The Value of Financial Information Essay Example
The Value of Financial Information Essay Example

The Value of Financial Information Essay Example

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  • Pages: 6 (1618 words)
  • Published: September 12, 2018
  • Type: Essay
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This paper seeks to explain why the annual financial statements continue to remain an important source of information to shareholders, despite the fact that they disclose information on past events when shareholders as investors require information about future events. To attain the objective of this paper, there is a need to discuss the nature of the financial statements, the manner of their creation or preparation, and the purpose of their preparation. Understanding these things would point out the value of the financial statements to investors.Investors normally need to have an information of past before they could rationally judge what will happen in the future.

They want to know whether they will earn with their investment decisions (Brigham and Houston, 2002). The financial statements are indeed historical information which may provide them the answer to their n


eed for information. As to how and why, are explained below. What are these financial statements? These include the profit and loss accounts or the income statement, balance sheet and cash flow statement.Income statement measures the financial performance of companies and would normally include the accounting elements of revenues and expenses. Revenues must exceed expense in order to have profits.

On other hand, if expenses exceed revenues the result would be net loss for the companies. Balance sheet on the other hand presents the historical financial position of the company on a per year basis in terms of the accounting elements of assets, liabilities and equity. The company’s total assets must be equal to the sum of it liabilities and equity.After the preparation of income statement and balance sheet, the cash flow statement, which is basically an expanded version of

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cash account in the balance sheet, can be prepared based from these earlier statements. It is therefore the emphasis of this paper to talk about the income statement and balance sheet to address the core issues.

How are these statements being prepared? As stated earlier, both the income statement and balance sheet have in them the accounting elements.The accounting elements are actually related to each other. The account elements of revenues (or incomes) and expenses are actually temporary accounts since at the end of the accounting period; these nominal accounts are closed to permanent accounts which are elements of the balance sheet. An asset is a resource that is managed and under the responsibility and control by the enterprise as a result of past events and from which future economic benefits are expected to flow to the enterprise (Deloitte Touche Tohmatsu, 2008).

On other hand, a liability is a current obligation of the company that has come from past events, the payment or extinguishment of which will result in an outflow from the enterprise of resources with economic benefits (Deloitte Touche Tohmatsu, 2008). Still another element is the equity which is the residual interest in the assets of the enterprise after deducting all its liabilities (Deloitte Touche Tohmatsu, 2008).The asset and liabilities are related to expenses and revenues in that one will make use of assets, or contract a liability with objective of generating revenues and the use of assets and incurrence of liabilities may constitute expenses. Since the objective is to generate revenues, expenses are necessary consequence.

It is therefore logical to think that revenues must exceed expenses in order to produce profits. The net

effect of revenues exceeding expenses will result to net increase in equity.Increasing the equity would therefore have the effect of increasing the wealth of stockholders who have taken risks to make their investments to the company (Ross et. al,1996; Van Horne, 1992). The elements of financial elements must however be recognized in the books before they could be used by the decision makers. There is recognition when an accounting element is incorporated or made part of the balance sheet or income statement and as long as the two criteria for recognition are satisfied (Deloitte Touche Tohmatsu, 2008).

First, there must be a probability that any future economic benefit associated with the item will flow to or from enterprise. Second, one can measure reliably the item’s cost or value (Deloitte Touche Tohmatsu, 2008). As could be seen not all elements are recognized. There are criteria that must be followed. It is the recognition that gives the importance of accounting since it is the start of the creation of something for decision making.

The criteria are actually required pursuant to be objective of financial reporting which is to provide information for decision making.These criteria were conceived under a set of underlying and implicit assumptions as well as accounting concepts. One underlying assumption that is very relevant is the going concern concept which assumes that the business entity is to continue operating for a period of time sufficient to carry out its contemplated objective, plans and contract and commitments unless the liquidation of the entity is imminent. Since the business is presumed to continue indefinitely, it values its assets at cost under a going concern assumption for depreciation.For this

reason, the basis for recording is the historical cost and not the liquidation value, fluctuations in the market are ignored and that the stockholders are not interested or least planning to stop the business and sell the same (Deloitte Touche Tohmatsu, 2008). In relation to objectives of financial reporting of providing information for decision making, users also value some qualitative characteristics of these statements (Droms, 1990; Meigs and Meigs, 1995).

