Financial statement

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Historical financial statements Wachovia National Bank 1906 statement.jpg
Historical financial statements

Financial statements (or financial reports) are formal records of the financial activities and position of a business, person, or other entity.

Contents

Relevant financial information is presented in a structured manner and in a form which is easy to understand. They typically include four basic financial statements accompanied by a management discussion and analysis: [1]

  1. A balance sheet or statement of financial position, reports on a company's assets, liabilities, and owners equity at a given point in time.
  2. An income statement—or profit and loss report (P&L report), or statement of comprehensive income, or statement of revenue & expense—reports on a company's income, expenses, and profits over a stated period. A profit and loss statement provides information on the operation of the enterprise. These include sales and the various expenses incurred during the stated period.
  3. A statement of changes in equity or statement of equity, or statement of retained earnings, reports on the changes in equity of the company over a stated period.
  4. A cash flow statement reports on a company's cash flow activities, particularly its operating, investing and financing activities over a stated period.

Notably, a balance sheet represents a single point in time, whereas the income statement, the statement of changes in equity, and the cash flow statement each represent activities over a stated period.

For large corporations, these statements may be complex and may include an extensive set of footnotes to the financial statements and management discussion and analysis. The notes typically describe each item on the balance sheet, income statement and cash flow statement in further detail. Notes to financial statements are considered an integral part of the financial statements.

Purpose for financial statements

"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." Financial statements should be understandable, relevant, reliable and comparable. Reported assets, liabilities, equity, income and expenses are directly related to an organization's financial position.

Financial statements are intended to be understandable by readers who have "a reasonable knowledge of business and economic activities and accounting and who are willing to study the information diligently." [2] Financial statements may be used by users for different purposes:

Consolidated

Consolidated financial statements are defined as "Financial statements of a group in which the assets, liabilities, equity, income, expenses and cash flows of the parent (company) and its subsidiaries are presented as those of a single economic entity", according to International Accounting Standard 27 "Consolidated and separate financial statements", and International Financial Reporting Standard 10 "Consolidated financial statements". [4] [5]

Government

The rules for the recording, measurement and presentation of government financial statements may be different from those required for business and even for non-profit organizations. They may use either of two accounting methods: accrual accounting, or cost accounting, or a combination of the two (OCBOA). A complete set of chart of accounts is also used that is substantially different from the chart of a profit-oriented business.

Personal

Personal financial statements may be required from persons applying for a personal loan or financial aid. Typically, a personal financial statement consists of a single form for reporting personally held assets and liabilities (debts), or personal sources of income and expenses, or both. The form to be filled out is determined by the organization supplying the loan or aid.

Although laws differ from country to country, an audit of the financial statements of a public company is usually required for investment, financing, and tax purposes. These are usually performed by independent accountants or auditing firms. Results of the audit are summarized in an audit report that either provide an unqualified opinion on the financial statements or qualifications as to its fairness and accuracy. The audit opinion on the financial statements is usually included in the annual report.

There has been much legal debate over who an auditor is liable to. Since audit reports tend to be addressed to the current shareholders, it is commonly thought that they owe a legal duty of care to them. But this may not be the case as determined by common law precedent. In Canada, auditors are liable only to investors using a prospectus to buy shares in the primary market. In the United Kingdom, they have been held liable to potential investors when the auditor was aware of the potential investor and how they would use the information in the financial statements. Nowadays auditors tend to include in their report liability restricting language, discouraging anyone other than the addressees of their report from relying on it. Liability is an important issue: in the UK, for example, auditors have unlimited liability.

In the United States, especially in the post-Enron era there has been substantial concern about the accuracy of financial statements. Corporate officers—the chief executive officer (CEO) and chief financial officer (CFO)—are personally responsible for fair financial reporting that provides an accurate sense of the organization to those reading the report.

Standards and regulations

Different countries have developed their own accounting principles over time, making international comparisons of companies difficult. To ensure uniformity and comparability between financial statements prepared by different companies, a set of guidelines and rules are used. Commonly referred to as Generally Accepted Accounting Principles (GAAP), these set of guidelines provide the basis in the preparation of financial statements, although many companies voluntarily disclose information beyond the scope of such requirements. [6]

Recently there has been a push towards standardizing accounting rules made by the International Accounting Standards Board (IASB). IASB develops International Financial Reporting Standards that have been adopted by Australia, Canada and the European Union (for publicly quoted companies only), are under consideration in South Africa and other countries. The United States Financial Accounting Standards Board has made a commitment to converge the U.S. GAAP and IFRS over time.

