Meaning of Financial Statements –
Financial Statements are the records of the financial position of a company. It is prepared by the management of the company with a view to present the financial performance of the business conducted by them to the owners and the external parties. The external parties are the parties who are either interested in the performance of the company. For eg – investors, government, tax authorities, employees etc.
The financial statements are a collection of –
- Balance Sheet – It presents the financial position of a company at the end of the accounting year.
- Profit and Loss account – It is also referred to as the Income Statement. It reflects the profit earned or loss incurred by the company during the accounting year.
- Cash flow statement – It summarises the cash position of the company by tracking the operating, investing and financing activities.
Nature of Financial Statements –
Financial statements are prepared for a particular period of time from accounting records maintained by the enterprise in a chronological order, i.e., as and when the events happened.
The figures recorded in the financial statement are quoted on the historical cost method and some principles/ conventions need to be followed to comply with the requirements of preparation of financial statements. They reveal the progress of management in achieving the desired results and the overall financial position of the enterprise.
The meaning and nature of financial statements can be better explained with the following points –
- Recorded Facts: Financial Statements do not record the financial figures at their current value, rather they are prepared using the data in accounting records of the enterprise which follow the historical cost method or the original cost method. For eg – fixed assets, trade receivable etc. are shown at their original cost. Therefore, the assets bought at different time periods would be shown at the cost price they were purchased.
- Accounting Conventions: Conventions are adopted to facilitate preparation of financial statements by enterprises. If all companies follow separate sets of accounting concepts and conventions, inter company comparison would become difficult and may not render fruitful results. Thus, accounting conventions are followed by companies consistently to make financial statements simpler, realistic and practical. For eg – inventory valuation follows the concept of cost or net realisable value whichever is lower, assets are presented at cost less depreciation value.
- Postulates: Postulates are certain assumptions concerning the economic, political and social environment in which accounting should operate, that are made by the accountant while making accounting records. Some common postulates are – going concern concept, money measurement postulate etc. Going concern postulate assumes that the entity has no intention of closing down and it will exist for a foreseeable future. These assumptions are followed while preparing accounting books.
- Personal Judgements: The personal judgement of the accountant plays a vital role even though certain accounting conventions are followed in preparing financial statements. Eg: when applying cost or market value whichever is less to inventory valuation, the accountant will use his personal judgement in evaluation of the cost in a particular case. The provisions made for doubtful debts are also affected by personal opinions and estimates of the accountant.
Thus, the meaning and nature of financial statements can be understood by the fact that they are based on historical costs and follow certain conventions and assumptions. They are also affected by the estimates or judgements of the accountant preparing them. All these factors play a massive role in the final draft of the financial statements.
Chapter 3 – Financial Statements of a Company
- Meaning and Nature of Financial Statements
- Objectives of Financial Statements
- Types of Financial Statements
- Uses and Importance of Financial Statements
- Limitations of Financial Statements