What and whom is the report for? · Understanding Accounting

Use this lesson when you can prepare financial statements but want to understand who uses them and why the company, reporting period, and units matter.

Who uses general-purpose financial reports?

General-purpose financial reports provide information for the common needs of existing and potential investors, lenders, and other creditors. These users make decisions about buying or holding investments, lending, and extending credit. Many cannot require a company to prepare a separate report for them.

Linden Peak is a corporation that manufactures sensors. Its bank wants annual financial statements before deciding whether to renew a loan. A shareholder wants information before deciding whether to buy more shares. Both can use Linden Peak's statements, although they have different decisions to make.

The bank can examine assets available to help meet obligations, debts already outstanding, and cash generated during the year. The shareholder can examine profitability and how management has used the company's resources. Neither reader receives an automatic decision from those figures. The bank also considers its lending terms and risks; the shareholder also considers the share price and other available investments.

The statements are not designed to give the company's total market value or predict every future payment. That limit does not make them useless. Current information can improve a judgment even when other evidence is needed.

Why not prepare a report for every reader?

Linden Peak's plant manager wants a report of defective sensors every hour. Management can request that detail from the company's own records. An annual income statement does not replace that operational report.

Some lenders can also negotiate additional information from a borrower. The distinction is not that external users can never request detail. General-purpose reporting serves common information needs, while a report prepared for a particular user answers that user's narrower question.

A shareholder's personal tax return is another different report. Linden Peak's statements describe the company, not the shareholder's personal income, other investments, or tax position.

Whose activities belong in the report?

The reporting entity is the business or group of activities represented by the financial reports. Identify that boundary before adding balances.

Suppose Linden Peak's chief executive owns a warehouse personally. The chief executive's ownership does not make the warehouse a corporate asset. If Linden Peak rents space in it, the rental agreement can give the company rights and obligations that require accounting. That is a different question from who owns the warehouse.

A reporting entity can also include a parent company and subsidiaries. Consolidated financial statements present the parent and subsidiaries included under the applicable accounting requirements as one reporting entity. A subsidiary is a company controlled by another company. Control and the specific consolidation requirements must be established; the lesson does not ask you to infer them from an ownership percentage alone.

The economic entity assumption keeps the business's accounting separate from an owner's personal activity. It does not settle every consolidation question. Those questions need the applicable accounting guidance and facts about the relationship between the companies.

What do the headings tell you?

Before using a reported amount, check these labels and assumptions:

Item to check	What it tells you	What still needs checking
Business legal form	Whether the business is organized as a corporation, partnership, or another legal form	Its tax treatment and the activities included in the financial reports
Reporting entity	Whose activities the statements represent	Whether the amounts you are comparing use the same boundary
Reporting date or period	Whether the amount describes a position at a date or activity during an interval	Whether the transactions were recorded in the correct period
Currency and scale	Which currency is used and whether amounts are shown in units, thousands, or millions	How the reported assets and liabilities were measured
Going concern	Whether the statements use the assumption that the entity continues operating	Whether conditions create doubt about its ability to continue and what the applicable guidance requires

The monetary unit assumption allows accounting amounts to be expressed in a common currency. It does not mean everything important can be captured in one monetary amount. A company's employee skills may matter to its prospects without appearing as a separately recorded asset.

The time period assumption allows ongoing business activity to be reported for defined intervals. Linden Peak's year-end balance sheet describes its position on December 31. Its annual income statement describes activity during the year ended on that date. A payment in January can settle an expense recorded in December; the payment date alone does not identify the expense period.

Going concern means continuing to operate, rather than liquidating the business by converting assets to cash and settling obligations. It is an accounting basis to evaluate under the applicable guidance, not a promise that the company will survive. A profitable year does not by itself settle whether the company can pay obligations when due.

Check your understanding

Linden Peak's chief executive proposes leaving a supplier guarantee out of the company's reports because the bank is mainly interested in Linden Peak's loans. The guarantee is a promise to pay if the supplier does not meet the specified obligation. Does the bank's main interest settle what Linden Peak should report?

Check your reasoning

No. The reports concern Linden Peak's rights and obligations, including those created by its own guarantee. The company must examine the agreement and applicable accounting requirements to decide what to record or disclose. The bank's interest in one kind of debt does not eliminate other reporting requirements. Other investors and creditors may also use the reports.

The facts here do not establish the amount or accounting treatment of the guarantee. They establish why a user's presumed preference cannot decide it.

FASB's conceptual framework describes the reporting purpose and its limits in Chapter 1, paragraphs OB2–OB10. Its concepts help explain financial reporting but do not replace applicable accounting rules.

More practice

Practice reporting purpose and assumptions on the grouped Chapter 4 practice page. Each question includes its own facts and an explanation or worked answer.