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   1. What is a financial statement?

The term financial statements implies that statements or reports which are prepared at the end of an accounting period (for example at the end of an year) for the purpose of communicating the financial information of a business’s activities to its stakeholders. Financial statements are produced in structured manners and in specific form to present relevant information

Different types of financial statements

Income statement or profit and loss account
A statement that shows revenues earned and expenses incurred during an accounting period. In short, it reflects the operations of a business in an accounting period

Balance sheet or statement of financial position
A statement that discloses the detail of assets, liabilities and capital of a business. All in all, it shows the financial position of a business

Cash flow statement or statement of cash flow
A statement that presents the movement of cash and cash equivalents into and out of the business

Statement of changes in equity
A statement that shows the changes in the capital of a business during an accounting period

Accounting policies and explanatory notes
Accounting policies adopted while preparing financial statements

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   2. What are the different financial statements out there?

Different types of financial statements

Income statement or profit and loss account
A statement that shows revenues earned and expenses incurred during an accounting period. In short, it reflects the operations of a business in an accounting period

Balance sheet or statement of financial position
A statement that discloses the detail of assets, liabilities and capital of a business. All in all, it shows the financial position of a business

Cash flow statement or statement of cash flow
A statement that presents the movement of cash and cash equivalents into and out of the business

Statement of changes in equity
A statement that shows the changes in the capital of a business during an accounting period

Accounting policies and explanatory notes
Accounting policies adopted while preparing financial statements

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   3. What are the objectives of financial statements?

Financial statements are the reports that show financial position, profitability and cash flows of an entity. Therefore, their main objective is to provide information about financial position, profitable and cash movements of an enterprise to the range of users such as investors, creditors, banks, government agencies, enterprise management etc. To accomplish this objective, financial statements provide information about assets, liabilities, capital, income and expenses of an entity

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   4. What are the uses or applications of financial statements?

Following are some uses of financial statements:

  • Owner(s) of business want to know the financial position of business either business is in profit or in loss
  • Investors because they want to invest in business (e.g. they purchase shares, bonds, debentures etc.)
  • Loan providers, banks and creditors want to know the profitability and financial position of the business
  • Management of business needs information for decision-making
  • Business's employees want to know the stability, future prospects and scope of business for their own welfare in the business organization
  • Government for the income tax purpose and government agencies for various other purposes such as credit rating

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   5. What are users of financial statements?

There are two major categories of financial statements’ users internal users and external users

Internal users
Internal users are those stakeholders that have a direct relationship with the organization

Board of directors
To formulate corporate level strategies, BOD needs financial information

Management of the business
Management needs financial information for decision making

Owner of the business
Owner wishes to know the profitably and financial position of his/her business

External users
External users have an indirect relation with the organization

Government agencies
Several government agencies such as SEC and tax authorities need financial information to implement their prudential regulations and to compute tax

Investors or shareholders
Financial information is greatly helpful for shareholders and investors to analyse business’s financial position

Creditors or account payable
Creditors evaluate business financial leverage and it’s profitable so as to evaluate credibility and default rate of the business using information given by the financial statements

Lenders
Lenders curious to know whether business is in profit or not, what’s its financial position and how much the business has been financially leveraged

Customers
Based their buying decisions on the company’s financial performance and position

Media and general public
Use financial information obtained from financial statements to analyse the financial performance a business

Rating agencies
Rating agencies rate and rank an entity on the basis of financial information extracted from financial statements

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   6. What are external users of financial statement?

External users have an indirect relation with the organization

Government agencies
Several government agencies such as SEC and tax authorities need financial information to implement their prudential regulations and to compute tax

Investors or shareholders
Financial information is greatly helpful for shareholders and investors to analyse business’s financial position

Creditors or accounts payable
Creditors evaluate business financial leverage and it’s profitable so as to evaluate credibility and default rate of the business using information given by the financial statements

Lenders
Lenders curious to know whether business is in profit or not, what’s its financial position and how much the business has been financially leveraged

Customers
Based their buying decisions on the company’s financial performance and position

Media and general public
Use financial information obtained from financial statements to analyse the financial performance a business

Rating agencies
Rating agencies rate and rank an entity on the basis of financial information extracted from financial statements

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   7. What are the internal users of financial statements?

Internal users are those stakeholders that have a direct relationship with the organization

Board of directors
To formulate corporate level strategies, BOD needs financial information

Management of the business
Management needs financial information for decision making

Owner of the business
Owner wishes to know the profitably and financial position of his/her business

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   8. What particulars should be disclosed in financial statement regarding the inventories or stock?

Some common things you need to disclose regarding inventories are:

- The policies followed and cost formulas used to calculate the value or cost of inventory
- The amount of inventories pledged for debts or liabilities
- Total cost of inventories
- Net realizable value of inventories
- The value of inventories expensed out or recognized as a expense for this period
- Opening and closing value of inventories or stock

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   9. Is balance sheet the part of accounting’s double entry system?

No, not at all.

Balance sheet is not the part of accounting double entry system rather than it is a report or statement that shows the details of total assets, liabilities and capital of an entity at a particular date. Double entry system is used keep the record of a business’s transactions in its books, but balance sheet is prepared to communicate financial position of a business to its stakeholders

All double entries for the transactions have already been passed and ledger accounts have been balanced off at the time of preparing balance sheet. Therefore, we just need to enter the balances of these accounts in balance sheet

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   10. When should the item of property, plant and equipment be eliminated from balance sheet?

