Objectives of financial reporting
/What are the Objectives of Financial Reporting?
The objectives of financial reporting cover three areas, dealing with useful information, cash flows, and liabilities. The objectives are noted below.
Provide Useful Information to Users
The first objective is to provide useful information to the users of financial reports. The information should be useful from a number of perspectives, such as whether to provide credit to a customer, whether to lend to a borrower, and whether to invest in a business. The information should be comprehensible to those with a reasonable grounding in business, which means that it should not be laced with jargon or burdened with so much detail that it is impossible to extract the essentials about a business from its financial statements.
Provide Cash Flow Information to Users
The second objective is to provide information about the cash flows to which an entity is subjected, including the timing and uncertainty of cash flows. This information is critical for determining the liquidity of a business, which in turn can be used to evaluate whether an organization can continue as a going concern.
Example
A company, Ocean Breeze Resorts, operates several beachfront hotels. Investors and creditors are interested not only in the company's profits but also in how much cash it generates and when that cash is available. Through its financial reports, the company provides the following:
A statement of cash flows, which shows cash inflows from room bookings, event hosting, and restaurant services. It also shows cash outflows for staff salaries, maintenance, utility bills, and loan repayments.
The report also shows the timing of peak cash inflows during the summer ,due to the tourist season. It also shows cash outflows, like property maintenance and renovations, which mostly occur during the off-season.
The report also addresses uncertainty, since management notes that cash inflows depend on weather conditions and economic factors like travel restrictions, which introduce uncertainty into future cash flows.
This information helps investors and creditors assess whether the company can generate enough cash to pay dividends or repay loans, when cash is expected to be available, and the risks that cash flows may vary unexpectedly due to seasonal or external factors.
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Provide Liability and Economic Resources Information to Users
The third objective is to disclose the obligations and economic resources of an entity. There should be an emphasis on the changes in liabilities and resources, which can be used to predict future cash flows. This information is contained within a reporting entity’s balance sheet, for which an example appears in the following exhibit.
Example
In the following exhibit, economic resources appear within the assets section at the top, while liabilities appear lower down in the report.
Source of the Financial Reporting Objectives
The preceding objectives were developed within the framework of a capitalist society, where accurate and complete information is needed in order to operate efficient capital markets. This list is an expanded version of the objectives set forth by the Financial Accounting Standards Board (FASB). The FASB assumed that creditors and investors would be the primary users of financial reports, and so developed a list of objectives that matches their needs.
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