accounting Standards Board, 2008, 22).
Understandability is an essential characteristic of the financial information and it basically implies that the information in the financial statements should be easy to understand in order to enable the users to make good decisions. With this regard, the users are thus assumed to know the various economic and business activities as well as accounting. The users are also required to have a willingness to learn the financial information in a diligent manner. Understandability and usefulness of information goes together.
The usefulness of the financial statements with regards to decision makers is dependent on the reports being complete and detailed enough.However; the understandability depends mainly on the background of the user in that, those who have higher accounting education understands more as compared to those with little or no accounting background (International Accounting Standards Committee Foundation & International Accounting Standards Board, 2008, 22).
Principles of Presentation
The International Accounting Standards (IAS) 1 identifies the following characteristics for the presentation of financial statements i.e. fair presentation and compliance with IFRS, going concern, accrual basis of accounting, materiality and aggregation, offsetting, frequency of reporting and consistency of presentation.
With regards to the fair presentation and compliance with International Financial Reporting Standards, financial statements are supposed to fairly present the financial performance, the cash flow and the financial position of a business entity.
Fair presentation entails the act of faithful representation with regards to the effects of business transactions as stated in the IAS framework. The International Accounting Standards (IAS) 1, states that the IFRS application coupled with disclosure when required should enhance the fair presentation of financial statements.
The International Accounting Standards 1 also recognizes that the mere compliance with International Financial Reporting Standards may be unsuitable or inadequate in certain circumstances. According to International Accounting Standards 1, an entity is supposed to use the IFRS virtually in all the circumstances so as to ensure that there is a fair presentation.However; the IAS 1 allows an entity to depart form this requirement in extremely unusual circumstances.
When an entity departs from this requirement of IFRS in a previous accounting period and the amounts that is recognized in the present period is affected as a result, the entity is thus required to disclose the title of the International Financial Reporting Standard that has been departed by an entity, the kind of the IFRS departure e.t.c.
The International Accounting Standard states that an entity is not supposed to deliberately depart from IFRS.In case where an entity deliberately depart form IFRS.In is required to act in accordance with the particular standard and also disclose in notes the effect (IASB,2009,903).
The other principle of presentation of financial statements is the going concern. The IAS provides that the financial statements should be prepared with regards to a going concern basis except in a case where the senior leadership team intends to cease the business entity or plans top liquidate it.
The management usually uses all the available information concerning the future of a business entity in determining whether the business will continue in its operations in the unforeseeable future. Thus an entity that has past profitable operations may be deemed to be a going concern entity (Kolitz, Quinn & McAllister, 2009, 152).
The International Accounting Standards 1 provides that a business should use an accrual basis of accounting during the preparation of financial statements. Paragraph 7 of IAS 1 explain that this basis of accounting is important as it allows items to be recognized as income,expenses,assets ,liability and equity when they meets the recognition criteria in the Accounting Framework.
Materiality and aggregation requires that the management evaluate the size and nature of the items in order to determine as to whether or not the information is material. Information is material if it has the ability of influencing the decisions of users and thus the IAS requires each and every material item to be presented individually in the financial statements. For immaterial amounts, they require not to be presented individually (Everingham, Kleynhans& Posthumus, 2008, 20).
Also, the IAS 1 requires that there should be no offsetting for the information to be fair and true. Offsetting of various transactions has the effect of hiding some situations in the accounting. Offsetting is not allowed due to the fact that it is possible to have two transactions with the similar absolute value and with different algebraic value. This kind of transactions would not reveal true and fair value (International Accounting Standards Board et.al. 2009, 401).
With regards to frequency of reporting, the IAS requires a business entity to present a detailed set of its financial statements each year. When a business entity adjusts its reporting time and in turn presents its financial statements earlier or later than one year, then the entity is required to disclose this.
In addition, the entity is also required to disclose the main reason for adopting a shorter or a longer period.Normally,an entity is deemed to consistently prepare its financial statements every year.However,there arises some circumstances which makes an entity to report at an early or late period but the standard usually doe not stop this practice (IASB,2009,906).
With regards to consistency of presentation, the same accounting principles should be used from one accounting period to another. The consistency of presentation requires that a firm should give same treatment to the comparable items form one period to another.
