© 2000 John Petroff
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© 2000 John Petroff |
A- For whom are GAAP financial statements intended
As it must be apparent from the first four chapters, there are many different possible reasons why one may be interested in knowing how well a firm is doing. For instance, suppliers, employees and customers may be concerned with the continued existence of a firm. The Internal Revenue Service (i.e. US tax collecting authority) may want to know whether the firm is really better off than what it has reported. And, management is obviously an avid user of financial statements with several possible purposes in mind: personnel evaluation, planning, control, capital allocation and budgeting.
All these objectives are however
secondary in comparison to the need for evaluation of the firm's
performance by those who have entrusted funds with the firm. There
are at least three reasons for this:
- the firm's performance may affect their claim against the firm
directly and immediately,
- their judgment about the firm's performance will determine their
willingness or unwillingness to leave their funds with the firm,
and
- their willingness to leave these funds with the firm will, in
turn, determine whether the firm will expand and prosper, or not.
The financial statements are aimed at and prepared for the outside providers of funds to the firm: shareholders, bondholders and other lenders. A major intent of the Securities and Exchange Act of 1933, was precisely to make sure that adequate information be disclosed to investors in financial statements. The Securities and Exchange Commission issues regulations pertaining to the content of financial statements for corporations whose shares are held by the general public in more than one state. In essence, these regulations are followed by all major companies in the United States. However, the accounting profession has most often pre-empted the need for changes in financial reporting. As shown below, the American Institute of Certified Public Accountants (AICPA at http://www.aicpa.org/) has issued over the years various publications that offer guidelines for accounting principles and practice. These guidelines are - certainly not requirements - only guidelines for the accounting profession to use where appropriate. Indeed, within the American system, there are different accounting systems for various sectors of the economy. For instance, retail, real estate, hotels, hospitals, all have their own particularities in accounting matters. In fact, there are no official statutes that regulate the accounting profession in the United States. Not from the Internal Revenue Service. Not from the Commerce Department. Even the regulations issued by the SEC pertained to only a requirement of complete disclosure of financial information, not how the accounting data has been compiled. (Note, however, that failure to comply with SEC disclosure requirements may result in a stop order and company liability to those who purchased shares.)
Aside from different rules of accounting being used by different
industries, each firm in the United States uses three sets of
accounting data: they are for
- management accounting
- tax accounting
- financial reporting
See review questions Q-6A.1 through Q-6A.8.
The most abundant data is the one for management accounting, but management also makes use of financial statements as core of its analysis and detailed data preparation. A firm's management uses the financial statements as informational tools far more than as analytical tools. For analytical purpose, management usually has a well developed management information system with reports containing data much more detailed and up-to-date than financial statements prepared for outsiders. For example management keeps track of sales by product, region, department, store, workshop and even individual salesperson, often on a daily basis. Another large set of numbers is needed for control in cost accounting. In preparing financial statements, management often looks at them through the eyes of an outside provider of funds.
See review questions Q-6A1.1 through Q-6A1.3.
Financial results are filed as basis for income tax assessment. The government often uses tax collections as a vehicle for economic policy. This is accomplished by various rules pertaining to what may, or may not, be reported as revenue or expense for tax purposes. For instance, the American government (as well as governments in many other countries) deems it useful for the country to encourage rapid modernization of equipment used in production. It accomplishes that by allowing an accelerated depreciation to be reported by firms in their Federal Corporate Income Tax return. Physically, the equipment does not depreciate faster in the first years than in subsequent years. Consequently, most firms use straight line depreciation for financial reporting purposes. But, for tax purposes, an accelerated depreciation is used and results in a tax saving on the tax return. Because of this discrepancy between depreciation for financial and depreciation for tax purposes, and many others, the results for tax purposes are not the same as those reported in the annual report. (The difference appears as a separate item in the balance sheet and is explained in a note to the financial statements, as will be outlined in Chapter 12 Section F-4 and Chapter 13 Section C-8.)
See review questions Q-6A2.1 and Q-6A2.2 .
3)- Financial reporting
The outside providers of funds, discussed in the previous chapters, are not exactly a homogeneous group: they are made of shareholders (both of common and preferred stocks) and lenders (of different type: from bondholder to banks and other creditors). The accounting profession must find a common viewpoint for all of these diverse outsiders. As was discussed in the previous two chapters, the concern of the outside providers of funds is not with the firm per se, but with the value of their claim against the firm. This is evident for instance in a number writings by leading professor of accounting who argue for a "relevant" accounting in the sense that accounting data is past history, but it must be presented in such a manner that one can draw inferences about the future. It is therefore necessary for the accounting numbers to help each of these outsiders in evaluating the financial asset which each claim represents.
See review questions Q-6A3.1 thought Q-6A3.3.
See research assignments R-6.2, R-6.3 and R-6.4.
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