Introduction to Financial Statements

There are numerous financial statements that serve different purposes. The main financial statements include:

Types of financial Statements:

Types of financial statements

Financial statement consists of:

  • Asset- A resource controlled by the business from which they will receive future economic benefits.
  • Liability– An obligation that legally requires a business to settle debts owed to other parties.
  • Equity- The amount left after total liabilities have been deducted from total assets.
  • Income- The increases in economic benefits during an accounting period. Usually classified as gains (revaluations/disposals) or revenue (from sales).
  • Expenses- The decreases in economic benefits during an accounting period. Usually losses on disposals of non-current assets and on revaluation.

Users can use financial statements to:

  1. Decide whether to buy, sell or hold shares
  2. Assess stewardship or accountability of managements
  3. Assess a company’s ability to provide benefits to employees

Preparation of Financial Statements

There are Two key assumptions in the preparation of financial statements:

  • Accrual Basis: Every transaction is recorded in the accounts when they occur not when the cash is actually received. They are reported in financial statement in the period to which they relate.
  • Going Concern: Financial statements are produced on the assumption that a business will continue to function in the foreseeable future.

Legal Requirements for Financial Statements

Some countries have introduced national laws to ensure financial statements are produced to give a true and fair view. True refers to factual accuracy, whilst fair refers to without bias and with a objective view.

However the issue with a true and fair view is that accounting standards may not be consistent with requirements to give a true and fair view (also known as true and fair override) which means managers can avoid adapting to certain accounting standards. The true and fair override is the loophole in the law and is a disputing argument within the accounting profession.

Legal VS Commercial View

Companies often use the legal form of transactions to determine accounting treatments, when this differs from the actual accounting treatment (Substance) that should be adopted. The IASB is the framework that can be used to avoid these issues.

Off-Balance Sheet

When a company has transactions that it doesn’t include in the statement of financial position such as assets or finance. This method can cause the company’s position to be misstated because of the misinterpretation.

When a company has transactions that it doesn’t include in the statement of financial position such as assets or finance. This is referred to as being – off balance sheet. This method can cause the company’s position to be misstated because of the misinterpretation.

Note that companies use off- balance sheet transactions to limit risk and/ or reduce for example interest costs etc. The off- balance sheet transaction may be beneficial to the company but not to users of financial information.

Off balance sheet advantages and disadvantages