Chapter 1

Financial Statements
Financial Statements
 Financial statements are the means by which the information accumulated and processed in
financial accounting is periodically communicated to the users.
 Financial statements are a structured financial representation of the financial position and
financial performance of an entity.

General Purpose financial statements

 General purpose financial statements are statements intended to meet the needs of users who
are not in a position to require an entity to prepare reports tailored to their particular
information needs.
 Reports prepared at the request of an entity’s management or bankers are NOT general purpose
financial statements because they are prepared SPECIFICALLY to meet the needs of
management or bankers.

Components of Financial Statements

 A complete set of financial statements comprises the following components
1. Statement of financial position
2. Income statement
3. Statement of Comprehensive income
4. Statement of changes in equity
5. Statement of cash flows
6. Notes, comprising a summary of significant accounting policies and other explanatory
information
 Many entities also present reports and statements such as environmental reports and value
added statements. However, such statements and reports are NOT components of financial
statements.

Objective of Financial Statements

 The objective of general purpose financial statements is to provide information about the
financial position, financial performance and cash flows of an entity that is useful to wide range
of users in making economic decisions.
 Financial statements also show the results of the stewardship of management of the resources
entrusted to it.
 To meet this objective, financial statements provide information about the following:
1. Assets
2. Liabilities
3. Equity
4. Income and expenses, including gains and losses
5. Contributions by and distributions to owners in their capacity as owners
6. Cash flows
  Such information along with the notes would assist users of financial statements in predicting
the entity’s cash flows and in particular their timing and certainty.
 Financial statements DO NOT provide all the information that users may need to make
economic decisions.
 The reason is that financial statements largely portray the financial effects of PAST EVENTS and
do not necessarily provide NONFINANCIAL information.

Financial Position
 The financial position comprises the assets, liabilities and equity of an entity at particular
moment in time.
 Financial position pertains to the liquidity, solvency, and the need of the entity for additional
financing.
 This information is showed in the statement of financial position.

Financial Performance
 Financial performance comprises of revenue, expenses and net income or loss of an entity for a
period of time.
 Performance is the level of income earned by the entity through the efficient and effective use
of its resources.
 It is also known as results of operations and is portrayed in the income statement and
statement of comprehensive income.

Cash Flows
 Cash flows are the cash receipts and cash payments arising from the operating, investing and
financing activities of the entity.
 This information is presented in the statement of cash flows.
 Cash flow information is useful in assessing the ability of the entity to generate cash and cash
equivalents.

Financial Reporting
 Financial reporting is the provision of financial information about an entity to external users
that is useful to them in making economic decisions and for assessing the effectiveness of the
entity’s management.
 The principal way of providing financial information to external users is through the annual
financial statements.
 Financial reporting encompasses NOT ONLY financial statements but also other means of
communicating information that relates directly or indirectly to the financial accounting process.
 Financial reports include not only financial statements but also other information such as
financial highlights, summary of important financial figures, analysis of financial statements and
significant ratios.
 Financial reports also include NONFINANCIAL information such as description of major products
and a listing of corporate officers and directors.
Objective of financial reporting
 The overall objective of financial reporting is to provide information that is useful for decision
making.

Target users of Financial Reporting

 General purpose financial reporting is directed primarily to the existing and potential investors,
lenders and other creditors which compose the primary user group.
 The reason is that existing and potential investors, lenders and other creditors have the most
critical and immediate need for information in financial reports.
 The primary users of financial information are the parties that provide resources to the entity.

Specific Objectives of Financial Reporting

 To provide information useful in making investing and credit decisions about providing
resources to the entity.
 To provide information useful in assessing the cash flow prospects of the entity.
 To provide information about entity resources, claims and changes in resources and claims.

Limitations of Financial Reporting

a. General purpose financial reports do not and cannot provide all of the information that existing
and potential investors, lenders and other creditors need.
b. General purpose financial reports are not designed to show the value of a reporting entity but
these reports provide information to help the primary users estimate the value of the entity.
c. General purpose financial reports are intended to provide common information to users and
cannot accommodate every specific request for information.
d. To a large extent, financial reports are based on estimate and judgement rather than exact
depiction.

Responsibility for financial statements

 The management if an entity has the primary responsibility for the preparation and presentation
of financial statements. Management is also accountable for the safekeeping of the resources
and their proper, efficient and profitable use.
 The Board of directors are in charge of giving responsibilities reviews and authorizes the
financial statements for issue before these are submitted to the shareholders of the entity.
 Shareholders are interested in information that helps them assess how effectively management
has fulfilled this role as this is relevant to the decision concerning their investment and the
reappointment or replacement of management.

General features of financial statements

1. Fair presentation and compliance with PFRS
2. Going concern
3. Accrual basis
4. Materiality and aggregation
 5. Offsetting
6. Frequency of reporting
7. Comparative information
8. Consistency of presentation

Fair Presentation
 Fair presentation requires an entity:
a. To select and apply accounting policies in accordance with PFRS.
b. To present information, including accounting policies, in a manner that provides relevant
and faithfully represented financial information.
c. To provide additional disclosures necessary for the users to understand the entity’s financial
statements
 An entity cannot rectify inappropriate accounting polices either by disclosure of the accounting
policies used or by notes or explanatory information.

Departure from standard

 If the management concludes that compliance with a requirement in a standard would be so
misleading, the entity shall depart from that requirement provided the relevant regulatory
Conceptual Framework requires, or otherwise does not prohibit, such departure.
 An entity is PERMITTED to depart from a standard:
a. In extremely rare circumstances.
b. When management concludes that compliance with the standard would be misleading.
c. When the departure from the standard is necessary to achieve fair presentation.
d. When the regulatory Conceptual Framework requires or otherwise does not prohibit such
departure.
 In such circumstances, it is incumbent upon the entity to disclose the following:
a. The management has concluded that the financial statements present fairly the financial
position, financial performance and cash flows of the entity.
b. That the entity has complied with applicable standards except that it has departed from a
particular requirement to achieve a fair presentation.
c. The title of the standard from which the entity has departed, the nature of the departure,
including the treatment that the standard would require, the reason why that treatment
would be so misleading and the treatment adopted.
d. For each period presented, the financial impact of the departure on each item in the
financial statements that would have been reported in complying with the requirement.

Going Concern
 Going concern means that the accounting entity is viewed as continuing in operation indefinitely
in the absence of evidence to the contrary.
 Going concern is also known as continuity assumption.
 Assets are normally recorded at original acquisition cost. As a rule, market values are ignored.
 However, some standards require measurement of certain assets at fair value.
  In making the assessment about the going concern assumption, management shall take into
account all available information about the future which is at least 12 months from the end of
reporting period.
 If the financial statements are not prepared on a going concern basis, such fact shall be
disclosed together with the measurement basis and the reason therefor.

Accrual Basis
 An entity shall prepare the financial statements, using the accrual basis of accounting except for
cash flow information.
 Accrual basis means that assets are recognized when receivable rather than when physically
received, and liabilities are recognized payable rather than when actually paid. They are
recorded and reported in the financial statements of the periods to which they relate.
 The essence of accrual accounting is the recognition of accounts receivable, accounts payable,
prepaid expenses, accrued expenses, deferred income, and accrued income.