Question 1: Explain the nature of the financial statements.
Answer:
Financial statements are the summarised reports of recorded-facts and are
prepared following the accounting concepts, conventions and requirements of
Law. The American Institute of Certified Public Accountants states the nature of financial statements as, “the statements prepared for the purpose of presenting a periodical review of report on progress by the management and deal with the
status of investment in the business and the results achieved during the period
under review. The following points explain the nature of financial statements.
(i) Recorded Facts :Financial statements are prepared on the basis of facts in the form of cost data recorded in accounting books. The original cost or historical cost is the basis of recording transactions. The figures of various accounts such as cash in hand, cash at bank, bills receivable, sundry debtors, fixed assets, etc are taken as per the figures recorded in the accounting books. The assets purchased at different times and at different prices are put together and shown at costs. As these are not based on market prices, the financial statements do not show current financial condition of the concern.
(ii) Accounting Conventions: Certain accounting conventions are followed while
preparing financial statements. The convention of valuing inventory at cost or
market price, whichever is lower, is followed. The valuing of assets at cost less
depreciation principle for balance sheet purposes is followed. • The convention of materiality is followed in dealing with small items like penci’s, pens, postage
stamps, etc. In this way the use of accounting conventions makes financial statements comparable, simple and realistic.
(iii) Based on Concepts: Financial statements are prepared on certain basic
assumptions (prerequisites) known as Concepts such as going concern concept,
money measurement concept, realisation concept, etc. Going concern concept
assumes that the enterprise is treated as a going concern and exists for a longer
period of time. So the assets are shown on historical cost basis. Money measurement concept assumes that the value of money will remain the same in
different periods. While, preparing profit and loss account the revenue is included in the sales of the year in which the sale was undertaken even though the sale price may be received over a number of years. The assumption is known as realisation concept.
(iv) Personal Judgements: Under more than one circumstance, facts and figures
presented through financial statements are based on personal opinion, estimates and judgements. The depreciation is provided taking into consideration the useful economic life of fixed assets. Provisions for doubtful debts are made on estimates and personal judgments. In valuing inventory, cost or market value, whichever is less is being followed.
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