Question

E1‑39. Assessing the Role of Financial Statements in Society

Financial statement information plays an important role in modern society and business.

a. Identify two or more external stakeholders who are interested in a company’s financial statements and what their particular interests are.

b. What are generally accepted accounting principles? What organizations have primary responsibility for the formulation of GAAP?

c. What role does financial statement information play in the allocation of society’s financial resources?

d. What are three aspects of the accounting environment that can create ethical pressure on management?

Answer 1

(a): Two external stakeholders who are interested in a company’s financial statements are – (i) creditors and lenders (ii) suppliers.

The particular interest of creditors and lenders is that they use financial statements to determine the financial health of the company and their ability to service debts. They use financial statements to determine whether loan should be granted to a company or not and whether the company be able to pay its debts as they become due.

Suppliers and vendors use financial statements to determine the likelihood of being paid and the future growth and survival prospects of a company.

(b): GAAP or generally accepted accounting principles is a cluster of accounting standards. In other words it is a common set of accepted accounting principles, standards, and procedures that companies and their accountants must follow when they compile their financial statements. The organizations that have prime responsibility for the formulation of GAAP are FASB (Financial Accounting Standards Board). Other organizations are SEC and AICPA.

(c ): Financial statement information play a significant role in the allocation of society’s financial resources. Financial statements provide useful information to different types of investors who are looking to invest their wealth and this ensures that investors are able to assess financial performances of companies. This helps in setting of stock and bond prices. When funds raised from stockholders are utilized in an effective manner then capital is obtained at reasonable costs. This ensures that society’s resources are effectively allocated.

(d): The three aspects are:

(i): Preparation of financial statements involves an understanding of complex accounting rules and significant assumptions and considerable estimation.

(ii): GAAP allows for differing accounting treatments for the same transaction.

(iii): Auditors are at a relative information disadvantage vis-à-vis company accountants. As the capital markets place increasing pressures on companies to perform, accountants are often placed in a difficult ethical position to use the flexibility given to them under GAAP in order to bias the financial results or to use their inside information to their advantage.