Reporting of Financial Statement Analysis

Reporting Financial Statements

In order to ensure uniformity, which aids in the effective translation of information to shareholders regarding different businesses and different industries, financial statements must be prepared and reported using certain guidelines and procedures. In the US, companies must conform to GAAP, or generally accepted accounting principles. These principles are set forward by the FASB, or the Financial Accounting Standards Board. Its mission is "to establish and improve standards of financial accounting and reporting for the guidance and education of the public, including issuers, auditors, and users of financial information. " To achieve this, FASB has five goals:

1. Improve the usefulness of financial reporting by focusing on the primary characteristics of relevance and reliability, and on the qualities of comparability and consistency.
2. Keep standards current to reflect changes in methods of doing business and in the economy.
3. Consider promptly any significant areas of deficiency in financial reporting that might be improved through standard setting.
4. Promote international convergence of accounting standards concurrent with improving the quality of financial reporting.
5. Improve common understanding of the nature and purposes of information in financial reports.

GAAP

GAAP is used to prepare, present and report financial statements for a wide variety of entities, including publicly traded and privately held companies, non-profit organizations, and government authorities. The basic objectives of GAAP state that financial reporting should provide information that is:

• useful to present to potential investors and creditors and other users in making rational investment, credit, and other financial decisions;
• helpful to present to potential investors and creditors and other users in assessing the amounts, timing, and uncertainty of prospective cash receipts;
• about economic resources, the claims to those resources, and the changes in them;
• helpful for making financial decisions;
• helpful in making long-term decisions;
• helpful in improving the performance of the business; and
• useful in maintaining records.

To achieve these basic objectives and implement fundamental qualities, GAAP has four basic assumptions, four basic principles, and four basic constraints.

Assumptions

Accounting Entity: assumes that the business is separate from its owners or other businesses. Revenue and expense should be kept separate from personal expenses.

Going Concern: assumes that the business will be in operation indefinitely. This validates the methods of asset capitalization, depreciation, and amortization. Only when liquidation is certain is this assumption not applicable. The business will continue to exist in the unforeseeable future.

Monetary Unit principle: assumes a stable currency is going to be the unit of record. The FASB accepts the nominal value of the US Dollar as the monetary unit of record, unadjusted for inflation.

The Time-period principle: implies that the economic activities of an enterprise can be divided into artificial time periods.

Principles

Historical cost principle: requires companies to account and report based on acquisition costs rather than fair market value for most assets and liabilities. This principle provides information that is reliable (removing opportunity to provide subjective and potentially biased market values), but not very relevant. Thus, there is a trend to use fair values. Most debts and securities are now reported at market values.

Revenue recognition principle: requires companies to record when revenue is (1) realized or realizable and (2) earned, not when cash is received. This way of accounting is called accrual basis accounting.

Matching principle: implies that expenses have to be matched with revenues as long as it is reasonable to do so. Expenses are recognized not when the work is performed, or when a product is produced, but when the work or the product actually makes its contribution to revenue. If no connection with revenue can be established, cost may be charged as expenses to the current period (e.g., office salaries and other administrative expenses). This principle allows greater evaluation of actual profitability and performance (shows how much was spent to earn revenue). Depreciation and Cost of Goods Sold are good examples of the application of this principle.

Full Disclosure principle: implies that the amount and kinds of information disclosed should be decided based on trade-off analysis, as a larger amount of information costs more to prepare and use. Information disclosed should be enough to make a judgment while keeping costs reasonable.

Constraints

Objectivity principle: the company's financial statements provided by the accountants should be based on objective evidence.

Materiality principle: the significance of an item should be considered when it is reported. An item is considered significant when it would affect the decision of a reasonable individual.

Consistency principle: the company uses the same accounting principles and methods from period to period.

Conservatism principle: when choosing between two solutions, the one that will be least likely to overstate assets and income should be picked.

International Financial Reporting Standards (IFRS)

There has been a recent push in the US to adopt IFRS to replace GAAP. IFRS is designed as a common global language for business affairs so that company accounts are understandable and comparable across international boundaries. They are a consequence of growing international shareholding and trade and are particulalrly important for companies that have dealings in several countries. IFRS financial statements are required to consist of:

1. a Statement of Financial Position
2. an Income Statement and, separately, a Statement of Comprehensive Income, which reconciles Profit or Loss on the Income statement to total comprehensive income
3. a Statement of Changes in Equity (SOCE)
4. a Statement of Cash Flows
5. notes, including a summary of the significant accounting policies

Reporting Financial Statements

Financial statements in the US are required to conform to the principles set forth by GAAP.