This means that the product or output of the financial accounting process should serve as useful input for rational investment and other similar economic decision.To be useful these financial statements be understandable where information should be within the grasp of users who have a reasonable knowledge of business and economic activities and accounting and who are willing to study the information diligently (Deloitte Touche Tohmatsu, 2008). To useful, the same must relevant or has the capacity influence the economic decisions of users by assisting them to evaluate the past, present, or future events relating to an enterprise and confirming or correcting pasty evaluation they have made (Deloitte Touche Tohmatsu, 2008).The other characteristics are materiality and timeliness, which could be deemed part of relevance.

Another important characteristic is reliability where information should be free from material error and bias and can be depended upon by users to represent events and transactions faithfully (Deloitte Touche Tohmatsu, 2008). Why are these statements being prepared in the first place? Financial reporting has its aim of providing information about the financial position, performance and changes in financial position of a firm for the economic-decision making of various users (Deloitte Touche Tohmatsu, 2008).Users, as a rule, would be interested in the

financial position of an enterprise which is normally affected by the economic resources it controls, its financial structure, its liquidity and solvency, and its capacity to adapt to changes in the environment in which it operates (Deloitte Touche Tohmatsu, 2008). By knowing the financial position of a company a person whether natural or juridical will have some basis on predicting future events. To forecast out of some information is more believable that to forecast out of nothing.

The first could use statistics and other generally acceptable model of prediction, while the other one is based on wishful thinking if not pure speculation. Generally, users would like to see how companies are taking care of these financial resources by looking at the financial performance of the company. In performance, one would like to know if the company as an enterprise is earning. An entity that cannot generate profits must be a sick business as a rule unless it is an industry wide reality in which case the industry is sick.By having knowledge on the variability of profits one may be able to make a forecast of the companies’ earning and cash flows and whether a firm may be able to hold on to it target parts, one of which is satisfying the interests of various stakeholders. In satisfying the objective of providing information to decision makers, it must be made clear that the income statement, balance sheet and cash flow are actually accompanied by the notes to financial statement and supplementary schedules.

The role of these two latest parts of the financial statements include explaining items in the balance sheet and income statement, disclosing the risks and uncertainties

affecting the enterprise, and explaining any resources and obligations not recognized in the balance sheet, thus enhancing the accounting characteristics of relevance and reliability. It can be concluded that this paper has just proved the natural tendency of humans to decide rationally by predicting the future out from the past. Decision makers would have to make use of some information of the past in order to understand what could happen in the future.The future would always be a continuation of the past and the present, no matter how surprising the future may be. However, for the past information to be useful, the same must be truthful, objective and relevant.

If expressed in accounting language, the annual financial statements will continue to remain an important source of information to shareholders, despite the fact that they disclose information on past events for as long these annual statements are prepared under an accounting standard that will ensure the understandability, relevance, reliability and timeliness of financial information contained in these financial statements.References:Brigham and Houston (2002) Fundamentals of Financial Management, Thomson South-Western, UK Deloitte Touche Tohmatsu, (2008) Summaries of International Reporting Standards, {www document} URL http://www. iasplus. com/standard/framewk. htm, Accessed May 12, 2008 Droms (1990) Finance and Accounting for Non Financial Managers, Addison-Wesley Publishing Company, England Meigs and Meigs (1995) Financial Accounting, McGraw-Hill, London, UK Ross et.

al (1996) Essentials of Corporate Finance ,IRWIN, London, UK Van Horne (1992) Financial Management and Policy, Prentice-Hall International, London, UK

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