Inclusion in annual reports

To entice new investors, public companies assemble their financial statements on fine paper with pleasing graphics and photos in an annual report to shareholders, attempting to capture the excitement and culture of the organization in a "marketing brochure" of sorts. Usually the company's chief executive will write a letter to shareholders, describing management's performance and the company's financial highlights.

In the United States, prior to the advent of the internet, the annual report was considered the most effective way for corporations to communicate with individual shareholders. Blue chip companies went to great expense to produce and mail out attractive annual reports to every shareholder. The annual report was often prepared in the style of a coffee table book.

Notes

Additional information added to the end of financial statements that help explain specific items in the statements as well as provide a more comprehensive assessment of a company's financial condition are known as notes (or "notes to financial statements").

Notes to financial statements can include information on debt, accounts, contingent liabilities, on going concern criteria, or on contextual information explaining the financial numbers (e.g. to indicate a lawsuit). The notes clarify individual statement line-items. Notes are also used to explain the accounting methods used to prepare the statements and they support valuations for how particular accounts have been computed. As an example: If a company lists a loss on a fixed asset impairment line in their income statement, the notes may state the reason for the impairment by describing how the asset became impaired.

In consolidated financial statements, all subsidiaries are listed as well as the amount of ownership (controlling interest) that the parent company has in the subsidiaries.

Any items within the financial statements that are valuated by estimation are part of the notes if a substantial difference exists between the amount of the estimate previously reported and the actual result. Full disclosure of the effects of the differences between the estimate and actual results should be included.

Management discussion and analysis

Management discussion and analysis or MD&A is an integrated part of a company's annual financial statements. The purpose of the MD&A is to provide a narrative explanation, through the eyes of management, of how an entity has performed in the past, its financial condition, and its future prospects. In so doing, the MD&A attempt to provide investors with complete, fair, and balanced information to help them decide whether to invest or continue to invest in an entity. [7]

The section contains a description of the year gone by and some of the key factors that influenced the business of the company in that year, as well as a fair and unbiased overview of the company's past, present, and future.

MD&A typically describes the corporation's liquidity position, capital resources, [8] results of its operations, underlying causes of material changes in financial statement items (such as asset impairment and restructuring charges), events of unusual or infrequent nature (such as mergers and acquisitions or share buybacks), positive and negative trends, effects of inflation, domestic and international market risks, [9] and significant uncertainties.

Move to electronic statements

Financial statements have been created on paper for hundreds of years. The growth of the Web has seen more and more financial statements created in an electronic form which is exchangeable over the Web. Common forms of electronic financial statements are PDF and HTML. These types of electronic financial statements have their drawbacks in that it still takes a human to read the information in order to reuse the information contained in a financial statement.

More recently a market driven global standard, XBRL (Extensible Business Reporting Language), which can be used for creating financial statements in a structured and computer readable format, has become more popular as a format for creating financial statements. Many regulators around the world such as the U.S. Securities and Exchange Commission have mandated XBRL for the submission of financial information.

The UN/CEFACT created, with respect to Generally Accepted Accounting Principles (GAAP), internal or external financial reporting XML messages to be used between enterprises and their partners, such as private interested parties (e.g. bank) and public collecting bodies (e.g. taxation authorities). Many regulators use such messages to collect financial and economic information.

See also

Related Research Articles

The Big Four are the four largest professional services networks in the world, the global accounting networks Deloitte, Ernst & Young (EY), KPMG, and PricewaterhouseCoopers (PwC). The four are often grouped because they are comparable in size relative to the rest of the market, both in terms of revenue and workforce; they are considered equal in their ability to provide a wide scope of professional services to their clients; and, among those looking to start a career in professional services, particularly accounting, they are considered equally attractive networks to work in, because of the frequency with which these firms engage with Fortune 500 companies.

<span class="mw-page-title-main">International Financial Reporting Standards</span> Technical standard

International Financial Reporting Standards, commonly called IFRS, are accounting standards issued by the IFRS Foundation and the International Accounting Standards Board (IASB). They constitute a standardised way of describing the company's financial performance and position so that company financial statements are understandable and comparable across international boundaries. They are particularly relevant for companies with shares or securities listed on a public stock exchange.

