Users of Accounting Information
The accounting process provides financial data for a broad range of individuals whose objectives in studying the data vary widely. Three primary users of accounting information were previously identified, Internal users, External users, and Government/ IRS. Each group uses accounting information differently, and requires the information to be presented differently.
Accounting supplies managers and owners with significant financial data that is useful for decision making. This type of accounting in generally referred to as managerial accounting.
Some of the ways internal users employ accounting information include the following:
- Assessing how management has discharged its responsibility for protecting and managing the company’s resources
- Shaping decisions about when to borrow or invest company resources
- Shaping decisions about expansion or downsizing
Typically called financial accounting, the record of a business’ financial history for use by external entities is used for many purposes. The external users of accounting information fall into six groups; each has different interests in the company and wants answers to unique questions. The groups and some of their possible questions are:
- Owners and prospective owners. Has the company earned satisfactory income on its total investment? Should an investment be made in this company? Should the present investment be increased, decreased, or retained at the same level? Can the company install costly pollution control equipment and still be profitable?
- Creditors and lenders. Should a loan be granted to the company? Will the company be able to pay its debts as they become due?
- Employees and their unions. Does the company have the ability to pay increased wages? Is the company financially able to provide long-term employment for its workforce?
- Customers. Does the company offer useful products at fair prices? Will the company survive long enough to honor its product warranties?
- Governmental units. Is the company, such as a local public utility, charging a fair rate for its services?
- General public. Is the company providing useful products and gainful employment for citizens without causing serious environmental problems?
Some of the ways external users employ accounting information include the following:
- Stockholders have the right to know how a company is managing its investments
- Federal and State Governments require tax returns and other documents often prepared by accountants
- Banks or lending institutions may use accounting information to guide decisions such as whether to lend or how much to lend a business
- Investors will also use accounting information to guide investment decisions.
General-purpose financial statements provide much of the information needed by external users of financial accounting. These financial statements are formal reports providing information on a company’s financial position, cash inflows and outflows, and the results of operations. Many companies publish these statements in annual reports, also known as a 10-K or a 10-Q (quarterly report). The annual report contains the independent auditor’s opinion as to the fairness of the financial statements, as well as information about the company’s activities, products, and plans. Typically, the best place to find these reports for a public company can be on their website under the Investor relations section. Financial statements used by external entities are prepared using generally accepted accounting principles, or GAAP.
Government agencies that track and use taxes are interested in the financial story of a business. They want to know whether the business is paying taxes according to current tax laws. The language in which tax-related financial statements are prepared is called IRC or Internal Revenue Code.
Limitations To Accounting Information
Limitations of accounting information include the following:
Accounting information plays a vital role in both financial and managerial oriented decisions. In order to come to effective financial or managerial decisions, many factors other than accounting should be duly considered. Despite its relevance to enterprises, it is not devoid of limitations.
I. Accounting is only one source of information and primarily provides information based on financial terms: Although this information is vital, decisions cannot be based solely on a monetary basis. Various decisions depend upon a diverse range of issues being considered. A unique combination of Quantitative as well as Qualitative factors should be considered to ensure an effective decision making process.
The historical perspective of financial accounting: In order to obtain a recent estimate of an entity’s financial performance, the corporate managers carefully scrutinize financial accounting information. In retrospect, this information is based on past performance. The information does provide clarity on the monetary issues but does not provide a definite insight into the strategic future; as the future holds various changes in terms of technology, economic situations as well as political scenarios etc. Such factors in relation to accounting are unpredictable. Therefore, a careful balance between historical accounting as well as the future forecasted outlook is required.
Historical cost accounting vs. underlying value in use: Some items loose their monetary value over a period of time, but under the financial accounting rules need to be included in financial reports. Though mentioned year after year in the books as monetary figures, the information may be unreliable due to the historical assumptions made on the item’s measurability criterion. For example, a machine in a textile factory is considered to have a useful life which extends over a period of ten years in monetary terms; however, after the period of ten years, the machine may still have the same value as prior years and contribute significantly to the overall operability of the factory.
Inability to reflect the true value of strategic management: Various factors such as goodwill and natural circumstances influence the operations of an enterprise; however, these elements are difficult to measure thus, leading to their unavoidable exclusion from financial reports. For example companies depend upon their shareholders, who in turn depend on the performance of the Chief Executive Officers. Although the CEOs may have been hired by the company based upon prior performance, their future performances are not reliably measurable as they may continually vary. In the initial stages, it may be impossible to measure whether the CEO’s presence will deter or appeal to the shareholders, which in turn will influence the profitability of the enterprise.
Measuring Volatility of external factors: Financial accounting information does not take into consideration volatile and ever increasing changes in the natural and commercial environment. Although scarcely measurable in monetary terms, their unstable nature may have adverse effects if included within the financial reports and have a volatile and cosmetic impact upon the earnings of the firm. For example, tariffs on trade, duties and other environmental issues can have significant short-term volatile effects on the organisation.
The effect of non-stable monetary unit: Based from region to region, accounting information is generated at all enterprises based on the assumption that the monetary unit is stable over a period of time. In the real world scenario, the unit fluctuates on a daily basis. Enterprises usually decide on a flat rate to calculate their financing and investing needs. However, this can have adverse impacts which cannot be communicated to shareholders, if the unit has high fluctuations.
- Quantification problem. Certain items are difficult to quantify in terms of value and not easily included in financial reports. For example, the value of a football club is dependent on its ability to attract supporters, this in turn is dependent on its ability to succeed, which is dependent on the abilities of the players, etc. it is not easy that an exact value could be placed on a player as this value will vary with the players fitness, etc.
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