In preparing and reporting financial statements, accountants must follow agreed guidelines. These guidelines are set by:
Generally Accepted Accounting Principles, (GAAP)
GAAP outline the standard framework of guidelines to be followed in financial accounting in all jurisdictions. It entails conventions, standards, and rules that accountants should follow in recording accounting statements and preparing financial statements. GAAP allows creditors and investors to make rational financial and investment decisions about a company. Through financial statements, GAAP allows business stakeholders assess the amounts, uncertainty, and timing of prospective cash receipts; changes in resources, improvement of business performance (Gibson, 2009). It also helps accountants maintain business records.
International Financial Reporting Standards (IFRS)
Gibson, (2009) explains that IFRS is a set of accounting standards developed to provide a framework on how public companies globally should prepare and disclose financial statements. Its importance is to ensure accountants uniformly maintain books of accounts that are understandable, comparable, relevant, and reliable to stakeholders. Financial information should be comparable relative to the preceding period for current period’s amounts. It also requires additional statement of financial position when an accounting policy is applied. IFRS provides that a complete set of financial statements is presented at least annually, though listed companies can publish interim financial statements.
The Securities and Exchange Commission (SEC)
SEC works as a watchdog to protect investors by ensuring that the markets are fair, efficient, and orderly. SEC works to facilitate capital formation by requiring public companies to prepare and disclose meaningful financial information to the public, to allow investors to make informed decisions about security transactions. The commission oversees the securities participants, such as exchanges, brokers and dealers, investment advisers, and mutual funds. It protects investors from potential loss of income by ensuring that fair and orderly practices are maintained in the capital markets (Gibson, 2009).
The Public Company Accounting Oversight Board (PCAOB)
The PCAOB oversees the audit reports of public companies to protect investors’ interests to ensure that accurate, informative, and independent audit reports are released to the public (Gibson, 2009). It investigates and instills discipline in all public registered accounting firms for breach of accounting regulations. It inspects audited reports, their performance and issuance to ensure that they are regulatory compliant.
Annual reports act as a source of information for investors to understand a company, sector, management views and analyze the financials involved (Gibson, 2009). They provide detailed information on the income statements, balance sheets, cash flows, and the financial schedules for two consecutive years. The financial statements help stakeholders understand a firm’s financial health.
Forms 10-K, 10-Q, and 8-K
These are reports that companies are required to provide to the public on the state of business. Form 10-K is prepared annually to give a comprehensive summary of a firm’s performance. It includes such information as firm’s organization structure, history, equity, and audited financial statements. Form 10-Q is filed on a quarterly basis for a firm’s quarter financial reports, but only three such forms are required as the fourth quarter’s information is included in 10-K. Additionally, form 8-K is also prepared in cases where a significant event has occurred in a company. Examples of these events are; bankruptcy, receivership, election or departure of a director, material definitive agreements, and acquisition or sale of assets (Gibson, 2009).
Financial statements are used to analyze a firm’s financial performance and position. They consist of balance sheet, income statement, cash flow statements, and the statement of retained earnings (Weil, Schipper, & Francis, 2014).
The balance sheet shows a firm’s assets, what the firm owns, and liabilities, what the firm is owed as at a particular period (Weil et al., 2014). It also shows equity, which is the difference between the assets and liabilities. In a balance sheet, the assets, both current and long-term are debited while the current, liabilities, long-term liabilities, and equity are credited. Both the credit and debit sides should balance.
It is also called the profit and loss statement shows a firm’s performance for an ending period. The income statement is formatted to include revenues and expenses with the difference being recorded as either a profit or a loss. The expenses and profits are recorded on the debit side while revenues and losses are included in the credit side (Weil et al., 2014).
Statement of retained earnings
This is the measure of the assets of a firm’s operations generated in profitable ventures, retained in the business, and not paid out to the shareholders as dividends (Weil et al., 2014). It consists of beginning retained earnings, prior period adjustments, additions, and subtraction as well as ending balance of retained earnings.
Cash flow statement
This gives an account of the sources and uses of cash for a particular fixed period of time. It serves to inform the stakeholders on the solvency of the business, where it is sourcing its operating cash from and on what that cash is being spend. It is segmented into cash from operating activities, such as operating income, depreciation expenses, gain or loss in sale of an asset, and increase in accounts receivable. Cash flows from investing and financing activities is also included. Cash flows from investing activities includes proceeds from sale of fixed assets, while cash flow from financing activities includes cash from securities invested (Weil et al., 2014).
The accounting equation
The accounting equation comprises of assets, liabilities and equity, whereby total assets must be equal to the sum of total liabilities and shareholder’s equity (Weil et al., 2014). Assets include; fixed assets, such as land, buildings, and plant and equipment, cash, cash equivalents, and market securities, inventories, account receivables, and goodwill.
Liabilities include; long term liabilities, and current liabilities, such as account payables, for example, notes payable, bonds payable, bank loans, money owed to suppliers and accruals, for instance, taxes owed, sales taxes, and Medicare taxes.
Equity consists of preferred stock, capital surplus, retained earnings, and common stock.