Accounting:

Accounting is an information system that identifies records and communicates the economic
events of an organization to interested users.
Users of Accounting Information:
Users of accounting information are divided into two broad groups. (a) Internal users and (b)
External users. They are discussed below:
(a) Internal users:
Internal users of accounting information are managers who plain, organize and man a business.
For internal users, accounting provides internal reports. Such internal reports are financial
comparisons of operating alternative, projections of income form new sales campaigns,
forecasts of cash needs for the nest year. The internal users are pointed out below:
Marketing Managers: Marketing managers use accounting information to perform marketing
activates of the business concern.
Production Manager: Production managers use accounting data to supervise production of
goods.
Finance Director: Finale director use accounting data to manage finance for the business
concern.
Company Officers: Company officers use accounting information to run the organization.
(b) External Users:
There are several types of external users of accounting information/ data. The internal users are
pointed out below:
Investors: Investors (owners) use accounting information to make decisions to buy, hold, or
sell stock.
Creditors: Creditors such as suppliers and bankers use accounting information to evaluate
risks of granting credit or lending money.
Taxing Authorities: Taxing authorities, such as the Internal Revenue Service, want to know
whether the company complies with the tax laws.
Regulatory Agencies: Regulatory agencies, such as the Securities and Exchange Commission
and the Trade Commission, want to know whether the company is operating within prescribed
rules.
Customers: Customers are interested in whether a company will continue to honour product
warranties and supports its product lines.
Labor Union: Labor unions want to know whether the owners can pay increased wages and
benefits.
Economic Planners: Economic Planners use accounting information to forecast economic
activities.
Cash basis Accounting:
Accounting basis in which revenue is recorded when cash is received and expenses is recorded
when cash is paid are known as cash basis accounting.
Accrual basis Accounting:
Accounting basis in which revenue is recorded when it is cached and expense is recorded when
it is incurred are known as accrual basis accounting.
The difference between cash basis accounting and accrual basis accounting:

Cash basis Accounting revenue are Accrual basis accounting revenue are
reported on the income. Statement in the reported on the income statement when they
period in which the cash is received from are earned which often occurs before the
customers. cash is received from the customers.

Expenses are reported on the income Expenses are reported on the income
statement when the cash is paid out. statement in the period when they occur-
which is often in a period different from
when the payment is made.

Cash basis accounting systems Accrual basis accounting is used by the most
frequently are found in organizations not companies.
requiring a complete set of double entry.
Such organization might include smaller,
unincorporated business and some
nonprofit organizations.

Cash basis shows none of these The accrual basis statement of financial
position contains receivables, payables,
accruals, prepayments and deferrals.

Purpose and use of financial statements. Inherent limitations of financial statements.

Purpose of Financial Statements:

The general purpose of the financial statements is to provide information about the results of
operations, financial position, and cash flows of an organization. This information is used by
the readers of financial statements to make decisions regarding the allocation of resources.

The objective of financial statements is to provide information about the financial position,
performance and changes in financial position of an enterprise that is useful to a wide range of
users in making economic decisions (IASB Framework).
Financial Statements provide useful information to a wide range of users:

 Managers require Financial Statements to manage the affairs of the company by

assessing its financial performance and position and taking important business
decisions.

 Shareholders use Financial Statements to assess the risk and return of their investment
in the company and take investment decisions based on their analysis.

 Prospective Investors need Financial Statements to assess the viability of investing in a

company. Investors may predict future dividends based on the profits disclosed in the
Financial Statements. Furthermore, risks associated with the investment may be gauged
from the Financial Statements. For instance, fluctuating profits indicate higher risk.
Therefore, Financial Statements provide a basis for the investment decisions of
potential investors.

 Financial Institutions (e.g. banks) use Financial Statements to decide whether to grant
a loan or credit to a business. Financial institutions assess the financial health of a
business to determine the probability of a bad loan. Any decision to lend must be
supported by a sufficient asset base and liquidity.

 Suppliers need Financial Statements to assess the credit worthiness of a business and
ascertain whether to supply goods on credit. Suppliers need to know if they will be
repaid. Terms of credit are set according to the assessment of their customers' financial
health.

 Customers use Financial Statements to assess whether a supplier has the resources to
ensure the steady supply of goods in the future. This is especially vital where a customer
is dependent on a supplier for a specialized component.

 Employees use Financial Statements for assessing the company's profitability and its
consequence on their future remuneration and job security.

 Competitors compare their performance with rival companies to learn and develop
strategies to improve their competitiveness.

 General Public may be interested in the effects of a company on the economy,

environment and the local community.

