Role, objectives and limitations of published Annual Financial Statements

Annual Financial statements contain the summary of all the transactions and events that takes place in as particular year which provides the true picture of the financial position as well as the financial performance of the reporting entity. The process of preparation and presentation of financial statements is termed as the financial reporting function of an entity.

Running Head: Accounting Statement Analysis
FINANCIAL STATEMENTS

Accounting Statement Analysis 1
Role, objectives and limitations of published Annual Financial Statements
Annual Financial statements contain the summary of all the transactions and events that takes
place in as particular year which provides the true picture of the financial position as well as the
financial performance of the reporting entity. The process of preparation and presentation of
financial statements is termed as the financial reporting function of an entity. Reporting entity is
the firm that prepares and presents their financial statements and publishes them so that they can
be used by the stakeholders of such companies in their decision making function in the areas in
which they are associated with the reporting entity. The information contained in financial
statements are communicated to the intended users by way of annual reports which is comprised
of various statements such as income statement, statement of financial position, statement of
cash flows along with the notes to accounts that provides details of the information contained in
such statements.

Accounting Statement Analysis 2
(Source: Saylor, 2016).
A financial statement serves an important tool for the entity’s owners, investors and
regulators in determining its true financial position. They provide necessary and relevant
information to such parties to help them in undertaking sound and effective decision making
(Schroeder, Clark & Cathey, 2001). The financial information in relation to an entity’s business
is structured in the financial statements in such a way that the users can easily understand it. An
entity’s financial statements must be prepared and presented in accordance with the Generally
Accepted Accounting Principles (GAAP) or in accordance with the International Financial
Reporting Standards (IFRS) (Callao, Jarne & Laínez, 2007). For each stakeholder group
financial statements play different roles. For existing and potential shareholders and investors,
these statements provide them insights about the profitability position of the company so that
they can determine the level of returns they can earn by investing in such company. Only a
profitable entity can offer sound returns to its investors and owners. For the banks and financial
institutions, financial statements serve as the basic documents to assess the financial health of the
company and its credit worthiness by evaluating its solvency position (Suh, 2017). The
governmental regulators bodies refer to these statements to check as to whether the reporting

Accounting Statement Analysis 3
entity complies with the regulatory requirements and for the determination of amount of taxation
that they must collect as revenue from such entity. The employees of the company use its
financial statements to determine the level of compensation they must receive from the company
on the basis of its profitability and for the assessment of existing and future employment
opportunities. Further, the owners and managers of the company uses such financial statements
to evaluate their overall business performance so that required strategies and policies can be
formulated for the subsequent periods in order to achieve the desired growth and success of
business (Carraher & Van Auken, 2013).
Financial statements are prepared to meet certain important objectives of financial reporting.
They are prepared to evaluate the true business performance of the business in financial terms so
that necessary managerial decisions can be taken by the top management for the further period of
the business (Zeff, 2013). These financial statements are published for their intended users i.e.
the stakeholders of the company so that they can assess the financial health of the business from
various aspects such as its profitability position, solvency position, liquidity position, market
valuation and worthiness (Foster, 2004). As financial statements help the potential shareholders
in determining company’s worth, it is important for them to compare the financial performance
of such company with its competitors and other firms where investment can be made. Therefore,
it is necessary that there must be uniformity in the rules of preparation and presentation of such
financial statements. Hence, regulation of accounting function across the globe is quite essential.
The use of accounting standards in framing the financial statements will not only promote
uniformity but will also encourage the reporting entities to maintain transparency. The lack of
appropriate regulation has made accounting function to lose its relevance which can be regained
by way of regulating it stringently. Moreover, financial statements are prepared to anticipate the

Accounting Statement Analysis 4
scope of growth of the business and to identify its financial strengths and weaknesses. Further,
financial statements help in carrying out forecasting and budgetary processes for so as to project
the future performance of the business. The financial projections are often used by the providers
of finance such as banks and financial institutions for the purpose of sanctioning loan to the
reporting entity. Also, financial statements are prepared and published in order to comply with
various regulatory requirements as applicable on the entity. These statements facilitate managers
in undertaking the decisions in regards to the allocation of scarce resources of their business and
for to take up significant business matters such as assets replacement, mergers and acquisition
and so on (Graham, Harvey & Rajgopal, 2005).
(Source: Money matters, 2018).