The items of property, plant and equipment are fixed assets and therefore they need to be presented in balance sheet so long as they are not disposed or future economic benefits are no longer expected from them.

Consequently, item of property, plant and equipment should be eliminated from balance sheet if:

  • They are sold or disposed
  • They are no longer useful for the entity or future economic benefits have been come to an end. For example a machine stop working properly and now it is not useful for the factory

The elimination of fixed assets from balance sheet is commonly known as fixed assets derecognition. The gains or losses arising from derecognition is reported in income statement

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   11. In which financial statement the gain or loss on sale of fixed assets is recorded?

The gains or losses arising from the sale or disposal of fixed assets are reported in the income statement

Gain or loss on sale of a fixed asset = Sale value of the fixed asset - Carrying value (or book value) of the fixed asset. A positive figure is treated as a gain while negative figure is regarded as a loss

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   12. Can an entity classify a liability or debt as a long term liability regardless of its maturity time?

According to international accounting standards, an entity can classify a liability as a non-current liability in the following situations even though it is payable within 12 months

If the business has intention to reschedule the payments so that the liability will be payable after a year

The original maturity period of the liability was more than a year and business had falsely assumed the liability as a current liability

Lastly, keep in mind that there is no hard and fast rule. Accounting rules (GAAPs) tend to change with the passage of time and there might be a slight difference in GAAPs followed in different parts of the world

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   13. What accounts are needed to be closed off after the preparation of financial statement?

Nominal accounts (accounts of revenues and expenses) are closed off after the preparing of income statement

Nominal accounts are also known as income statement accounts and temporary accounts. Nominal accounts are closed off at the end an accounting period (e.g. a year) and their balances are NOT transferred to the next accounting period rather that their closing balances are presented in income statement

Nominal accounts are referred to as income statement accounts because nominal accounts are accounts of incomes and expenses and their balances are shown in income statement.

Examples of nominal accounts

Nominal accounts of incomes
Sales account, commission income account, rent income account, discount received account etc

Nominal account of expenses
Purchases account, rent account, employee wages or salaries accounts, factory lease and depreciation expenses accounts, heating and electricity expenses accounts, repair and renewal of machinery and plant accounts, freight and demurrage expenses accounts etc.

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   14. Why there is uniformity and resemblance of format in the financial statements of different companies?

If two or more companies follow the same set of accounting rules, procedures and conventions (GAAPs) to prepare financial statements, then obvious there would be resemblance and uniformity of financial statements’ format. For example if two companies pursue the international accounting standards, their financial statement would look alike in terms of format

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   15. What are the common size financial statements?

The financial statements that express their items in percentages of some bases rather than presenting items in absolute figures. For example operating expenses can be shown in income statement as 25% of total sales, commission income = 2% of total sales, cost of goods sold = 70% of total sales during an accounting period

In other words, a financial statement that reports its items as the percentage of a common figure (for example total assets or sales). Each item of the financial statement is reported as percentage of that figure

Applications

A common size financial statement is used as an analytical and comparison tool, companies use these financial statements to compare with competitors common size financial statements and to analyse their performance in short and long run. Since financial statement are based on percentage, a company can compare its performance with other large or small companies’ performance without worrying about actual values of financial statements’ items. It is nearly impossible to directly compare the financial statements of two different companies because these companies may vary in size. Therefore, companies try to standardize financial statements in the form of common size statements.

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   16. In which financial statement dividends are reported?

The dividends whether paid by the company or dividends which are still unpaid but declared to be paid to shareholders are reported in the following financial statements:

Dividends are presented in statement of changes in equity

Dividends paid to shareholders are shown in cash flow statement under financing activities

Dividends are not reported in balance sheet. However, balance sheet adjust the amount of dividends between its cash and equity sections

Dividends are not expenses but a kind of drawings. Therefore, they are not signified or shown in standard income statements

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   17. What are audited financial statements?

An audited financial statement is the one that has been verified and certified by an auditor or chartered accountant that the financial statement is prepared in conformity with international accounting standards or GAAPs. Therefore, financial statement represents the true and fair view of a business’s financial position or performance

Generally, auditors are those accountants that are expert in financial reporting. There are audit firms that provide auditing service as an external source of auditing for a company, but companies hire auditors themselves as well

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   18. What is a proforma financial statement?

The financial statements based on some assumed transactions or economic event which are likely to be occurred in future. Typical financial statements show past financial position and financial performance of an entity whereas Performa financial statements try to predict the future financial position and performance of an entity

Performa financial statements help management to analyze, evaluate and control the future economic events or transactions and since they are based on future rather than past, they are mainly used to formulate and implement strategies and plans for the future growth and welfare of the entity. Performa financial statements are used to implements strategies because these financial statements help management to analyze various results or consequences of different measures and procedures

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   19. What is a Consolidated Financial Statement?


Consolidated financial statement is defined as a combine financial statement of a parent company and its Subsidiaries (daughter companies). For example an income statement that shows the financial performance of company A, B, C and D in which company A acts as a parent company while company B, C and D are its subsidiaries

Subsidiary is a company owned or controlled by another company and the Owner Company is known as parent company

Consolidated financial statements are helpful since they present the aggregate view of financial position and performance of a group of companies which is not possible with typical financial statements that show financial position and performance of a single company

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