Nature of Financial Statements

Financial Statements are external reports which give financial information to outsiders. The basic financial statements are the balance sheet and the income statements (also called the profit and loss account). In addition, one more financial statement is also prepared especially by the limited companies namely, the statements of cash flows. The nature of the financial statements has been described by the American Institute of Certified Public Accountants as:

“Financial statements are prepared for the purpose of presenting a periodical review or report on progress by management and deal with the status of the investment in the business and the results achieved during the period under review. They reflect a combination of record facts, accounting conventions and personal judgments and the judgments necessarily depends on the competence and integrity of those who make them and on their adherence to generally accepted accounting principles and conventions.

Recorded facts:

The recorded facts refer to the figure in financial statements as taken from accounting records. Balance sheet is not a statement of values in terms of the present worth of the business unit. Similarly, the statement of income records only the actual amount realized and accrued as revenue and the amount spent as expenses. In some cases, however, revaluation of assets and liabilities may be attempted, as for example, at the time of admission of a partner. But such revaluations are not altered from year to year so as to show the current worth or the business. The revalued figures continue for longer periods.

Accounting concepts and conventions:

Simply stated, such terms refer to basic assumptions, procedures or conditions accepted by common consent, It has already been stated that the financial statements to be useful and comparable must be prepared in line with the generally accepted accounting principles. In general terms, the concepts and conventions are concerned with the problems of assets valuations, depreciation of fixed assets, distinction between expenditure and expense and the matching of expenses and revenues for the proper measurement of income. Accounting statements are prepared on the assumption that the business is a separate entity distinct from its owners. And that only monetary transactions shall be recorded; that the business will continue indefinitely and that the financial statements shall be prepared at regular intervals. Any departure from these well recognized concepts and conventions must be clearly stated at the foot of the financial statements.
Personal Judgment: Accounting is a social and not an exact science and therefore financial statements reflect the opinion and judgment of the accountant and of management. The estimated life and the method of depreciation to be used for allocation of cost, the method of inventory valuation, the valuation of fixed assets, the method of valuation of intangible assets, such as goodwill, patents, copyright, trade marks and so on are some areas where the accountants and management have ample scope to exercise their personal judgment. The elements of personal judgment would affect the accuracy of the financial statements. However the strict application of generally accepted accounting principles might, to a great extent, reduce the ill-effects of personal judgment and opinion.

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