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Financial Statements Roles and Limitations Essay


Introduction

Businesses rely on the information about their financial performance in order to evaluate their current position and formulate future goals. Thus, accountants play a significant role in creating reports of past operations and present indicators. In this case, a major contribution comes in the form of annual financial statements which companies most often publish at the end of their fiscal year. The contents of these documents are standardised and utilised by the majority of companies. A report usually contains the financial position of the firm, its financial performance, and the statement of cash flows (Atrill & McLaney 2015).

However, while the goals of these three parts can be easily understood by both their creator and the shareholders for whom they are prepared, the issues that an accountant may encounter may be left unacknowledged. Financial accountants face many challenges, including the unclear result of various deals, the need to balance certain decisions and predictions and outside pressure, during the development of annual statements.

Statement of Financial Position (SoFP)

Roles and Objectives

The main aim of the SoFT is to show how the company is performing at the moment. First of all, it contains information about assets, both tangible and intangible. Second, it also records the firm’s liabilities and equity of the owners.

These indicators reveal the stability of the company, potential risks, and the overall place of the business on the market. The main objectives of the company’s managers are to review the contents of the SoFP and determine how the balance in the components can be maintained. If one fails to achieve this goal, the company may suffer significant consequences and even face liquidation (Capps, Koonce & Petroni 2015). Thus, one may see that the issue of representing balance adequately emerges in regards to the development of the SoFP.

Challenges and Limitations

One of the difficulties in documenting the balance of assets, liabilities and equity lies in the relationship between the mentioned above position of the business and its performance. Companies do not close all deals and use all purchased or acquired goods by the end of the fiscal year. For example, some contracts require payments but do not deliver products at the same time. Similarly, businesses can acquire assets that do not have any immediate value. Therefore, a large part of all assets and expenses cannot be sufficiently depicted in annual financial statements.

Here, the subjective nature of accounting is revealed – the decisions that accountants make during the creation of such reports affect the results that the company can present to the world and use for their own objectives (Nobes & Stadler 2015). It becomes a concern of the employee to calculate which expenses and assets should be documented in the categories. According to Sacer, Malis and Pavic (2016), SoFPs are especially volatile as they show all intangible and tangible possessions of the business. The importance of these decisions is often increased due to the scale of operations and the risks linked to liabilities.

Moreover, accountants often have to estimate the value of these entities, as reports require one to present measurable information. Here, the need for regulations arises in order to restrict estimations and create a foundation for their results.

Sacer, Malis and Pavic (2016) present IFRS (International Financial Reporting Standards) as the most valuable framework for SoFPs. However, the creators of these measures, the International Accounting Standards Board (IASB), also note that this system is not perfect because subjectivity and estimation are core principles of accounting. Nonetheless, IFRS allow accountants to use subjective calculations as long as the latter have to be made. The board states that the level of uncertainty should be acknowledged when making these calculations.

Statement of Financial Performance (Income Statement)

Roles and Objectives

The purpose of the statement of financial performance is to demonstrate the result of all processes which happened in the company in the latest fiscal year. The primary focus in this document is wealth generation which contains such calculations as total revenue and total expenses. By using this statement, the company can determine the effectiveness of its business and how the profit was received. Notable, many various parts constitute a complete income statement, and all of them play a crucial role in the final result. Therefore, apart from the introduced above issues of uncertainty, accountants also encounter problems of measurement and exceptional costs.

Challenges and Limitations

The first issue is interconnected with the one relating to SoFP. In some instances, operations and costs are difficult to define and estimate. Here, however, the main concern is not assets but income recognition. There are two types of this problem – short-term income recognition of contracts and long-term recognition of large projects, property, and intangible acquisitions. Another problem is connected to calculating the cost of sales which is directly tied with the inventory of the firm.

Some businesses sell a wide variety of non-unique goods which cannot be easily tracked. Their individual cost, in this case, cannot be documented for every instance of sale. As a result, the accountant working with such products has to use estimations in order to present not only the amounts of sold goods but also their cost and the time of the transaction (Wang 2014). Furthermore, a problem in the process of estimation occurs when the products cannot be counted as separate units. In addition to the amiability to determine the precise amount, these objects cannot be dated as well.

Measuring the value of such inventories is also subject to some challenges. Accountants cannot establish the exact value of inventories as their financial burden often fluctuates with market changes. One can choose to base the value on the cost of acquired goods or use their perspective price and worth that can be realised (Nobes & Stadler 2015). Both ways present some degree of uncertainty and require predicting the final revenue.

