Financial Statements & Documentation

Financial Statements & Documentation

Introduction

·       Financial statements are formal records of the financial activities and position of a business, organization, or individual.

·       They summarize all accounting data into systematic statements that provide information about assets, liabilities, equity, income, expenses, and cash flows.

·       They are prepared at the end of an accounting period to provide a true and fair view of the financial performance and position of the entity.

• American Institute of Certified Public Accountants (AICPA):
  “Financial statements are the means of conveying to management and to interested outsiders a concise picture of the profitability and financial position of a business.”
• Anthony & Reece:
  “Financial statements are the end products of the accounting process, which reveal the financial results of the business operations and the financial position of the concern.”
• Simple Definition:
  Financial statements are a collection of reports (Balance Sheet, Income Statement, Cash Flow Statement, etc.) that provide quantitative financial information about a business.

Nature of Financial Statements

1. Historical in Nature – They record past events, not future projections.
2. Expressed in Monetary Terms – Only items measurable in money are included.
3. Prepared Periodically – Usually at the end of a quarter or year.
4. Summarized Form – They present summarized financial data, not detailed records.
5. Derived from Accounting Records – Based on journal entries, ledgers, trial balances.
6. Affected by Personal Judgments – Involves estimates (e.g., depreciation, provision for bad debts).
7. Regulated by Principles/Standards – Follow GAAP, IFRS, or other accounting standards.

Objectives of Financial Statements

1. Provide Information about Financial Position – Assets, liabilities, and equity.
2. Measure Financial Performance – Profit or loss during a period.
3. Assist in Decision-Making – Useful for managers, investors, creditors, and regulators.
4. Determine Cash Flows – Sources and uses of funds.
5. Ensure Accountability & Stewardship – Management accountability towards owners.
6. Facilitate Comparison – Between different years and with other firms.
7. Legal & Statutory Compliance – Required by law for audit and tax purposes.

Characteristics of Financial Statements

1. Reliability – Information should be accurate and free from bias.
2. Relevance – Must be useful for decision-making.
3. Understandability – Presented in a clear, simple format.
4. Comparability – Consistent accounting methods to compare across periods/firms.
5. Materiality – Only significant information should be included.
6. Objectivity – Based on verifiable evidence, not personal opinion.
7. Timeliness – Should be prepared within a reasonable time.

Limitations of Financial Statements

1. Historical Nature – Do not show future potential.
2. Incomplete Information – Non-monetary factors (e.g., employee satisfaction, goodwill reputation) are excluded.
3. Affected by Estimates – Provisions for depreciation, doubtful debts, etc. may not be exact.
4. Influenced by Accounting Policies – Different methods (FIFO, LIFO, straight-line depreciation, WDV) affect results.
5. No Real Value Representation – Assets are shown at historical cost, not current market value.
6. Possibility of Manipulation – Window dressing may mislead stakeholders.
7. Do Not Reflect Economic Conditions – Inflation/deflation is not adequately considered.

Examples of Financial Statements

1. Income Statement (Profit & Loss Account):
   Shows revenue, expenses, and net profit/loss.
• Example: A hospital reports ₹50,00,000 revenue, ₹40,00,000 expenses → Net Profit ₹10,00,000.
2. Balance Sheet (Statement of Financial Position):
   Shows assets, liabilities, and equity at year-end.
• Example:
• Assets: ₹80,00,000
• Liabilities: ₹50,00,000
• Equity: ₹30,00,000
3. Cash Flow Statement:
   Reports inflow and outflow of cash from operating, investing, and financing activities.
• Example: Operating inflow ₹15,00,000, investing outflow ₹8,00,000, financing inflow ₹5,00,000 → Net cash inflow ₹12,00,000.
4. Statement of Changes in Equity:
   Shows changes in owners’ capital, retained earnings, and reserves.
5. Notes to Accounts:
   Explanations, accounting policies, and additional details of items in the financial statements.

Documentation in Financial Statements

• Invoices, Vouchers, Bills – Proof of transactions.
• Ledgers & Journals – Primary records.
• Bank Statements – Verification of cash/bank balances.
• Contracts & Agreements – For loans, leases, investments.
• Audit Reports – Independent certification of correctness.

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