Financial statements are meant to provide the financial information of an entity as clearly and precisely as possible. They are records that clearly outline the financial activities of a business firm. Financial statements usually include a statement of comprehensive income, statement of financial position, statement of changes in equity, and the cash-flow statement (Wolk, Dodd & Rozycki, 2008). In order to maintain continuity of information and its presentation across international borders, the International Financial Reporting Standards (IFRS) have been adopted as a regulatory framework. Users of the financial statements are not only the entity in question, but also include investors, government agencies, competitors, employees, tax authorities, and other key stakeholders. Some key elements in the preparation of financial statements include assets, liabilities, expenses, and equity (Downes & Goodman, 1991).
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Financial statements are useless because they are incomplete; not all assets or liabilities are included
As financial statements are prepared, some aspects of assets and liabilities are likely to be omitted. According to the IFRS, an asset is a resource with an economic value, which an entity controls with the expectations to reap future benefits. A liability is a legal debt or duty that arises in the course of business. The regulatory framework has stipulations that should be observed regarding asset and liability reporting. However, at times, the interpretation could be different and omissions could occur due to various reasons such as evading tax and fraud. This leads to the need of audit services where the auditor seeks to make sure that the financial statements reflect a true and fair picture of the entity’s financial position (International Accounting Standards Committee Foundation & International Accounting Standards Board, 2008).
However, financial statements with such omissions could be misleading to individuals or firms that choose to rely on them. In this case, the position of the firm is not accurately depicted. Thus, it is the role of the auditor to uncover such malpractices whether committed intentionally or otherwise (Warren, Reeve, Duchac & Warren, 2012). However, investors and other stakeholders are protected if they can prove that their reliance on the information caused them harm. In this case, they then can sue the firm or its auditors for legal damages (Epstein & Jermakowicz, 2010).
Financial statements are useless because they present assets at their historical costs rather than their fair market values
According to the IFRS, assets should be recorded using their historical cost. The historical cost concept ignores that the asset could be disposed in the open market. The balance sheet or statement of financial position reflects the business’ financial position. The financial statements are prepared with the use of historical cost from which a depreciation provision is subtracted to present a true and fair view. The historical cost concept adopts the accounting quality of reliability (International Accounting Standards Committee Foundation & International Accounting Standards Board, 2008).
On the other hand, the fair market value concept follows the quality of relevance. Although relevant, the fair market value is not reliable. This is because the item can realize a variety of prices where it is to be disposed. In this case, the information lacks reliability. The aspect of reliability is the reason as to why IFRS adopt the historical approach while reporting of assets in the financial statements (Daniels, 1980).
Financial statements are very important to the business as they indicate the trend the entity has adopted. They also guide investors and other stakeholders when making decisions regarding the business. In respect to their preparation, disputes have emerged relating to the guidelines and their implementation. However, IFRS has tried to explain and educate users of financial statements in order to reduce the disputes.
Daniels, M. B. (1980). Corporation financial statements. New York: Arno Press.
Downes, J., & Goodman, J. E. (1991). Dictionary of finance and investment terms. New York: Barron’s.
Epstein, B. J., & Jermakowicz, E. K. (2010). Wiley 2010 interpretation and application of international financial reporting standards: [includes summary of key provisions of U.S. GAAP VS. IFRS]. Hoboken, NJ: Wiley.
International Accounting Standards Committee Foundation, & International Accounting Standards Board. (2008). A guide through International Financial Reporting Standards (IFRSs) 2008: Including the full text of the Standards and Interpretations and accompanying documents issued by the International Accounting Standards Board as approved at 1 July 2008: with extensive cross-references and other annotations. London, U.K: International Accounting Standards Committee Foundation.
Warren, C. S., Reeve, J. M., Duchac, J. E., & Warren, C. S. (2012). Financial and managerial accounting. Mason, Ohio: South-Western Cengage Learning.
Wolk, H. I., Dodd, J. L., & Rozycki, J. J. (2008). Accounting theory: Conceptual issues in a political and economic environment. Los Angeles: Sage Publications.