<span class="mw-page-title-main">Balance sheet</span> Accounting financial summary

In financial accounting, a balance sheet is a summary of the financial balances of an individual or organization, whether it be a sole proprietorship, a business partnership, a corporation, private limited company or other organization such as government or not-for-profit entity. Assets, liabilities and ownership equity are listed as of a specific date, such as the end of its financial year. A balance sheet is often described as a "snapshot of a company's financial condition". It is the summary of each and every financial statement of an organization

<span class="mw-page-title-main">Historical cost</span>

In accounting, an economic item's historical cost is the original nominal monetary value of that item. Historical cost accounting involves reporting assets and liabilities at their historical costs, which are not updated for changes in the items' values. Consequently, the amounts reported for these balance sheet items often differ from their current economic or market values.

This page is an index of accounting topics.

<span class="mw-page-title-main">Financial audit</span> Type of audit

A financial audit is conducted to provide an opinion whether "financial statements" are stated in accordance with specified criteria. Normally, the criteria are international accounting standards, although auditors may conduct audits of financial statements prepared using the cash basis or some other basis of accounting appropriate for the organization. In providing an opinion whether financial statements are fairly stated in accordance with accounting standards, the auditor gathers evidence to determine whether the statements contain material errors or other misstatements.

<span class="mw-page-title-main">Income statement</span> Type of financial statement

An income statement or profit and loss account is one of the financial statements of a company and shows the company's revenues and expenses during a particular period.

<span class="mw-page-title-main">Financial accounting</span> Field of accounting

Financial accounting is a branch of accounting concerned with the summary, analysis and reporting of financial transactions related to a business. This involves the preparation of financial statements available for public use. Stockholders, suppliers, banks, employees, government agencies, business owners, and other stakeholders are examples of people interested in receiving such information for decision making purposes.

Deloitte Touche Tohmatsu Limited, commonly referred to as Deloitte, is an international professional services network headquartered in London, England. Deloitte is the largest professional services network by revenue and number of professionals in the world and is considered one of the Big Four accounting firms along with EY, KPMG and PricewaterhouseCoopers (PWC).

<span class="mw-page-title-main">Auditor's report</span> Type of written document

An auditor's report is a formal opinion, or disclaimer thereof, issued by either an internal auditor or an independent external auditor as a result of an internal or external audit, as an assurance service in order for the user to make decisions based on the results of the audit.

<span class="mw-page-title-main">Consolidated financial statement</span>

Consolidated financial statements are the "financial statements of a group in which the assets, liabilities, equity, income, expenses and cash flows of the parent company and its subsidiaries are presented as those of a single economic entity", according to International Accounting Standard 27 "Consolidated and separate financial statements", and International Financial Reporting Standard 10 "Consolidated financial statements".

<span class="mw-page-title-main">Statement of changes in equity</span>

A statement of changes in equity and similarly the statement of changes in owner's equity for a sole trader, statement of changes in partners' equity for a partnership, statement of changes in shareholders' equity for a company or statement of changes in taxpayers' equity for government financial statements is one of the four basic financial statements.

<span class="mw-page-title-main">External auditor</span> Person who audits an entitys financial statements and is independent of that entity

An external auditor performs an audit, in accordance with specific laws or rules, of the financial statements of a company, government entity, other legal entity, or organization, and is independent of the entity being audited. Users of these entities' financial information, such as investors, government agencies, and the general public, rely on the external auditor to present an unbiased and independent audit report.

<span class="mw-page-title-main">Going concern</span>

A going concern is an accounting term for a business that is assumed will meet its financial obligations when they become due. It functions without the threat of liquidation for the foreseeable future, which is usually regarded as at least the next 12 months or the specified accounting period. The presumption of going concern for the business implies the basic declaration of intention to keep operating its activities at least for the next year, which is a basic assumption for preparing financial statements that comprehend the conceptual framework of the IFRS. Hence, a declaration of going concern means that the business has neither the intention nor the need to liquidate or to materially curtail the scale of its operations.

