Financial Statements Conceptual Frameworks and Financial Statements Essay

Financial Statements

Conceptual Frameworks and Financial Statements

It has been said that financial statements provide comprehensive information about the reporting entity that is useful to existing and potential stakeholders. While that is generally considered to be true, it is important to address what makes it true. Financial statements are created by the company to which the financial information belongs, so there is some concern that these might not be as accurate as they would be if they were to be completed by an independent party (Hall & McKeith, 2010). This is why some financial statements will be independently verified and that information will be included in the statements. By doing that, the company is putting their information on the line and saying it is clearly correct (Elliot & Elliot, 2011). That can help investors and others when they are trying to make a decision about the financial health of a company and whether they want to be a part of that company's future (Elliot & Elliot, 2011; Melville, 2012).

Addressed here will be an analysis of the above-referenced statement in the context of various specifics regarding financial statements. The conceptual framework, which is a relatively new concept, will be addressed first. This will be followed by the general purpose and key components of financial statements, as well as the issues that can surround and cloud them. Capital maintenance must also be touched on, for it must be understood in order to accept the bigger picture of the value of financial statements. Finally, a summary and discussion will conclude the paper and showcase the information that has been presented, as well as why it provides so much value to investors and other stakeholders.

The Concept of a Conceptual Framework

The idea of a conceptual framework for financial statements is very new (Elliot & Elliot, 2011). Most of the standards that have been set for accounting in the past have not provided or been based upon any kind of conceptual framework at all (Dunn, 2010). That is a serious concern, because it led to haphazard information and the creation of statements that basically had no rhyme or reason to them. While they did provide some valuable information, locating that information and making sure one could find it based on the same information being provided in other statements was frustrating (Hall & McKeith, 2010). This was seen for financial statements in one country alone, and for statements where an international comparison was being made (Elliot & Elliot, 2011). Having specific standards and a conceptual framework to use as a guide for creating financial statements makes them much easier to cope with and helps to streamline and simplify them.

From the point-of-view of the investor who needs to determine whether a particular company is a good risk or whether it would be best to avoid it in favor or a competing company, a conceptual framework for financial statements is very important (Melville, 2012). It was something that was needed long before investors could really articulate what was needed and why. Theoretically, it should be the conceptual framework that drives the creation of standardization when it comes to financial statements (Melville, 2012). However, there are problems with that and it is often the political, social, and economic factors that are actually driving the creation of these types of statements. Fortunately, adjustments continue to be made and there is hope for future improvement. A strengthening of the conceptual framework could provide investors with much better information.

The General Purpose of Financial Statements

The main purpose of the financial statement is not to put everything in one place for the company. In theory, the company already knows all of its financial information, and does not need it provided in report form. That just makes more work for the company, and it would likely not produce a financial statement for its own internal use. However, financial statements are created because they are important to the end user (Melville, 2012). In the case of the vast majority of these statements, the end user is the investor who may be considering putting his or her money into that company. Naturally, this money is very important to the company, especially if it is trying to grow, move past competitors, or simply stay in the market (Elliot & Elliot, 2011). Not all companies look good on paper, so a financial statement can be the downfall of a company that is trying to impress investors if the company has serious problems with cash flow or does not follow a conceptual framework that is easy and simple for the investor to decipher (Melville, 2012).Because a financial statement has such an impact on investors, it must be done right (Dunn, 2010). This is especially true if a company wants to bring in investors from overseas, since there are some difficulties with accounting standards for financial statements across international lines (Dunn, 2010). Until there are international accounting standards that every company is required to follow, confusion will persist. However, there are some basic standards that are generally accepted as being international (Melville, 2012). Companies that want to have success in the international market when it comes to investors should produce reports that meet international standards. This is part of understanding the general purpose of financial reports and who they are really for.

Key Components of the Financial Statement

In order to provide a good financial statement to the investors that are considering a company, that company must understand the key components that are necessary in financial statement (Dunn, 2010). Leaving out something important could be considered a critical error that would stop an investor from considering the company any further, even if the information was not "required" to be included. Companies must be intuitive and must also be aware of what their competitors are doing and what investors are expecting when they create their financial statements (Melville, 2012). They must also couple this information with the information that is required, so they do not run afoul of the reporting entities to which they must provide accurate financial information. Many things can go into a financial statement, but there are two main groups that have to be considered when creating them.

These are the measurement of the company's performance and the measurement of its financial position (Elliott & Elliott, 2011). Without both of those areas, there will be many things missing from a financial statement that investors will want to know. The company's performance is measured by considering the expenses the company must pay out vs. The income it generates (Elliott & Elliott, 2011). The financial position of the company is different, and is measured through an examination of assets, equity, and liabilities (Elliott & Elliott, 2011). When it comes to financial statements, both of these areas must be examined in order to clearly provide an investor with information needed in order to determine if an investment in the company will be a good risk. For example, if the company has a low level of liabilities and many assets that can be encouraging, but not if the company is paying out so many expenses that it has no income and is actually losing money.

A Consideration of Capital Maintenance

Another important issue for an investor looking at a financial statement is the consideration of capital maintenance. There are set amounts of money needed to maintain the capital in a business (Melville, 2012). Anything that is made over and above that amount can be considered profit, but it would be improper to consider all income as profit. The capital must be maintained with some of that income, and so that income is not actually profit (Melville, 2012). For example, if a business brings in $10,000 in one month, but needed $7,000 to maintain capital, it cannot realistic claim that it brought in $10,000 in profit. It can, however, claim that it brought in $3,000 in profit after capital maintenance. This is one thing an investor must be very careful of, because it can be difficult to determine if a company is handling this information correctly due to the discrepancies that are often seen in the way companies generate their financial statements (Hall & McKeith, 2010).

For any company that does not understand capital maintenance correctly, the financial statements it generates can be incorrect. That can lead an investor to believe the company is much more profitable than what it actual is, which can be very harmful from an investment standpoint (Dunn, 2010). More standardization and the following of a conceptual framework for financial statements can help to alleviate some of the difficulties with issues like capital maintenance, but until these are completely integrated and used by every company on an international level, investors will have to be aware of the concerns they could face in determining this information (Melville, 2012). The more awareness they have the more protected they will be financially, and the less likely they will be to make a bad investment decision….....