Financial reporting is defined as the process of producing statements which disclose the financial status of an organization to investors, management, government and the public (if the company is publicly traded). Gibson (20120) argues that these disclosed financial information about a particular company shows how it performs over a specific period of time. The financial reports are generally issued on a yearly or quarterly basis. The financial reports are found in the annual report of a public company.
The four basic financial reports are income statements (profit and loss statements), balance sheets, statements of shareholders’ equity, and cash flow statements.
Purpose of financial reporting
There are two primary purposes served by financial reporting. First, it enables the management to make effective decisions in relation to the company’s overall strategies and objectives. The information disclosed in the financial reports assist the management in discerning the weaknesses and strengths of the organization as well as its general financial health (Wahlen, Jones & Pagach, 2013). Secondly, the financial reporting presents important information on the activities and financial health of the organization to its stakeholders which includes its potential investors, shareholders, government regulators and consumers. It’s to ascertain that the company is being managed appropriately. Furthermore, it should be noted that if a company is publicly traded, it becomes subjected to stringent reporting regulations imposed by the Securities and Exchange Commission (SEC).
Generally Accepted Accounting Principles (GAAP)
Generally Accepted Accounting Principles (GAAP) are common set of accounting procedures, standards and principles that companies use while compiling their financial statements. The GAAP constitute a collection of authoritative standards (outlined by policy boards), for instance, Financial Accounting Standards Board (FASB) and Accounting Principles Board and the commonly agreeable ways of recording and reporting financial statements.
When a company is distributing to the public its financial statements it must adhere to GAAP benchmark. If the stock of the corporation is publicly traded, its financial statements must adhere to the rules that the U.S. Securities and Exchange Commission (SEC) has established (Williams & Carcello, 2008). This would encompass ensuring that the corporation’s financial statements are audited by an independent Certified Public Accounting (CPA) firm.
Examples of the basic Accounting Principles and guidelines are matching principle, cost principle and full disclosure.
Full disclosure principle
The principle means that all the information that is in relation to the business of the corporation be reported either in the notes to the financial statements or in the content of the financial statements.
This denotes the historical cost of the itembeing reported in the financial statements. Historical cost refers to the amount of money that was paid on an item at the time it was bought and it isn’t changed to account for the inflation (Bragg, 2013).
This principle relates to the way a business reports is accounting information on expenses and incomes. The principle requires that companies use the accrual form of accounting and then match the business expenses to business income for a particular time period.
This is the measure of importance of a misstatement in the company’s accounting records. For instance, this principle creates a gray area in the accounting standards which would be best sorted by professional judgment. An example is the effect on the financial statements of understating the price of an asset with a particular value (Georgiades, 2008).
Going concern principle
This concerns the intent of a business to continue its operations into the foreseeable future and never to liquidate the business.
Sources of GAAP
The sources of GAAP can be categorized as:
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- First, is the officially established accounting principles which consist of the FASAB Statements of Federal Financial Accounting Standards and Interpretations. The FASAB Standards and Interpretations is periodically incorporated in the publications by the FASAB (Bragg, 2013).
- Technical Bulletins of FASAB and, if specifically declared applicable to the federal reporting entities by the AICPA and should be cleared by AICPA Industry Audit and Accounting Guides and FASAB.
- The Technical Releases of the FASAB’s Accounting and Auditing Policy Committee.
- The implementation guides which are published by the FASAB staff, and also the practices which are broadly recognized and are prevalent in the federal government.