The Objective of Financial Reporting

The main objective of financial reporting is to provide financial information to current capital provides to make decisions. This information might also be useful to users who are not capital providers. The general purpose financial reporting develops superior reporting standards to help in the efficient functioning of economies and the efficient allocation of resources in capital markets. General purpose financial reporting focuses on an extensive range of users’ needs that lack the ability to obtain financial information needed from the entity. It should be broad enough to comprehend information for the various users. Therefore, the financial report is where they depend on to acquire information. Diverse users may require different information which might go beyond the scope of general purpose financial reporting.

The financial reports are prepared from the entity’s perspective (deemed to have substance on its own, spate from that of its owners), instead of the entity’s capital providers. An entity attains economic resources (its assets) from capital providers in exchange for claims to those resources (its liabilities and equity). Capital providers include;

  1. Equity investors:  Equity investors normally invest economic resources in an entity expecting to receive a return on, as well as a return of, the resources invested in. Hence, equity investors are concerned with the amount, timing, uncertainty of an entity’s future cash flows and the entity’s competence in generating those cash flows which affects the prices of their equity interests. Furthermore, they are concerned with the performance of directors and management of the entity in discharging their responsibility to make efficient and profitable use of the assets invested.
  2. Lenders:  Lenders usually expect to receive a return in the form of interest, repayments of borrowings, and increases in the prices of debt securities. Lenders have similar interests as the equity investors.
  3. Other creditors:  Other creditors provide resources because of their relationship with the entity, instead of a capital provider; no primary relationship.

Capital providers make decisions through useful information provided in financial reporting by particular entity. Financial reporting usefulness in assessing cash flow prospects depends on the entity’s current cash resources and the ability to generate sufficient cash to reimburse its capital providers. Besides, financial reporting usefulness in assessing stewardship includes the management’s responsibilities to protect the entity’s economic resources (assets) from unfavourable effects. Management is also liable for safeguarding the assets of the entity which conforms to the laws, regulations and contractual provisions; thus, the importance of management’s performance in the decision usefulness.

The general purpose financial reporting is limited to information which does not reflect pertinent information from other sources that should be considered by the users. Financial reporting information is based on estimates, judgements, and models of the financial effects on an entity of transactions and other events in which, is only ideal for preparers and standard setters to strive. Achieving the framework’s vision of ideal financial reporting to the fullest will be difficult in the short term because of technical infeasibility and cost constrains.

Financial reporting should include information about: the economic resources of an entity (assets), the claims of the entity are (liabilities and equity), the effects of transaction and any events or circumstances that can affect the entity’s resources and claims and provide useful information about the ability of entity to generate its cash flow and how well the entity meets its management responsibilities.

The usefulness of financial reporting to the users:

  1. Provide useful information about the amount, timing, and uncertainty of future cash flow
  2. To identify the entity’s financial strengths and weaknesses (especially for capital providers)
  3. To indicate the potential of entity’s cash flow for its economic resources and claims
  4. To identify the effectiveness of the entity’s management responsibilities
  5. To assess availabilities of the entity’s nature and quantity of the resources for the use in its operation
  6. To estimate the values of the entity.

The quantitative measures and other information regarding the changes in entity’s economics resources and claims in the financial report can help the users to assess the amount, timing, and uncertainty of its cash flow; and indicate the effectiveness of management responsibilities.

Furthermore, the entity must provide a positive return on its economic resources in order to generate net cash inflows; and return the earning to its investors. Other information like variability of returns, past financial performance, and management’s ability can be used to assess the entity’s future financial performance.

The information regarding the accrual accounting in financial reporting can better provide the users to assess the entity’s past financial performance and future prospects in generating net cash inflows without obtaining additional capital from its investors.

The entity’s cash flow performance in financial reporting assist the investors to understand the entity’s business model and operation through assessing how the entity obtains and spends cash. Information about its borrowing, repayment of borrowing, cash dividends and other distribution to investors, as well as the factors of entity’s liquidity and solvency, can also assist the investors to determine the entity’s cash flow accounting.

Besides, information about the changes of entity’s resources and claims not resulting from financial performance may assist the investors to differentiate the changes that are results of the entity’s financial performance and those that are not.

The information of management explanation should be included in financial reporting to assist users for a better understanding about management decision in any events and circumstances that have affected or may affect the entity’s financial performance. It is because the internal parties know about the entity’s performance than the external users.

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