The purposes and benefits of accounting keeps widening as the importance of accounting broadens. I am writing this article in response to a question sent to me by one of my readers in a previous article referred to above. This post will be tailored to meet the specific requirement of the question which I have reproduced below:
“Pls i need answer to this question: 1.what is the major purpose of accounting records and reports. 2. Compare the characteristics needs or desired in financial statements by : a. Bankers. b. Investors. c. Unions. d. Management. Thanks” NB this is an unedited copy and paste.
SUGGESTED SOLUTION TO QUESTION ‘WHAT IS THE MAJOR PURPOSE OF ACCOUNTING RECORDS?’
The major purposes of accounting records and reports are in two folds. One is to be in consonant with the law and the other is to enable sound economically significant decisions to be made.
Ever since businesses become separated from their owners, the amount of financial resource that a business can access becomes limitless. This obvious benefit of becoming a public company made businesses prone to all sorts of financial and economic crimes and irregularities.
One of the ways to ensure that fraudsters do not use limited liability company to reap the general public off their had earned money is to place some stringent conditions that must be met before a company can go public, and one of such requirements is that proper accounting records and reports must be kept.
The problem wasn’t completely solved by asking business owners intending to go public to provide financial reports in an acceptable manners as this development created a new phrase in business world known as ‘stewardship reporting’.
This stewardship reporting is all about managers rendering account of assets and liabilities entrusted to them. Although, auditors are employed to give opinion on the accounting records and reports in the bid to make the reports credible, this still remains a heated area of accounting that have generated a lot of heat in the past and is still generating more heat as cases of corporate scandal continue to increase.
The other aspect of keeping records and reports is to enable decision makers make reasonable decisions backed by facts and figures. To remain focused on this question, the next section will dwell on comparing the needs of the various users of accounting information as specified in the question. I will start by discussing the interest of each of the mentioned users of AIS and then compare them in the summary part of this article.
PURPOSE OF ACCOUNTING RECORDS AND REPORTS TO BANKERS:
Bankers’ main purpose of using accounting records and reports of a company is to carryout credit analysis of the said company. Various tools have been developed in recent time to allow bankers ascertain the credit worthiness of a company.
One of such early tool is the uni-variate bankruptcy predicting tool developed by Beaver (1966). This was later enhanced by Altman (1968) in what he called a multivariate discriminant analysis- Z-Score. Other tools for carrying out credit analysis include; neural network analysis, logit analysis, and probit analysis.
This article is not intended to discuss these models but to bring them to your knowledge. One striking similarities between these models is that they all make use of one form of business ratio or the other in predicting how financially viable a potential loan beneficiary is. Bankers employ the services of credit analyst to analyze the financial statements of a company in the light of other non financial variables.
PURPOSE OF ACCOUNTING RECORDS AND REPORTS TO INVESTORS
Investors as the ultimate risk bearers in a company analyses a company for both current investment and potential investment opportunities. Note that investors in this context are just the equity holders. Business activities are analysed using what finance experts called fundamental analysis in order to determine a value for an investment.
The process of business valuation is the application of valuation method on both accounting records and other qualitative information. Usually, a cut off is subjectively set as a benchmark upon which investment decisions are made. Financial planners also fall back to accounting figures when developing investment strategy for their clients.
PURPOSE OF ACCOUNTING RECORDS AND REPORTS TO UNIONS
What union is after in accounting information is to have enough information as regards the profitability of an organization so as to be in a position to fight for salary increment and other perks for her members. They have similar interest as the investors.
The only difference is that the union have nothing at stake if a company did not make profit- after all, minimum wage must be paid to the workers! Government agencies can also be classed under this heading as their major interest in accounting record is for determination of taxable income making economic projections as well as developmental planning. Student unions in schools also look into accounting reports so that they will know which company to pay courtesy visits.
PURPOSE OF ACCOUNTING RECORDS AND REPORTS TO MANAGEMENT
Management are both the primary preparer of accounting records and reports and the primary users of accounting information. Management rely on management accounting information to make managerial decision.
Decisions of whether to invest in a new plant or not are based on (internal accounting reports) that will then be evaluated in the light of the prevailing circumstances through what is called investment appraisal.
The rewards of management in most management control systems are closely linked to the financial performances. This makes the interest of management and that of other interested parties to conflict. In fact, managers are prone to making suboptimal decisions that will make their reported accounting records look rosy.
Notice that all the four users of financial statement information have one objective; to make profitable decision. However, they all come from different perspectives so as to satisfy their need. Three major perspectives can be observed from this article (1) those enquiring into the profitability of a company, (2) those seeking the safety of their monies in the form of loans and debt instruments, and (3) those that are seeking favour.
Most of these needs conflicts in most cases thereby making it difficult for a single financial statement to provide all the information needed by a stakeholder without inflicting pain directly or indirectly to the other user of the information.
Take the informational need of management and bankers for instance where management will be doing all that is within their power to cover losses while the banker will be looking for clues to long term insolvency. For accounting records and reports to provide information to the numerous financial interest groups, a balance must be sought so as not to defeat the main purposes of accounting records and reports as discussed earlier.