The primary means of communicating the financial effects of organizational activities and transactions of a company to outsiders is the financial reporting system. This reporting system includes communicating financial information through annual financial statements, as well as through reports filed with the Securities and Exchange Commission, voluntary forecasts, and other financial and nonfinancial releases. Financial statements are the main source of financial information conveyed to parties external to the company. The full set of primary financial statements consists of a balance sheet, income statement, and statement of cash flows.
External financial statements have a general purpose and are designed to meet the needs of investors, creditors, and other users of the external reports. They are historical in that they communicate activities and events that have already occurred. Financial statements are prepared on an accrual basis; they measure the impact of events and transactions when they occur and not simply when the cash consequences of such events and transactions are realized. Financial statements are useful in evaluating an enterprise's profitability, liquidity, and long-term solvency and equity structure. An analysis is conducted from the perspective of external users of financial statements and it relies on the annual report of a corporation and other publicly available information. Management, of course, also has access to extensive internal financial data, and their concerns extend to subdivisions of the enterprise, such as the performance of subsidiaries, divisions, departments, and operating functions.
External reports are intended primarily for stockholders, creditors, directors, and regulators such as the SEC. Although externally reported information is also useful to corporate management at the highest level, it is far too aggregate to be useful for decision makin by lower levels of management. And even top levels of management need financial information for decision making with respect to the performance of the various components or segments of the enterprise. It is vital that managers understand how their corporation organizes itself and at what levels the various functions such as manufacturing, marketing, finance, and research and development are performed.
Managers evaluate whether they are getting the financial and cost information they need to plan, control, and evaluate the performance of the corporate segment that they manage. Managers will also gain a better understanding standing of the impact of organization on cost determination and thereby gain a better understanding of the validity of the information they receive. The objective here is not to turn managers into accountants. Rather it is to turn managers into more informed users of the financial and cost information they receive from the accounting function and to be aware of information they need and re not getting. An enterprise, or reporting entity, may consist of many components such as subsidiaries (domestic and foreign) or divisions organized along geographical or product lines. Within each of these components some or all of the essential business functions, such as manufacturing, marketing, and research, may be performed.
Other functions, such as legal, finance, and corporate administration, that benefit the entity as a whole are usually performed only at corporate headquarters. Internal financial reporting is the process of reporting disaggregated financial and cost information to each of the levels of management within as enterprise. The objective of internal reporting is to provide each level of management with relevant and reliable financial and cost information to enable it to plan, control, and evaluate the performance of the organizational segment and functions under its control. While presentation of prospective information may provide complete financial statements, they may be offered in a more summarized form. However, they must include as a minimum the following items: sales or gross revenues, gross profit or cost of sales, unusual or infrequent occurring items, Provision for income taxes, discontinued operations for extraordinary items, income from continuing operations, net income, primary and fully diluted earnings per share, significant changes in financial position (which is satisfied by a cash flow statement), description of what the presentation intends to report, summary of significant assumptions, and summary of significant accounting polices. Presentation that omit one or more of these minimum disclosures are partial presentations, which could include sales forecasts, projection of financial needs, projected or forecasted capital expenditures, forecasts of operating income, projection of taxes owed, and forecasts of balances in accounts such as receivables or payables.
Knowing the structural, record keeping, and personal functions of a company are prerequisite for understanding and evaluating the company's financial and cost data. This knowledge comes from understanding the methods, motivation, and purpose of corporate organization; the way structuring controls the profits and losses of segments; and a company's various bases for reporting financial information. Managers need to be able to determine exactly who is responsible for each of the functions or operations of the company and how the functions or operations interact in the process of generating costs, revenues, and profits. It is seldom possible to form a judgment about the performance of an individual segment or division by inspecting the records of only that segment or division. All financial information must be analyzed together to serve useful in and out of a corporate entity.
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