Accounting Statement Analysis 5
According to the Barth (2006), the financial statements have numerous great importance
and benefits of financial statements, there are certain limitations that hamper the effectiveness of
the financial reporting function of a reporting entity. The biggest problem with the annual
financial statements is that they merely cover the quantitative information i.e. the information
about the financial performance of the company and not the qualitative information that tells
about the performance of business in various other areas such as its social responsibility
fulfillment, quality of its products and services, employees satisfaction, its sustainability
practices and its loyalty towards the customers. All these areas are necessary to be covered while
evaluating the overall financial statements. Unfortunately, the traditional financial reports do not
contain such information and due to the lack of such important discussions, the annual reports do
not serve their core purpose to the full extent. According to Efendi, Srivastava & Swanson
(2007), the other problem with the financial statements is that they can easily be manipulated by
the management of the company to mislead the stakeholders by revealing the falsified financial
results of such company. This practice of manipulation is termed as window dressing or
unethical earnings management practices which leads to incorrect decision making at
shareholders and other stakeholder’s end. The cases of accounting scandals that took place in
large corporations like ABC Learning, WorldCom, Enron etc. have made the financial reporting
function lose its relevance in the eyes of general public. In all the cases, one thing that remained
common was the heavy manipulation of accounting books to mislead the stakeholders of the
entity by finding loopholes in laws and regulations related to accounting (Barth & Landsman,
2010). For instance, in case of Enron the financial statements were manipulated by reporting the
expenses of 3.3 billion as the capital investments with the motive of achieving the desired
profitability. The financial statements of different entities are prepared using the different

Accounting Statement Analysis 6
accounting policies and procedures that creates the problem of non-uniformity which in turn
creates difficulty in making comparisons of two different entities. Furthermore, financial
statements are prepared on the basis of various professional judgments which are highly
subjective in nature and vary from person to person. According to the Penman (2007), the
financial statements are generally prepared using the historical cost accounting method where
costs of the assets are incorporated in the statement of financial position. However, some of the
entity’s assets are subject to changes in their market prices which are being ignored under
historical accounting. All these limitations affect the effectiveness of financial statements of the
entity.
It can now be concluded that financial statements plays vital role in assessing the financial
health of the business. Therefore, these statements must be prepared with due diligence and with
the highest degree of transparency in order to enable the stakeholders of the company to take
informed economic decisions in relation to such company. However, due to certain limitations
financial reports must not be completely relied upon by the stakeholders and they must seek for
the more information about the business performance of the company in the form of integrated
reports from the reporting entity.

Accounting Statement Analysis 7
References:
Barth, M.E. and Landsman, W.R., 2010. How did financial reporting contribute to the financial
crisis?. European accounting review, 19(3), pp.399-423.
Barth, M.E., 2006. Including estimates of the future in today's financial statements. Accounting
Horizons, 20(3), pp.271-285.
Callao, S., Jarne, J.I. and Laínez, J.A., 2007. Adoption of IFRS in Spain: Effect on the
comparability and relevance of financial reporting. Journal of International Accounting, Auditing
and Taxation, 16(2), pp.148-178.
Carraher, S. and Van Auken, H., 2013. The use of financial statements for decision making by
small firms. Journal of Small Business & Entrepreneurship, 26(3), pp.323-336.
Efendi, J., Srivastava, A. and Swanson, E.P., 2007. Why do corporate managers misstate
financial statements? The role of option compensation and other factors. Journal of financial
economics, 85(3), pp.667-708.
Foster, G., 2004. Financial Statement Analysis, 2/e. Pearson Education India.
Graham, J.R., Harvey, C.R. and Rajgopal, S., 2005. The economic implications of corporate
financial reporting. Journal of accounting and economics, 40(1-3), pp.3-73.
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business research, 37(sup1), pp.33-44.

Accounting Statement Analysis 8
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Tran, M., 2002. WorldCom accounting scandal. Available at:
https://www.theguardian.com/business/2002/aug/09/corporatefraud.worldcom2 Accessed on
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