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Develop skills in handling accounting data to prepare financial statements and appreciate the role of accounting from an open systems perspective

Understand the functions of accounting standards and accounting regulatory bodies and the importance of business accounting to corporate and business planning

Appreciate the role and use of accounting in management decision making and control

Understand the behavioural dimensions of accounting approaches and techniques

Demonstrate a broad appreciation of current developments in accounting

Question

An annual report of an entity is a comprehensive report containing relevant information of significant activities undertaken by the entity in the particular financial year. This report primarily contains financial information relating to the business of the entity but it also contains certain non-financial information about the reporting entity. It gives the true picture of company’s state of affairs. The financial performance of the company in any particular year can be assessed using its annual reports. It also contains a section which contain the details of the key personnel i.e. chairman, board of directors etc. of the company. The annual reports are prepared and presented for various purposes such as providing the financial information to various users, highlighting the key achievements of the company, promoting the business of the company by showing the sound financial results, attracting the prospective investors to invest their funds in the company, complying the regulations formed by various governmental agencies and to raise the finances from banks and financial institutions.  

There are various users of the annual reports of the company. These users are mainly categorised as direct users and indirect users. Direct users of annual reports of the company are the ones whose decisions are directly influenced by the financial results of the company. The direct users of a reporting entity may range from its shareholders or investors, prospective investors, management i.e. the top level and line level management, suppliers to the providers of finance and creditors etc. However, the indirect users are those parties which represents and functions for the direct users. They are not directly influenced with the reporting entity. Indirect users of a company can be the regulatory bodies, stock market and the financial analysts or advisors. Few of the user groups of company’s annual reports have been discussed below:

These are the parties that fulfils the finance requirements of the business entities by providing them the loans and advances for various business purposes. Before granting the huge amount of funds in the form of loan the financial institutions needs to assess the financial health as well as the credit worthiness of the company. To evaluate the financial performance of the company which has applied for the funds, these finance providers studies the financial reports of the entity which contains where financial statements such as statement of financial position or statement of financial performance or cash flow statement (Armstrong, Guay & Weber, 2010). The banks needs to refer to the statement of financial performance to critically analyse the overall profitability position and the statement of financial position to examine the asset base of the borrowing company. The loans by these banks and financial institutions are generally provided on the basis of security provided by the borrowing entities. The borrowing entities keeps their assets on mortgage to raise funds from these financial institutions. While assessing the financial situation of the borrowing entity, these finance providers not only considers the past or current performance but they also need to consider the financial performance of the company in the upcoming financial years. For this purpose these financial institutions demands the projected financial statements for the certain financing years in which the company is going to operate its business. Before initiating the funding process, these finance providers have to determine whether the company will be able to meet the interest obligations related to the loan amount on time to time basis and whether it will honour the final payment on time. In case of any default on part of borrowing company on the repayment of principle amount or interest payments, the financial institutions can recover the due amount by disposing the assets (securities) that are backed with the loan. Therefore, they need to assess the valuation and situation of securitised assets of the borrowing company on a regular basis until the loan is repaid entirely. However, the statement of financial position of the company is prepared on the basis of historical cost valuations therefore it gets difficult for these providers of finance to ascertain the true valuation of assets held as collateral securities from the balance sheet.

Answer

Shareholders are the owners of the company who are interested in the company’s profit in return of their capital investment in the company. They are entitled to the dividend which is paid out of the total earnings of the company. Therefore, these shareholders are interested in analysing the overall earnings of the company to assess their return that company can potentially offer to them and the risk involved in their investment decision. Moreover, only the companies with higher earnings potential are preferred by the potential investors as these companies are able to offer higher return on investments to their shareholders and investors. If the track record of company’s shows losses or high fluctuations of the profits majorly on the downside, then it cannot attract the potential investors to bring in the capital to the business as it involves higher financial risk.

They are generally the most interested users of the financial statements of the company as they have to overlook the functioning of entire business of the company. To manage the business affairs successfully, top management of the company formulates various strategies and policies. For such strategic and financial planning, managers need the information as to how the company is performing and what are reasons of any business failures or losses, if any. The financial statement analysis helps the managers to identify the financial strengths and weaknesses of business which enables them to take sound economic and strategic decisions of the company. The lower level management personnel who are typically involved in carrying out the basic operations of the business requires the financial information to understand the financial targets and goals of their organisation. The financial goals helps them in taking the necessary and requisite actions so that they can contribute to the success of the business. The financial results from the past terms helps them in showing them the areas where improvements can be made in future. Moreover, the sound financial situation of the business also helps in determining the labour retention capacity of the company. If the company is not performing well, it imposes higher risk on the employees of the company regarding the loss of their jobs. They may need the financial information to assess the profitability of the company so that they can understand its impact on their future remuneration (Debreceny, Gray & Mock, 2001). Also, the employees of the company requires to know about the stock prices of the company when they holds the stock option plans offered by the company (Healy & Palepu, 2012).

