Why Are Accurate Financial Statements Important for Outside Business Interests Essay
Accounting is specifically “a system by which economic information is identified, recorded, summarized and reported for the use of decision makers”; however, accounting involves interpretation and analyzing of all financial information, including taxing, personal financial information and investment (Alba, Bathija, & Thonton, 2005). Accounting is defined as the language of business, in that it specifically records the financial data that is required for businesses to operate both efficiently and effectively.
Modern accounting includes investigation, forecasting, analyzing, compliance, as well as record keeping and report generation (Gaylord & Ried, 2006). Accounting is said to be a service activity designed to accumulate, measure, and communicate financial information about businesses and other organizations and to provide information for making informed decisions about the business and about how to best utilize resources within the business (Albreacht, Stice, Stice, & Swain, 2008).
Accounting leads to the generation of reports and documents, which include financial statements. If accounting is the language of business, then accounting financial statements are the dictionary that defines the terms and the rules of the language (Horngren, Harrison, & Oliver, 2012). Financial statements are a key product of the accounting process as they report on a business in financial terms.
In fact, the financial statements that are created by the business can tell the complete story and create an accurate picture of the business that can be used by those outside of the business, such as investors and other businesses, to gauge the health and profitability of the business or to make decisions regarding investing or buy-outs (Horngren, Harrison, & Oliver, 2012). Therefore accurate financial statements are required so that a complete and honest depiction of the business can be created and so that those outside of the business can get and honest and ethical understanding of the business in financial terms.
Financial Accounting Financial accounting is defined as the branch of accounting that is specifically concerned with the preparation of financial statements for use by those outside of the company, who may have very limited access to information regarding the company (Porter & Norton, 2011). Financial accounting differs from managerial or personal accounting in that financial accounting provides information for those outside of the company, while managerial accounting is used strictly by organizational decision-makers in order to make decisions that would affect how the company operates (Horngren, Harrison, & Oliver, 2012).
External users, outsiders, are those who are not directly involved in the operation of the business and who may not have day-to-day communication or dealings with the company. Documents Generated Generally Accepted Accounting Principles (GAAP) is the common set of accounting principles, standards, and procedures that companies use to compile their financial statements. These principles are both authoritatively set standards, in that they are required by law, and commonly accepted ways for businesses to records and report accounting information (Horngren, Sundem, Stratton, Schatzberg, & Burgstahler, 2007).
GAAP is the forum in which all companies must report certain financial information to the public so that all companies report consistent financial data that can be understood and compared to other companies and is also used to report financial data to regulatory authorities. GAAP requires that all companies complete and submit four financial statements: the balance sheet, statement of cash flows, income statement, and statement of retained earnings or owner’s equity (Horngren, Sundem, Stratton, Schatzberg, ; Burgstahler, 2007).
The balance sheet provides detailed information about the company’s assets, liabilities, and the shareholder’s equity. The assets the company has or owns must balance with the liabilities and the shareholder’s equity (Horngren, Harrison, & Oliver, 2012). The income statement, which shows the detailed costs and expenses associated with the company’s operations, reports how much revenue the company earned over the specific period of time the statement covers. The statement of cash flows report and show the detail inflows and outflows of cash.
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 (Horngren, Harrison, ; Oliver, 2012). Finally, the statement of retained earnings shows the amount of accumulated earnings that have been retained within the company during the reporting period, such as the fiscal year. At the end of each fiscal year-end, the amount of net income or loss is added to the opening amount of retained earnings to arrive at the closing retained earnings (Porter ; Norton, 2011).
Who Uses the Documents The documents generated in the process of financial accounting are used by those outside of the company and are specifically prepared with information that would be useful for decision-makers who are not part of the company. These statements are generally used by stockholders, creditors, financial analysts, government agencies, potential investors, and other business entities (Porter ; Norton, 2011).
While the main use of these statements are to make financial or investment decisions regarding the company, such as a stockholder choosing to buy or sell the company’s stock or by lenders looking to make a loan decision, these same statements are also used by regulators and governing authorities to verify accounting practices or to verify tax liabilities (Porter ; Norton, 2011). Finally, financial statements are used by suppliers to check creditworthiness, by trade associations to promote the organization, and stockbrokers who use the information to advise clients (Porter ; Norton, 2011).
Why is Accurate Financial Statements Important Accurate financial statements are important to those outside of the business that generates the statements for several reasons, including: so an accurate picture of the company can be created; to understand the financial position of the company and to identify trends; to assure the company complies with GAAP; and to make decisions about investing in the business or making financial transactions with the business. Accurate financial statements are equired for investors and lenders to understand the financial health of the organization and to make decisions based upon accurate information. If statements contain errors, omissions, or fraud, then the decisions made can be made for the wrong reasons and can harm stakeholders (Francis ; Schipper, 1999). Accurate statements are required by other businesses, including business partners, so that companies can understand the market and can make decisions regarding partnerships, mergers, or acquisitions of the business.
These same statements are used by individuals to decide on the risk of the company or the possibility of bankruptcy (Graham, Harvey, ; Rajgopal, 2005). For regulators the financial statements accuracy is vital to assure the company is operating both honestly and ethically and requires financial statements to verify business activities. All financial reports are mandatory and must adhere to GAAP so that regulators, investors, auditors, and other businesses can have a common set of financial data that is constructed in a uniform and exacting way (Horngren, Sundem, Stratton, Schatzberg, ; Burgstahler, 2007).
Thus, auditors use these reports to verify business practices and to assure that companies are compliant with laws. Conclusion Financial accounting is the process of generating specific financial statements that are used by those outside of the company to make financial decisions, to verify business activities, or to simply get an accurate picture of the company for business or personal reasons. While GAAP requires the generation of these statements and also governs their creation, there are additional reasons why businesses must create and distribute only accurate financial statements.
Accurate statements show that a company is ethical and honest, it shows the business complies with laws, and it also gives outsiders a very clear picture of the financial status of the company in the short and long-run. How a company creates these statements will say a lot about the company and accurate financial statements can make a very positive statement about the company, even when the data reported is not financially positive.
Alba, J. , Bathija, M. , ; Thonton, M. 2005). Vault career guide to accounting . New York, NY: Vault, Inc. Albreacht, S. , Stice, J. , Stice, E. , ; Swain, M. (2008). Accounting: Concepts and Applications. Mason, OH: Thomson Higher Education. Gaylord, G. , ; Ried, G. (2006). Careers in accounting . New York, NY: McGraw-Hill. Francis, J. , ; Schipper, K. (1999). Have Financial Statements Lost Their Relevance? Journal of Accounting Research, 37(2), 319-352. Graham, J. , Harvey, C. , ; Rajgopal, S. (2005).
The economic implications of corporate financial reporting. Journal of Accounting and Economics, 40(1-3), 3-73. Horngren, C. , Harrison, W. , ; Oliver, M. (2012). Accounting (9th ed. ). Upper Saddle River, NJ: Prentice Hall. Horngren, C. , Sundem, G. , Stratton, W. , Schatzberg, J. , ; Burgstahler, D. (2007). Introduction to Management Accounting, 14th ed. Upper Saddle River, NJ: Prentice Hall. Porter, G. , ; Norton, C. (2011). Financial Accounting (7th). Mason, OH: South-Western Cenage.