Question

QUESTION 1                                                                                                           

Answer the following questions:

1.          Briefly state what makes Accounting information useful to its users.             (5)
2.         List at least five types of users of financial statements and briefly explain each      user’s information expectation from the financial statements.                       (10)

Answer 1

Answer.

The degree of usefulness of accounting information depends on the user. For some, it matters more than others. It depends on the level of stake a user has in the company.

There are basically Two kind of users: internal and external

Importance for Internal Users:

Internal users comprises of Owners, Top Management and Employees.

Accounting information is important for Owners/shareholders in a sense that they need to get an overview about the financial health of their company. They need financial results to make decisions about the future of the company, whether they should expand the production facility, halt the production or maintain production at the current level.

Top management uses accounting information to check performance of different departments, and hence for making decisions for the promotion,demotion or laying off the employees or other corrective measures.

Employees are concerned about the financial information as their jobs are dependent on the financial health of the company. Bonuses, allowances and increments in their salaries also depend on the accounting information.

External Users:

External users consists of Government Agencies, investors and Financial institutions.

Government agencies that are users of accounting information are tax authorities and other regulatory bodies. Tax authorities levy tax on the basis of financial information of a company. Regulatory bodies examine the accounts of a company in order to check the accuracy of their accounts or whether they are resorting on illegal accounting practices.

Investors make investment decisions on the basis of accounting information of a company.

Financial institutions like banks or other lenders of money look into accounting information in order to judge the financial health of the company. They make decision of lending money to the company on the basis of these information.

2. Users of Accounting Information:

Investors

Investors need to know how well their investment is performing. Investors primarily rely on the financial statements published by companies to assess the profitability, valuation and risk of their investment.

Investors use accounting information to determine whether an investment is a good fit for their portfolio and whether they should hold, increase or decrease their investment.

Lendors

Lenders use accounting information of borrowers to assess their credit worthiness, i.e. their ability to pay back any loan.

Lenders offer loans and other credit facilities on terms that are based on the assessment of financial health of borrowers.

Good financial health is indicated by the borrower’s ability to pay its liabilities on time, high profitability, substantial securable assets and liquidity.

Poor liquidity, low profitability, lack of assets that can be secured and an inability to pay liabilities on time demonstrate poor financial health of borrowers.

On a lighter note, borrowers can only get a loan from lenders if they can prove that they don’t need the money.

Suppliers

Just like lenders, suppliers need accounting information to assess the credit-worthiness of its customers before offering goods and services on credit.

Some suppliers only have a handful of customers. These customers could be very large businesses themselves. Suppliers need accounting information of its key customers to assess whether their business is in good health which is necessary for sustainable business growth.

Customers

Most consumers don’t care about the financial information of its suppliers.

Industrial consumers however need accounting information about its suppliers in order to assess whether they have the required resources that are necessary for a steady supply of goods or services in the future. Continuity in supply of quality inputs is essential for any business.

Tax Authorities

Tax authorities determine whether a business declared the correct amount of tax in its tax returns.

Occasionally, tax authorities conduct audits of the tax returns filed by businesses in order to verify the information with the underlying accounting records.

Tax authorities also cross reference accounting information of suppliers and consumers in order to identify potential tax evaders.