Direct and Indirect Users of Annual Reports

Every business is regulated by one or the other governmental regulators. These governmental bodies needs to assess the performance of the economy to make necessary policies, plans and budgets for the upcoming years. Therefore, they refer the annual financial reports of the companies to determine their contribution to the overall economy of the country (Kaplan Financial Knowledge Bank, 2012). Moreover, the regulatory bodies are concerned with the financial performance of the company so as to ascertain their tax obligations. The governmental agencies review the financial information of the company to identify the correctness of tax claims made in the annual tax returns by the companies and to ensure that these entities are regular in meeting their taxes expenses. Further, there are various governmental regulators that requires the company to comply with their rules and regulations in various contexts in the course of their business. So annual reports enables those regulators to determine whether the companies are complying with such regulations and if there is need to impose fines and penalties on such companies for the non-compliances or severe intervention of governmental rules and policies (Thomason, 2017).

They need to know about the financial information of the company to evaluate the credit worthiness of the company so as to trade grant credit to the companies for the supply of goods. The terms and conditions of the credit to be allowed to these entities are set on the basis of assessment of entity’s financial health. These suppliers are interested in giving the trade credits to the firms with financial stability in the business in terms of ability of firm to meet the short term financial obligations. They require the financial reports to examine the effectiveness and efficiency of firm’s ability to generate the cash flows for its business (EFRAG, 2009). A firm with bad track record of financial results or low credit ratings is generally not preferred by the dealers of wholesale markets to allow trade credits as it increases their risk of default. On the other hand, if the firm’s annual statements shows the satisfactory financial performance in past and current periods, then more and more suppliers are attracted to deal with such firms even on the basis of trade credit. The credit worthiness of the company is sometimes not revealed by the financial statements of company as it does not contain the details of average period taken by the firm to settle its trade payables and also it lacks comparative data from last few financial years hence annual reports fails to satisfy the information needs of the company.

Providers of Finance

A wide customer base can only be maintained by a business entity in case of its strong goodwill. The sound financial performance of the company helps it in maintaining its goodwill in the market. Customers need information of company’s performance in terms of profitability. As profitability of the company indicates that company has generated sufficient sales by achieving maximum customer satisfaction (Pokhrel, 2016). Also, the long term and short term financial standing of the company raises the confidence of its customers that the company will be able to serve their demands in the long run. The customers are interested in assessing the firm’s potential to supply the top quality products and services along with adequate after sale services. They are also interested in knowing about the environmental policies which the firm is supposed to comply and the status of firm in complying with those policies. However, the annual reports of the company do not supply this kind of non-monetary information and hence it gets difficult for the customers to assess their potential dealers i.e. suppliers.

The goodwill of the firm supports it in surviving and growing smoothly. The company is always responsible to the society in which it is operating. It must fulfil the expectations of the society by efficient utilisation of resources of the society. The society desire to have an adequate knowledge of firm’s impact on the local community and the environment in which it is operating (Dunn, N.D.) It is of utmost importance for a firm to generate the trust of general public and therefore such firms must deliver the information regarding the efforts it makes to fulfil the corporate social responsibility.

Though the information provided through the means of annual report helps the users in their decision making to a great extent, still it often fails to satisfy the entire user’s needs of information completely (Way, 2017). Annual reporting is mainly concerned with including and communicating the financial information to the intended users of the reports through the means of such annual reports. However, the non-financial information needs of the users remains unfulfilled by such reports (Hirshleifer & Teoh, 2003).

The financial statements of the company do not enable the users to figure out the accurate worth of company’s business. The cash flow statements and the other statements of financial performance and position merely shows as to how much the entity is earning or spending on the monthly basis and then these monthly statements are combined to determine the annual results. However, these statements do not show how many actual assets or liabilities are in the name of company currently (Money Matters, 2017). Also, the financial statements of the company lacks the information regarding the market trends and demands. Although the statement of financial performance of the entity shows information regarding the quantum of revenue that is generated from the sale of products and services but these figures do not reflect the impact of market trends and demands (Jane, 2017). Due to this the financial statements proves to provide limited information to the users to reach at the correct decision making. An annual report may show that the current fiscal year’s income of the company is more than the previous financial year. But such information does not provide the concrete base to conclude that company is performing well. Furthermore, the financial statements of all the entities are prepared on the basis of their historical cost valuation of the assets (Ball, 2006). But the values of the assets possessed by the business of the company keeps on changing with the changing market conditions. The fair values of these assets are therefore ignored in the financial statements which does not enable the users of these statements to identify the true and appropriate value of its business (Ettredge, Richardson & Scholz, 2001). Rather, the annual reports should provide the comparative data of the other rivalry firms from the same industry which is necessary to assess the true picture of company’s financial performance. Further, the financial standing of the company is not the only factor that defines the performance of the business of the company rather the other information regarding the company’s efficiency in performing several marketing campaigns in comparison to its competitors, the company’s relationship with its employees and managers etc. is also necessary to understand the overall soundness of entity’s existence (Graham, Harvey, Rajgopal, 2005).

