Question

1. What information should an investor be able to find within the financial statements and why is is important that they be reviewed by a third party?

2. Firms speak of the use of Generally Accepted Accounting Principles (GAAP). Why is this approach important and who assures that it is followed? (There are several parties involved)

3. What is accrual accounting and how does it differ from cash based accounting?

4. What information does the balance sheet contain as compared to the income statement?

Answer 1

Answer to Q#1 (First question in the list): For a firm, financial statements refer to set of financial reports prepared and presented based on accounting records maintained at the end of respective reporting period concerned, in accordance with applicable statutory requirements under the U.S.GAAP and other applicable accounting standards as per IFRS. Financial statements of a company or a firm consists of Balance sheet as at the last day of the reporting period, Income statement & Statement of cash flows for the reporting period and Notes to accounts thereon. Income statement explains operating results of the company achieved during the reporting period in terms of net income or net loss for the period. When revenues are more than costs & expenses recorded for the period, firm is said to have earned net income; When revenues are less than costs & expenses recorded for the period, firm is said to have suffered net loss for the period. Balance sheet explains financial position of the company as at last day of the reporting period in terms of net assets held & net liabilities owed by the company. Difference between total net assets and total net liabilities is the networth of the company. Net worth of the company is technically termed as stockholders' equity wherein data related to amount & class of equity capital contributed to the company, retained earnings till the last day of reporting period, reduced by treasury stock held, if any will be reported. Assets will be classified as current assets and non-current assets. If assets' life time is estimated to be one year or less from the last day of reporting period, they are current assets, otherwise, they are non-current assets. Similarly, if liabilities are payable within one year from the last day of reporting period, they are current liabilities, otherwise, they are long-term liabilities. Third parties may use the financial statements for various purposes. That is, investors use them for analyzing and deciding whether to contribute capital to the company or not; creditors use them for analyzing and deciding whether to supply goods or services to the firm on account or not; Bankers and financial institutions use them for analyzing and deciding whether to lend money to the firm or not; Tax authorities use them for analyzing and confirming whether tax dues & assets reported by firm are correct or not.