<span class="mw-page-title-main">Materiality (auditing)</span> Concept in auditing and accounting

Materiality is a concept or convention within auditing and accounting relating to the importance/significance of an amount, transaction, or discrepancy. The objective of an audit of financial statements is to enable the auditor to express an opinion whether the financial statements are prepared, in all material respects, in conformity with an identified financial reporting framework such as Generally Accepted Accounting Principles (GAAP).

<span class="mw-page-title-main">Provision (accounting)</span> Account which records a present liability of an entity

In financial accounting under International Financial Reporting Standards (IFRS), a provision is an account that records a present liability of an entity. The recording of the liability in the entity's balance sheet is matched to an appropriate expense account on the entity's income statement. In U.S. Generally Accepted Accounting Principles, a provision is an expense. Thus, "Provision for Income Taxes" is an expense in U.S. GAAP but a liability in IFRS. 

<span class="mw-page-title-main">Hedge accounting</span>

Hedge accounting is an accountancy practice, the aim of which is to provide an offset to the mark-to-market movement of the derivative in the profit and loss account.

The following outline is provided as an overview of and topical guide to accounting:

<span class="mw-page-title-main">IAS 1</span>

International Accounting Standard 1: Presentation of Financial Statements or IAS 1 is an international financial reporting standard adopted by the International Accounting Standards Board (IASB). It lays out the guidelines for the presentation of financial statements and sets out minimum requirements of their content; it is applicable to all general purpose financial statements that are based on International Financial Reporting Standards (IFRS).

<span class="mw-page-title-main">IAS 23</span> International financial reporting standard

International Accounting Standard 23: Borrowing Costs or IAS 23 is an international financial reporting standard adopted by the International Accounting Standards Board (IASB). Borrowing costs refer to the interest & other costs that an entity incurs in connection with the borrowing of funds. IAS 23 provides guidance on how to measure borrowing costs, particularly when the costs of acquisition, construction or production are funded by an entity’s general borrowings. The standard mandates that borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset must be capitalized as part of that asset. Other borrowing costs are recognised as an expense.

References

  1. "Presentation of Financial Statements" Standard IAS 1, International Accounting Standards Board. Accessed 24 June 2007.
  2. "The Framework for the Preparation and Presentation of Financial Statements" International Accounting Standards Board. Accessed 24 June 2007.
  3. "Accounting standards and value relevance of financial statements: An international analysis". Science Direct. Retrieved 1 April 2023.
  4. "IAS 27 — Separate Financial Statements (2011)". www.iasplus.com. IAS Plus (This material is provided by Deloitte Touche Tohmatsu Limited (“DTTL”), or a member firm of DTTL, or one of their related entities. This material is provided “AS IS” and without warranty of any kind, express or implied. Without limiting the foregoing, neither Deloitte Touche Tohmatsu Limited (“DTTL”), nor any member firm of DTTL (a “DTTL Member Firm”), nor any of their related entities (collectively, the “Deloitte Network”) warrants that this material will be error-free or will meet any particular criteria of performance or quality, and each entity of the Deloitte Network expressly disclaims all implied warranties, including without limitation warranties of merchantability, title, fitness for a particular purpose, non-infringement, compatibility, and accuracy.). Retrieved 2013-11-29.
  5. "IFRS 10 — Consolidated Financial Statements". www.iasplus.com. IAS Plus (This material is provided by Deloitte Touche Tohmatsu Limited (“DTTL”), or a member firm of DTTL, or one of their related entities. This material is provided “AS IS” and without warranty of any kind, express or implied. Without limiting the foregoing, neither Deloitte Touche Tohmatsu Limited (“DTTL”), nor any member firm of DTTL (a “DTTL Member Firm”), nor any of their related entities (collectively, the “Deloitte Network”) warrants that this material will be error-free or will meet any particular criteria of performance or quality, and each entity of the Deloitte Network expressly disclaims all implied warranties, including without limitation warranties of merchantability, title, fitness for a particular purpose, non-infringement, compatibility, and accuracy.). Retrieved 2013-11-29.
  6. FASB, 2001. Improving Business Reporting: Insights into Enhancing Voluntary Disclosures. Retrieved on April 20, 2012.
  7. MD&A & Other Performance Reporting
  8. "Nico Resources Management's Discussion and Analysis". Archived from the original on 2006-11-15. Retrieved 2014-02-19.
  9. "PepsiCo Management's Discussion and Analysis". Archived from the original on 2012-03-19. Retrieved 2014-02-19.

Further reading