 Governments require Financial Statements to determine the correctness of tax declared

in the tax returns. Government also keeps track of economic progress through analysis
of Financial Statements of businesses from different sectors of the economy.
Income Statement/Statement of Comprehensive Income:

Income statement reports the ravens and expenses for a specific period of time.

The uses of income statement:

revenue that can

be earned during the period.

from the revenue.

The limitations of income statement:

t income.

net income.

Balance sheet/ Statement of Financial Position:

A balance sheet reports the assets, liabilities and owners’ equity at a specific date.

The uses of balance sheet:

a business organization.

Limitation of balance sheet:

(i) Balance sheet do not show the financial position of whole period. It is prepared at
specified date.

(ii) Fixed asset shows in balance sheet at cost/historical price that cannot show the actual
financial position.

(iii) There are some assets that have no real existence and market value such as primary
expense, share discount (etc) that are shown in balance sheet.

(iv) In balance sheet, there are some subject matter that depends on approximation and that
is favorable for the businesses (institutions such as good will, copy- right royalty (etc).

(v) Balance sheet avoids the consideration of inflation and deflation.

Inherent limitations of financial statements:

The limitations of financial statements are those factors that a user should be aware of before
relying on them to an excessive extent. Knowledge of these factors could result in a reduction
of invested funds in a business, or actions taken to investigate further. The following are all
limitations of financial statements:

Conventionalized Representation:

Financial statements are highly standardized in terms of their overall format and presentation
although businesses are very diverse in their nature. This may limit the usefulness of the
information.

Financial statements are highly aggregated in that information on a great many transactions
and balances is combined into a few figures in the accounts, which can often make it difficult
for the reader to evaluate the components of the business.

Allocation issues include, for example, the application of the accrual concept and depreciation
of non-current current assets, where management's judgements and estimates affect the period
in which expenses or income are recognized.

Backward-looking:

Financial statements are backward-looking whereas most users of financial information base
their decisions on expectations about the future. Financial statements contribute towards this
by helping to identify trends and by confirming the accuracy of previous expectations, but
cannot realistically provide the complete information set required for all economic decisions
by all users.

Omission of non-financial information:

By their nature, financial statements contain financial information. They do not generally
include non-financial data such as:

 Narrative description of the major operations.

 Discussion of business risks and opportunities.
 Narrative analysis of the entity's performance and prospects.
 Management policies and how the business is governed and contolled.
Financial statements include the elements as defined in the IASB Conceptual Framework. This
means that items which do not meet those definitions are not included. For example, the value
of the entity's internally generated goodwill i.e. through its reputation, loyalty and expertise of
its management and employees, or its client portfolio. While some companies do experiment
with different types of disclosure for such items, these disclosures are considered unsuitable
for inclusion in the financial statements (precisely because such items do not fall within its
definition of assets).

Other sources of information:

Some of the sources of financial statements are addressed in the other information which is
often provided along with financial statements, especially by large companies, such as
operating and financial reviews and the Chairman’s statement,

There are also many other sources of information available to at least some users of financial
statements, for example:

 In owner-managed businesses, the owners have access to internal management information

because they are the management. This information is, potentially, available on a
continuous real-time basis and may include:
 Future plans for the business
 Budgets or forecasts
 Management accounts, including, for example, divisional analysis
 Banks will often obtain additional access to entity information under the terms of loan
agreements.
 Potential investors (e.g. if they are planning to take a major stake or even a controlling
Interest) will often negotiate additional access to corporate information.
 Publicly available information, such as entity brochures and publicity material (e.g. press
releases)
 Brokers' reports on major companies, and
 Press reports and other media coverage (e.g. television or internet).
Ques 2: Components of financial statements (with purpose & which information they
provide).

There are four main components of financial statements. They are:

a. balance sheets;
b. income statements;
c. cash flow statements; and
d. statements of shareholders’ equity.
Balance sheets show what a company owns and what it owes at a fixed point in time. Income
statements show how much money a company made and spent over a period of time. Cash flow
statements show the exchange of money between a company and the outside world also over a
period of time. The fourth financial statement, called a “statement of shareholders’ equity,”
shows changes in the interests of the company’s shareholders over time.

Balance Sheet:

A balance sheet provides details information about assets, liability and owner’s equity.

Assets are things that a company owns that have value. This typically means they can either be
sold or used by the company to make products or provide services that can be sold. Assets
include physical property, such as plants, trucks, equipment and inventory. It also includes
things that can’t be touched but nevertheless exist and have value, such as trademarks and
patents. And cash itself is an asset. So are investments a company makes.