Another calculation that is regulated by such standards as IFRS is that of prepayments. These operations occur when the business pays for goods or services that are going to be delivered in parts or the future. Here, the income statement should acknowledge only the expense that has been realised and the goods or services were delivered. The part of the prepayment that was not realised should remain as the part of assets in this time period.

Here, lies a challenge of estimating which contributions and purchases can be linked to the present fiscal year and which should be moved to the next one. Thus, the accountant has to determine how the acquired assets and services are used in the business’ daily operations.

Cash Flow Statement

Roles and Objectives

The statement of cash flow is the final part of annual financial statements. It presents the overview of cash movements that happened in the fiscal year. Its primary role is to show which operations and processes generated or required the most significant amounts of money. Moreover, they indicate which areas of performance are stable and sustainable – the firm may see to which degree its structure is able to improve and grow (Wang 2014).

The report covers multiple uses of cash as well as its sources and amounts at the start and the end of the fiscal year. For example, the statement shows how much cash was generated through customer purchases while accounting for supplier payments and taxes (Atrill & McLaney 2015). Similarly, investments, repaid debt and employee payments are reported in the cash flow statement. Here, the methods of analysis, assumption and deprecation present the main challenges to accountants.

Challenges and Limitations

The first issue that accountants may encounter while developing the cash flow statement is the choice of a direct or indirect method. The mostly utilised indirect method uses net income as the main measure, while the direct method utilises cash received directly from customers and paid to suppliers. Thus, it can be observed that estimation, again, is at the foundation of all presented results. This is the principal limitation of accounting as a whole – concrete numbers, although yielding reliable conclusions, are not readily available to most companies (Atrill & McLaney 2015). Accountants using approximations have the responsibility to demonstrate accurate numbers under the international regulations.

However, this and the previous statements may be influenced by CEOs. According to Bishop, DeZoort, Hermanson (2016), the accounting experiences of CFOs are often plagued with the CEOs’ pressure to demonstrate financial outcomes that are better than actual numbers. Nonetheless, even if the accountant does not experience pressure and follows the guidelines of the national or international standards, the issue of assumption persists.

Conclusion

Companies can use annual statements to fulfil a variety of objectives. Most numbers are meant to show the current position of the company and reveal its potential to shareholders and owners. Furthermore, the cash flow statement also provides a level of transparency if prepared following regulations. However, while developing these documents, accountants face some challenges. The main problem in generating such major reports is the need for approximation.

The subjectivity of accounting as a whole is an issue that may result in substantial losses for companies, especially if the final report is used for future predictions. Other concerns also include the pressure of the management to present the best outcomes and the task of deciding how assets and expenses should be documented.

Reference List

Atrill, P & McLaney, E 2015, Accounting and finance for non-specialist, 10th edn, Pearson, Harlow.

Bishop, CC, DeZoort, FT & Hermanson, DR 2016, ‘The effect of CEO social influence pressure and CFO accounting experience on CFO financial reporting decisions,’ Auditing: A Journal of Practice & Theory, vol. 36, no. 1, pp. 21-41.

Capps, G, Koonce, L & Petroni, KR 2015, ‘Natural optimism in financial reporting: a state of mind,’ Accounting Horizons, vol. 30, no. 1, pp. 79-91.

Nobes, CW & Stadler, C 2015, ‘The qualitative characteristics of financial information, and managers’ accounting decisions: evidence from IFRS policy changes,’ Accounting and Business Research, vol. 45, no. 5, pp. 572-601.

Sacer, IM, Malis, SS & Pavic, I 2016, ‘The impact of accounting estimates on financial position and business performance–case of non-current intangible and tangible assets,’ Procedia Economics and Finance, vol. 39, pp. 399-411.

Wang, C 2014, ‘Accounting standards harmonization and financial statement comparability: evidence from transnational information transfer,’ Journal of Accounting Research, vol. 52, no. 4, pp. 955-992.

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IvyPanda. "Financial Statements Roles and Limitations." December 19, 2020. https://ivypanda.com/essays/financial-statements-roles-and-limitations/.

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IvyPanda. 2020. "Financial Statements Roles and Limitations." December 19, 2020. https://ivypanda.com/essays/financial-statements-roles-and-limitations/.

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