Question

QUESTION 1

1. Define Financial Statements.

2. Explain three (3) different ways of representing the Financial Statement of a company.

3. State Five (5) users of Financial Statement and explain their interest

4. Differentiate between external and internal users of financial statements

Answer 1

1. Financial Statements means the records of the financial activities undertaken by a person or business. It helps in understanding the financial position of the business as to where it stands how much profit or loss it has made etc. Financial Statements of any business include Balance Sheet, Profit or Loss Accounts, Cash Flow Statements and Statement of changes in equity.

2. Three different ways of representing financial statements of a company are:

a) Balance Sheet or Statement of Financial Position - showing the assets, liabilities and shareholder's funds at the end of the year. It is a snapshot of events at one point in time. It consists of everything owned by the business and a list of various sources of finance used to fund the assets. Assets = Liabilities + Equity. this is called the accounting equation.

b) Statement of Profit or Loss - this draws together the various expenses incurred by the company and the revenue earned by the company from its trading activities. It compares the income generated with the costs incurred for earning that income, the balance being either profit or loss.

c) The Cashflow Statement - shows where the money has come from and where it has gone. It shows the cash movements. Cashflows are important because an entity needs cash to survive, however, the main motive of a business is to earn a profit.

3. Users of Financial Statements and their interests:

a) Equity Investors - Investment decisions by investors require information about profit and cash flows. Existing shareholders also require this information so as to know if their money invested is earning anything or not.

b) Loan Creditors - A lender wants to know whether the business is earning sufficient cash to repay their loan.

c) Employees - Employees are interested in knowing business's ability to pay their salaries and also to offer job security in the future.

d) Business Contacts - like suppliers and customers are interested in knowing the continuity of their sales and purchases from the business.

e) Tax authorities are interested in knowing the income generated by the business for the calculation of tax liabilities.

4. Internal Users are the persons involved in the operations of the company like managers and employees so as to make informed decisions like budgeting, investing and financing decisions whereas external users of financial statements are the ones who are not involved in the operations but hold some financial interest whether direct or indirect like owners, government agencies, lenders, banks etc.