Liabilities are amounts of money that a company owes to others. This can include all kinds of
obligations, like money borrowed from a bank to launch a new product, rent for use of a
building, money owed to suppliers for materials, payroll a company owes to its employees,
environmental cleanup costs, or taxes owed to the government. Liabilities also include
obligations to provide goods or services to customers in the future.

Shareholders’ equity is sometimes called capital or net worth. It’s the money that would be left
if a company sold all of its assets and paid off all of its liabilities. This leftover money belongs
to the shareholders, or the owners, of the company

Income Statements:

An income statement is a report that shows how much revenue a company earned over a
specific time period (usually for a year or some portion of a year). An income statement also
shows the costs and expenses associated with earning that revenue. The literal “bottom line”
of the statement usually shows the company’s net earnings or losses. This tells you how much
the company earned or lost over the period.

Income statements also report earnings per share (or “EPS”). This calculation tells you how
much money shareholders would receive if the company decided to distribute all of the net
earnings for the period. (Companies almost never distribute all of their earnings. Usually they
reinvest them in the business.)
Cash Flow Statements:

Cash flow statements report a company’s inflows and outflows of cash. This is important
because a company needs to have enough cash on hand to pay its expenses and purchase assets.
While an income statement can tell you whether a company made a profit, a cash flow
statement can tell you whether the company generated cash.

A cash flow statement shows changes over time rather than absolute dollar amounts at a point
in time. It uses and reorders the information from a company’s balance sheet and income
statement.

The bottom line of the cash flow statement shows the net increase or decrease in cash for the
period. Generally, cash flow statements are divided into three main parts. Each part reviews
the cash flow from one of three types of activities: (1) operating activities; (2) investing
activities; and (3) financing activities.

Operating Activities:

The first part of a cash flow statement analyzes a company’s cash flow from net income or
losses. For most companies, this section of the cash flow statement reconciles the net income
(as shown on the income statement) to the actual cash the company received from or used in
its operating activities. To do this, it adjusts net income for any non-cash items (such as adding
back depreciation expenses) and adjusts for any cash that was used or provided by other
operating assets and liabilities.

Investing Activities

The second part of a cash flow statement shows the cash flow from all investing activities,
which generally include purchases or sales of long-term assets, such as property, plant and
equipment, as well as investment securities. If a company buys a piece of machinery, the cash
flow statement would reflect this activity as a cash outflow from investing activities because it
used cash. If the company decided to sell off some investments from an investment portfolio,
the proceeds from the sales would show up as a cash inflow from investing activities because
it provided cash.

Financing Activities

The third part of a cash flow statement shows the cash flow from all financing activities.
Typical sources of cash flow include cash raised by selling stocks and bonds or borrowing from
banks. Likewise, paying back a bank loan would show up as a use of cash flow.
Statement of Changes in Shareholders Equity:

A statement of changes in shareholders equity is a financial statement that presents a summary

of the changes in shareholders’ equity accounts over the reporting period. It reconciles the
opening balances of equity accounts with their closing balances.

There are two types of changes in shareholders’ equity: (a) changes that originate from
transactions with shareholders such as issue of new shares, payment of dividends, etc. and (b)
changes that result from changes in total comprehensive income, such as net income for the
period, revaluation of fixed assets, changes in fair value of available for sale investments, etc.

“Departure from accounting standard is permissible in certain circumstances” explain.

In very rare circumstances, an entity may need to produce financial reports which do not
comply with a specific accounting standard, if compliance with the standard would be so
misleading, they do not provide useful information to user, and the financial statements would
no longer be fairly reported.

Under these circumstances, an entity may depart from the requirements of an International
Financial Reporting Standard, but it must disclose:

i. That management has concluded that the financial statement presents fairly the entity’s
financial position, financial performance and cash flows.

ii. That it has complied with applicable standards and interpretations, except that it has
departed from a particular requirement to achieve a fair presentation.

iii. The title of the standard or interpretation from which the entity has departed, the nature
of the departure, including the treatment that the IFRS would require, the reason why
that treatment would be misleading, and the treatment adopted.

iv. For each period presented, the financial effect of the departure on each item in the
financial statements that would have been reported in complying with the requirement.
Accounting Concepts

1. Separate Entity Concept

2. Going Concern Concept
3. Money Measurement Concept
4. Periodic Concept
5. Cost Concept
6. Dual Aspect Concept
7. Matching Concept

Accounting Conventions:

1. Full Disclosure
2. Conservatism
3. Consistency
4. Materiality

Qualitative Characteristics of Accounting Information:

1. Reliability
2. Relevant
3. Understandability
4. Comparability