Why produce accounting info?
Purpose of producing accounting information and descriptions of the main users
Accounting is primarily concerned with collecting, analysing and communicating financial data.
Accounting exists for a particular purpose and that is to give users better information on which to base their decisions as well as give them a clearer picture of the business as a whole.
Although managers and shareholders are probably the significant users of accounting information there are also external users who are also likely to use it to decide whether to:
- Invest in the ownership of a business
- Lend money to the business
- Offer credit facilities
- Enter into contracts for purchases
Legislation governing accounting information
There is an enormous amount of legislation governing the way financial information is recorded and displayed to users. The companies act of (1985 & 1989) relate specifically to limited companies, which require them to conform to procedures in preparation and presentation of accounts. Also the law states that accounting statements should be sent to shareholders and a copy must be lodged with the registrar of companies for public viewing.
In order to provide a useful service to users, financial information should possess certain qualities for example, relevance, reliability, comparability and understandability. Information should have the ability to influence decisions otherwise there isn’t any point in producing the information.
Accounting information should be free from significant error or bias. The information, which is presented, should be capable of being relied on by users to represent what it is supposed to represent.
Main content of accounting information
Accounting information is used to provide users with an overall picture of the financial position and performance of the business.
The two main statements, which do this, are the profit and loss account and the balance sheet.
Profit and loss account – is designed to show the firms activities and generated revenue over an accounting period as well as all relevant costs experienced in earning that revenue.
Balance sheet – is designed to show an organization’s overall financial worth at a given point in time. A balance sheet also shows were and how an organization has obtained and spent capital.
Why users are interested in accounting information?
Shareholders – the business is legally required to provide shareholders with accounting information in the form of company reports. Shareholders are interested in analysing accounts to determine whether or not the business is being properly managed. They are also interested in profitability, stability and the return they may make on their investment. The shareholders main objective is to maximise investment return and if their aims are not met agency problems may arise.
Managers – managers run the organization on behalf of the owners and they use accounting information to pinpoint areas of inefficiency and to help them plan and set budgets.
For example managers may need accounting information to decide whether to:
- produce new products or services (such as 3G mobile phones)
- increase and decrease price and quantity of products and services already existing (such as transport fare rises)
- borrow money to finance the business (such as opening new stores)
- changing purchasing, production or distribution methods (such as prudential increasing business production overseas due to cheaper labour costs
Employees – employees are interested in looking at companies profit levels which helps them to assess the likely improvements in working conditions and wages. For example if the employees can see that the business is financially stable this leads to greater job security and motivation.
Governments – Inland Revenue uses financial information to assess how much corporation tax and VAT needs to be paid. Government agencies also look at accounting information to make sure that the business is operating legally and ethically
Lenders – financers have lent money to the business and are interested in accounting information to assess if the organization can repay the money borrowed and make interest payments. Lenders don’t just analyse profitability but also stability, efficiency and the capital return on the businesses past & present investment projects. If the business is stable with a good future, lenders will be more willing to offer capital.
Creditors – companies which are going to supply goods on credit will examine accounting information of their customer’s ability to pay, its financial stability and how long it takes on average to pay back debts. Creditors won’t want to supply goods to customers who are not likely to settle their debts.
Potential investors – potential investors are interested in assessing the likely risk and returns in investing with a particular business.
In addition investors will also be interested in making comparisons between organizations and analysing accounts through a range of ratios to help them to decide on the best opportunities.
Customers – customers are interested in knowing if a business is financially sound, they will not want to place orders or pay deposits to a business that might not be able to continue trading
Competitors – competitors use financial information to keep a step ahead of rivals as well as to assess the threat posed by other businesses to profitability and market share. Information can also be used to produce a benchmark to assess their own performance and efficiency.
Community – the community as a whole are interested in assessing whether the business will continue to provide employment and essential community resources. Community representatives are also interested in how the business is contributing socially and ethically.
Accounting information is the main means of communication between the business and stakeholders. It is a great communication tool that gives users the important information that can aid them in decision-making.
Different user groups have different objectives, however they use the same information but consider factors that directly affect their overall aims.
For example creditors look at the companies debts and working capital to assess if the customer can settle its debt. Whereas on the other hand employees look at stability and profits to answer their specific questions
So it’s the purpose of accounting information, which gives users the basis to analyse their main interests.