This plays an important role of adding value to the financial statement due to the fact that the statement of one accounting period can be compared with the statement of another accounting period. Consistency of presentation also facilitates both understandability and comparability (International Accounting Standards Board, 2007, 790).
Fundamental Accounting Assumptions
Fundamental accounting assumptions also known as Generally Accepted Accounting Principles refers to the factors that are taken for granted during the preparation of financial statements. The main objective of the fundamental accounting assumptions is to provide a true and fair view. True implies that the financial statements should not dissimulate or misrepresent the financial status of a firm at any accounting period.
Fair on the other hand implies that the financial accounts provides the users with information that is relevant and complete in order to enable them to make sound business decisions. The true and fair aspect is derived from the application of the following financial accounting assumptions i.e. the accounting entity, the going concern entity, time period entity and the monetary value entity (Weygandt et al., 2008, 37).
An accounting entity refers to an economic unit that is capable of controlling the economic resources. An accounting unit thus represents an economic unit through which financial statements are prepared. Accounting entities are capable of doing business on their own and they occur in various forms such as sole proprietorship, partnerships, limited liability companies, corporations e.t.c (Pointer, & Stillman, 2004, 32).
Going concern assumption assumes that the business operations will continue even in the unforeseeable future i.e. it is assumed that a business organization has no intention or the necessity of liquidation. The IAS 1 requires the management to assess the ability of an entity to continue in its operations in future period when they are preparing the financial statements (Weygandt et al., 2008, 37).
Time period assumption assumes that the firm’s accounting indefinite life is divided into artificial time periods.Therefore, accountants measures the operating entity mainly during shorter time periods. The accountants can thus adopt such time periods as calendar year, fiscal year and natural business year while they are reporting (Singhvi & Bodhanwala, 2006, 9).
Monetary value assumption implies that the financial reporting is done by use of money as standards for measuring unit. The IAS also assumes further that the monetary standard adopted represents a stable unit (Weygandt et al., 2008, 37).
For the financial reporting to meet its objectives i.e. to ensure that financial statement give a true and fair value, there is need to exercise objectivity i.e. measurements that are unbiased and also subject to verification by an independent third party. Measurements of financial statements entail the process of determining the monetary amounts that the financial statements are to be recognized.
There are various basis of measuring and valuing the financial statements i.e. historical cost, current cost, settlement value and present value. Historical cost refers to the cash amount or the equivalent that is paid in order to obtain an asset. Current cost entails the cash amount that is required to be paid if an asset was to be purchased today.
The settlement value entails the cash amount that could currently be obtained when an asset is being disposed off. The present value entails the present discounted value of future net cash flow that an item can generate during the normal course of a business. The objectivity requires that the assets and liabilities and the value of the transaction should be verifiable (Walton, et.al. 2003, 106).
Also, accountants have adopted the creative accounting concepts in an effort to ensure that the financial statements are fairly presented and that they give a true and fair view. Creative accounting usually involved the act of manipulating the accounting rules. This process entails the accountants to use their knowledge regarding the accounting rules in order to distort figures and manipulate the values that are reported in the financial statements (McLeay & Riccaboni, 2001, 157).
In order to measure that the financial statements are fairly presented, there is need to fully disclose all the transactions that can influence the judgment of the financial statement users. If an accounting entity adopts an accounting method which is method from the one it has been using earlier, then this must be disclosed plus the effects of such a departure in the firm’s net profit (Epstein, & Jermakowicz, 2010, 68).
Also, the IAS requires that the transactions should be incorporated in the financial statements once they satisfy the recognition criteria so as to measure that there is a fair presentation.
The recognition criteria are as follows; definition i.e. the transaction must meet the definition of an element, measurement i.e. an item to be recognized should have a relevant attribute which is verifiable, reliability i.e. the information about the item to be recognized should have represented faithfully, relevant i.e. the information about an item should be capable of influencing the decisions of users.
In order to ensure that there is a fair presentation, the IAS in requires that revenue should be recognized when the earning process is complete i.e. the accountants must meet the following conditions in order to recognize revenue; earning process is complete or at least, the biggest portion is complete, objective evidence exist regarding the amount that is earned among others (Epstein, & Jermakowicz, 2010, 68).
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