Accounting theory of financial statements for the board exam.
Write the meaning of financial statement.
Define financial statement. State its two importances.
The summary of detailed information about financial position and performances of a concern is known as the financial statement.
The financial statement is prepared at the end of accounting period.
The purpose for preparing financial statement is for the periodical review of the activities of the organization and results achieved by the organization.
It includes profit and loss account (income statement) and balance sheet.
The income statement also may include manufacturing and trading account.
Profit and loss account indicates operation results of for a particular period.
Balance sheet indicates the financial position regarding assets, liabilities and capital.
Thus, financial statements are the strong form of accounting.
Write any three features of financial statement.
State the importance of financial statement.
Financial statements are prepared from the accounting record maintained by the firm.
The accounting records are historical and expressed in terms of money.
So it is related to a period. It provides reliable information of business activities and their result.
It also provides information about resources of a business.
The main features of financial statements are as under:
· Financial statement is concerned with past and so it is historical.
· Financial statement is financial in nature and is expressed in terms of money.
· Financial statement presents the summary of revenue and expenses of a firm.
· Financial statement shows the financial position through the help of balance sheet.
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Write any three objectives of financial statement analysis.
List-out any three objectives of financial statement analysis.
Mention any three objectives of financial statement analysis.
The main objectives of financial statement analysis are given below:
To judge liquidity
Financial statement analysis helps to judge the short term solvency position of the company. It can be determined by comparing the amount of current assets and current liabilities.
To judge solvency
Financial statements analysis supports to measure long term solvency position of the company. It can be determined by comparing the long–term debts with shareholders fund and fixed assets.
To judge profitability
Financial statement analysis judges the profitability position of the company. The amount of gross profit and net profit is compared with sales or assets. It also helps to know net profit margin, return on investment, return on assets etc.
To help for planning and budgeting
Planning and budgeting should be prepared on the basis of past financial information. Financial statement analysis helps for planning and budgeting for future performance.
Write three limitation of financial statement analysis.
Although financial statement analysis is important tool yet it has following limitations:
Only focus on quantity
Financial statements analysis does not consider and evaluate the quality like team work, dedicated employees, effective management, good relation between management and employees etc.
It provides only monetary information like profit and loss, solvency position, liquidity position etc.
Mislead to the users
In some cases, financial statement analysis misleads to its user.
When given information in financial statements are incorrect, users are misled for wrong decision.
Not useful for planning
Financial statements involve information of past performance of the company.
Therefore, historical information provides ready-made information of past performance.
It is not useful for future planning.
Based on personal judgment
Financial statement analysis provides only information about liquidity, solvency, turnover and profitability position of past performance.
But, it does not provide ready-made information to the managers to take right decision.
Managers need to use their personal skill and experience for taking decision.
What are the contents of financial statement?
There are different types of financial statement. The main financial statements are:
An income statement shows the net result of the business operations during an accounting period.
It may include manufacturing account, trading account, profit and loss account.
Income statement presents the summary of revenues, expenses and net income or net loss of a firm.
It serves as a profitability measure of the firm.
Balance sheet is not an account; it is a statement of assets and liabilities of a business organization.
It shows the financial position of firm.
The balance sheet is prepared at the end or accounting period.
It is prepared after preparation income statement (manufacturing account, trading, profit and loss account).
Generally, it is prepared from accumulated profit and reserve of previous year.
It is prepared to find out dividend paid for the year.
Company does not distribute entire profit to shareholders.
It transfers some profit to reserves and funds then distribute the dividend.
Cash flow statement
Cash flow statement is somewhat similar to fund flow statement.
The fund flow statement is based on accrual. But, cash flow statement is based on cash.
It reports only cash transaction.
It provides information about inflow and outflow of cash.
Cash flow statement is classified into operating activities, investing activities and financing activities is known cash flow statement.
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