FS IN ITS RELIABLE AND RELEVANT SENSE
Introduction
This paper will discuss the mature of FS, accounting principles, users of FS and reliability/ relevance of FS. Its purpose is to answer the question, “How FS provide relevant and reliable information for stewardship and decision making purpose?” The importance of FS has already been established as far as accounting method is discovered. However, the quality of FS is hard to measure with generalization, say, its public relevance/ reliability. The sub-topics will provide the platform for realizing the resolution for the bottleneck and unlocking the secret towards a quality FS maybe on its minimum/ optimal aspect.
The Nature of Financial Statements
Put simply, financial statements (FS) show the money of the firm in all forms and tell where such money came from, where it went and where it is now (2006). There are three main FS that can specify its different functions making such records more organized and classifiable; namely, balance sheet, profit and loss account and cash flow. Basically, the firm uses these elements of FS in order to achieve its financial objectives (1999). The balance sheet reflects the book (rather market) value of the firm’s investment and financing activities (1999 ). It contains information about the company’s assets, liabilities and shareholder’s equity which summarizes balance into Assets = Liabilities + Shareholder’s Equity (2006). As the assets is classified according to how quickly they can be converted into cash (e.g. current, non-current, fixed), liabilities are listed based on their due dates (e.g. current, long-term).
On the other hand, profit and loss (P& L) account shows how the company has earned or spent over a period of time (2006). Also referred as the bottom-line, It presents in detail a certain kind of imaginary “stairs” that reflects how the company reduced the total (gross) sales amount to associate them against expenses. Initially, sales discounts and returns revealed net sales. Then, it is further reduced by deducting the cost of sales that result to gross margin. Thereafter, operating expenses, depreciation, interests and taxes provide specific outcomes until net earnings or profit is derived. It also reports how much shareholders will take apart of the computed net earnings through earnings per share (2006). Lastly, cash flow or the lifeblood of the organization (Mcmenamin 1999 p. 14) reports the inflows and outflows of cash ( 2006). It reflects the changes in cash over time and can tell whether the company has generated cash. It contains cash flow summary from investing, financing and operating activities of the firm. Due to this, it is comfortable to say that cash flow serves as the signal for the firm to adjust its decision-making based on its capacity to support (through cash) any planned activity.
If studied closely, these elements of FS are actually insufficient as standalone accounts for the specific users. The balance sheet does not reflect some intangible assets like advertisements, R&D and quality. However, the P&L account revives this bottleneck by presenting those accounts in the form of expenses. In the extreme, P&L does can not assure if the firm has actually cash available to pay bills and other investments (1999) where cash flow is referred to fill the gap. In the contrary, cash flow is overly focused on liquidity which is very narrow, if not short term, compared to balance sheet. They compensate each other’s weaknesses to make FS competent of gaining the credibility to enhance decision-making. This reveals that the three basic FS information about profitability, liquidity and capital structure are evenly distributed to the roles of P&L account, cash flow and balance sheet.
Historic Cost Convention versus Accrual Concept
Historic cost convention (HCC) is an accounting technique that valuates an asset for balance sheet posting at the price paid for the asset at the time of acquisition (ADVFN 2006). At this state, FS tends to be conservative not only because it makes no adjustment for the changes in market value of assets except for writing-down but also does not commit writing-up (2004). It is an advantageous principle simply because the firm is in a safer-mode as it protects its assets from fluctuations of a dynamic market. It does not gain and it does not loose through mere speculations and interactions of buyers and sellers. However, the bottleneck of HCC is that, for the purposes of stock valuation and other marketable securities, it cannot have indications to show its relationship with the current market situation.
On the other hand, accrual concept measures the performance of a company through economic transactions it engages even though cash have not yet occurred or incurred (2006). The concept is an opposition to HCC as it aspires for matching principle (2004) and allows the firm to combine its future value on its present cash flow for a more accurate representation of its financial well-being. It advantage is that it is relatively more accurate than HCC; however, the process is more complex making it more expensive than HCC. As business transactions becomes more pervasive and vast accrual concept is compatible to apply in the method of valuating the firm to compensate for its expensive implementation.
Users of FS
Major user groups of FS include investors/ shareholders, employees, lenders, suppliers, customers, government and the public. Basically, investors and shareholders are concerned on income (from dividends) and gain (from stocks price), employees on wage, salary and employment opportunities, lenders on the resources of the firm (both cash and non-cash), suppliers on financial stability of cash flow, customers on ability to supply quality goods, government on performance for the purposes of taxation and the public on employment, environmental and other social responsibility disclosures (2006). In general, firms must comply with the FS needs of these stakeholders to concede their legitimacy to exist in the society (1996). Otherwise, the latter can implore aggressive or indirect actions (strikes, pull-out of investments, litigation, etc.) that can ultimately lead to corporate demise.
How to Obtain FS Reliability and Relevance
According to (2002), FS is relevant if it influences the decision of the users while it obtains reliability if the content has quality and materiality that can be assured by auditors and authorities ( 2006). With different components of FS, varying principles in valuing assets and pool of users, these characteristics are attainable. For steward purposes, users are assured that their key interest accounts in FS is recorded in an organized manner for easily access and understanding. Firms cannot undermine recording importance because it is also crucial to their strategic planning. In effect, the reliance of business and users to FS stewardship is evident which makes relevance and reliable information an end-product of such relationship. The record will reveal how the company accomplishes its responsibilities to specific stakeholders while it has also the ability to reflect how such stakeholders reward the company from such accomplishment. In the end, FS will hold these features as long as both parties are willing and able to continue their relationship with one another. For decision-making purpose, FS has components that are intended to specific users as well as additional attachments to reflect the necessary papers to merit every entry. As a result, users can utilize the information for better decision-making without anxiety that they are too complex or too bias. FS is also regulated by authorities that can induce responsible reporting by entities.
Conclusion
The existence of FS components helps users to instantly segregate what are relevant accounts. Employees can prioritize P&L account, government on the balance sheet and suppliers on cash flow to simplify the complexity of every FS. In this way, relevance is achieved not only because users put an effort to the endeavor but also FS design aid in the process. On the other hand, the presence of different accounting principles and concepts situate every asset and account in a more reliable position. This is because there are items in the balance sheet like share price which is very vulnerable to the market which make it compatible and appropriate to use other principles other than historical cost convention. In addition, for big companies, the use of accrual accounting aids them to reflect their diverse and long-term projects while small ones prefer strict adherence for liquidity per se. As a result, reliability of FS requires adaptation from the nature of business, its assets/ accounts and its stakeholders which situate contrasting principles as a necessary condition. In aggregate, the interaction of FS and its users define how relevant and reliable the information would be including their ability to adapt from the lacking of one another.
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