Investors or Shareholders


Since annual reports of the company serves as the only means of communication of financial results to its stakeholders to make them enable to make multitude of analyses before reaching to the final decision regarding their economic association with the company, these reports must provide all the necessary and relevant data to such user groups (Elliott & Elliott, 2007). The extent and the reasons why these annual reports do not satisfy the overall information needs of the users have now been discussed above. Therefore, the initiatives can be taken to overcome the limitations of the annual financial reports will be discussed further.

Firstly, the companies must provide the details of its quarterly results to the intended users. The interim financial reports must be emphasised by the management of the company to deliver the financial results of the company on the periodic basis so that they can better assess the overall performance of the company in a fiscal year (Ernst & Young, 2014). The annual reports must contain the non-financial information also such the market competition, the political situation of the company, the details of company’s efficiency in complying the governmental rules and regulations, customer satisfaction, employee relations etc. Moreover, the financial statements of the company must be prepared taking into account the fair values of the assets that are resulted due to the changed market situations so that true and fair valuation of company’s worth can be made by the readers of financial reports (Ettredge, Richardson & Scholz, 2001). The financial information that is incorporated in the annual reports must be based on the realistic business situation and not merely on the accounting concepts and conventions. The financial statements of the company must be prepared and presented keeping in mind the inflationary effects of the necessary aspects of the business (Sanz, 2011).

References:

Armstrong, C.S., Guay, W.R. and Weber, J.P., 2010. The role of information and financial reporting in corporate governance and debt contracting. Journal of Accounting and Economics, 50(2), pp.179-234.

Ball, R., 2006. International Financial Reporting Standards (IFRS): pros and cons for investors. Accounting and business research, 36(sup1), pp.5-27.

Debreceny, R., Gray, G.L. and Mock, T.J., 2001. Financial reporting websites: what users want in terms of form and content.

Dunn, P., (N.D.). Use and Users of Financial Statements. Retrieved From: < https://www.bookkeepers.org.uk/out/?dlid=54362> Accessed on 03-01-2018.

EFRAG, (2009). Elements of the Framework Debate: The Needs of Users of Financial Information a User Survey. Retrieved From: < https://www.efrag.org/Assets/Download?assetUrl=%2Fsites%2Fwebpublishing%2FSiteAssets%2FPAAinE%2520Paper%2520-%2520The%2520Needs%2520of%2520Users%2520of%25

20Financial%2520Information%2520-%2520May%25202009.pdf> Accessed on 03-01-2018.

Elliott, B. and Elliott, J., 2007. Financial accounting and reporting. Pearson Education.

Ernst & Young, 2014. Disclosure effectiveness: What investors, company executives and other stakeholders are saying. Retrieved from: < https://www.ey.com/Publication/vwLUAssets/EY-disclosure-effectiveness-november-2014/$FILE/EY-disclosure-effectiveness-november-2014.pdf> Accessed on 02-01-2018.

Ettredge, M., Richardson, V.J. and Scholz, S., 2001. The presentation of financial information at corporate Web sites. International Journal of Accounting Information Systems, 2(3), pp.149-168.

Freeman, R.E. and Reed, D.L., 1983. Stockholders and stakeholders: A new perspective on corporate governance. California management review, 25(3), pp.88-106.

Graham, J.R., Harvey, C.R. and Rajgopal, S., 2005. The economic implications of corporate financial reporting. Journal of accounting and economics, 40(1), pp.3-73.

Healy, P.M. and Palepu, K.G., 2012. Business analysis valuation: Using financial statements. Cengage Learning.

Hirshleifer, D. and Teoh, S.H., 2003. Limited attention, information disclosure, and financial reporting. Journal of accounting and economics, 36(1), pp.337-386.

Jane, M., 2017. Limitations of Using Financial Statements to Analyse Performance. Retrieved from: https://smallbusiness.chron.com/limitations-using-financial-statements-analyze-performance-24471.html> Accessed on 02-01-2018.

Kaplan Financial Knowledge Bank, 2012. The conceptual Framework. Users of the Financial Statements. Retrieved From: < https://kfknowledgebank.kaplan.co.uk/KFKB/Wiki%20Pages/The%20Users%20of%20Financial%20Statements.aspx> Accessed on 03-01-2018.

Money Matters, 2017. Limitations of Financial Statements. Retrieved from: < https://accountlearning.com/limitations-of-financial-statements/> Accessed on 02-01-2018.

Pokhrel, B.D., 2016. Financial statement: Who use them and why? Retrieved From: < https://www.bayt.com/en/specialties/q/308642/financial-statement-who-use-them-and-why/> Accessed on 03-01-2018.

Sanz, B., 2011, Trying to Overcome the Limitations of the Financial Accounts: The Spanish Experience. Retrieved from: https://www.imf.org/external/np/seminars/eng/2011/sta/pdf/spain.pdf. Accessed on 02-01-2018.

Thomason, K., 2017. Who Are the Users of Financial Statements? Retrieved From: < https://bizfluent.com/info-8190111-users-financial-statements.html> Accessed on 03-01-2018.

Way. J., (2017). What Is the Importance of a Company's Financial Statements? Retrieved From: < https://smallbusiness.chron.com/importance-companys-financial-statements-21332.html> Accessed on 03-01-2018.

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