How financial statements considered very important?
The statement of accounting concept 1 deals with the definition of the reporting entities. These statements tell that which entity is said to be a reporting entity and which entity is excluded from being called so. In simple terms, the entities that need to make financial statements in order to provide the users of such statement true and fair position about the financial position and stability such entities are known as reporting entities. They are entitled to prepare their financial statement in accordance with the accounting standards and the statements of accounting concepts. If they fail to follow such standards then they may not give genuine information to the stakeholders. The reports prepared by the entities are widely used by the stakeholders to make a decision regarding their investments (Accounting for Small Business Owners, 2017).
Statement of Accounting Concept 1
There are certain entities that require preparing financial reports as prescribed by certain rules and regulations. However, some of them are even excluded. According to this concept all entities irrespective of its size, nature of operation, legal form whether profit oriented or not belonging to private or public sector should prepare financial reports if there exists any users who are dependent on these financial reports to take their decisions (Anon, 2017).
There may exist an individual entity or a group of entities operating together. Such group of entities may have a controlling authority on each other. Both theses type of entities will be covered under the definition of reporting entities. Any group which is covered under the term of economic entity will be regarded as a reporting entity even if the user of such financial reports does not exist. One of the entities that is included in the group of entities will have a control over the other entities to achieve the objective that is set up by the controlling authority. The control here signifies any kind of financial dependence directly or indirectly, appointment or dismissals of managers or the governing body of the entity, and the ultimate power in order to direct the activities of the entity (Breitner and Anthony, 2013).
In case of an individual, if he is able to deploy resources then but its objective is to achieve personal gains and does not satisfies the condition of falling under the definition of economic entity then it does not have to prepare financial reports (Dyckman, Magee and Pfeiffer, 2014).
As far we have come to know that if an entity has users of the financial reports who uses them in order to take decisions for their resource allocation then it is compulsory to prepare such financial reports. It is important for the company to identify the users of these reports before the preparation (Easton, 2015). The factors that are used to identify the users are indicative only and can be identified on the basis of three main categories- the separation existing between the ownership and the management, the economic and political influence and certain financial characteristics (Edmonds et al., 2016).
- Separation between management and ownership- The larger the space between the management and the ownership of the company there are more chances that there exist users of the financial reports for their decision making (Harrison, Horngren and Thomas, n.d.).
- Economic and political influence- If the entity holds an important position in regards to politics and economic conditions then there are higher chances of the existence of the users of the financial statements to allocate their resource in the best place.
- Financial characteristics –Financial characteristics includes the size of operation, the value of assets held, indebtedness of the company as well as the number of workers that are employed (Ittelson, 2009). Such entities that has these characteristics present are expected to have users that may be dependent on the financial statements in order to invest and allocate their resources efficiently.
The main purpose for the preparation of such financial reports is to provide correct information about the financial stability and position of an entity so that the users can make a wise decision of allocating their resource in the best possible place (Kimmel, Weygandt and Kieso, n.d.). However, if ther are any kind of information which is considered materialistic but has been concealed then it may lead these users to take a wrong decision. Therefore, the financial reports should be prepared with extra care and due diligence so that all material facts are disclosed properly and no facts are concealed.
The entity should be capable enough to use the resource in the most efficient way so that the users can determine about the financial condition of the entity in the forthcoming years. If the resources are utilised in an optimum manner then it will help the stakeholders to feel safe about their investment and also help them generate higher returns (Loughran, 2011). The management of the company should be knowledgeable enough to allocate the resources in the best place to get the best results (Piper, 2015).
It is important for every stakeholder to know about the past and current trends of an entity before taking its decisions (Pratt, 2014). It enables to compare the present performance with the past and ascertain that what is the extent of improvement that the company has shown. The financial statements provide various information such as the asset and liabilities along with the expenses and gains (Spiceland, Thomas and Herrmann, 2011). The assets of the company reflect the financial position and stability to pay off the liabilities. It gives a general idea of the going concern of the company by determining the key financial ratios with the help of the financial statements. The income and expenses reveals the continuous flow of resources and whether the expenses that were incurred were actually required or wasteful. If the entity is found to make wasteful expenditures then the stakeholders may not take interest in those companies as these are the signs of poor management (Warren, Reeve and Duchac, n.d.).
The financial statements should be prepared with full knowledge and truthfulness because it not only reflects the financial performance of the company but also the non- financial aspects are covered therein. The stakeholders in order to check the company’s awareness towards the society check the social responsibility carried out (Weil, 2014). An entity is not considered efficient only when it has a good profitability but it should also fulfil its responsibility towards the society. Therefore, proper disclosures of the corporate social responsibility that the entity has performed should be disclosed in the financial reports.
The stakeholders trust their hard earned money with the company and so it is their right to get correct information and give them back good returns. Therefore, the entity should not include any such wrong fact in the financial statements which would influence the decision of the stakeholders and mislead them. All the information provided should be in accordance with the various accounting concepts and standards. The non compliance of the accounting standards leads to violation of law and is punishable (Weygandt, Kimmel and Kieso, n.d.). If the company fails to comply with these rules and regulations or if there is any defect found in the financial statements then the there will be a huge loss of reputation in the market and it will become very difficult for them to survive and have a sufficient market share. Therefore, a reporting entity must provide all relevant information in the financial statements which will enable the users to take decisions wisely (Williams et al., 2015).
The accounting concept 1 defines the entities that falls under the category of reporting entity, the entities which fall in such category has been properly stated above. These entities require to make financial statements on compliance with certain rules and regulations because these reports are important and highly influence the decisions of various stakeholders. It is important for them to have complete information prior to the decision making.
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