NATURE AND PURPOSE OF FINANCIAL STATEMENTS

For correctly realising the role of auditing, you must understand the nature and purpose of the financial statements. ‘Financial statements’ is a set of documents which show the result of business operation during a period – how the result was achieved and the position of assets and liabilities on the given date. Progress made or success achieved  during a certain period can also be readily ascertained from such a set of documents. It also makes an implied representation that it has been properly prepared, shows correct figures and the figures are set against correct description and context. Regardless of the type of entity – whether in the public or private sector or whether for profit or not – all entities use economic resources to pursue their goals. Financial statements enable an entity’s management to provide useful information about its financial position at a particular point of time and the results of its operations and its changes in financial position for a particular period of time. External financial reporting for these entities is directed toward the common interest of various users. Financial statements provide owners with information about the stewardship of management. They also provide a basis for investors’ decisions about whether to buy or sell securities; for credit rating services’ decisions about the credit worthiness of entities; for bankers’ decisions about whether to lend money, and for decisions of other creditors, regulators and others outside the entity.
Information contained in the statement of accounts of a business are primarily intended for the owners. However, many others make use of the information for different purposes. Management of the business uses it for decision-making purposes, lenders and creditors examine it to establish the degree of safety of their money. Government levies tax putting a prima facie reliance on the statements and regulates the socio-economic state of affairs on a summary view of the information contained in various accounting statement made available to it. Investors review the information for making investment decisions and the financial analysts can use the information to assess the performance of an entity. Financial statements are of great significance to workers as well; they want to be assured that reasonable and legitimate share of the revenue earned by the organisation has been paid to them as
bonus and the distribution pattern has not violated the norms of social justice. You will realise, from the above the importance and utility of statements of account and the need for their reliability. To ensure the acceptable degree of reliability and accuracy of the financial statements, examination and appraisal of accounts and the financial picture by an independent expert is necessary. This is what has led to the evolution of the auditing profession. However, you must be clear on one point. The statements of account are viewed by different interests from different angles; consequently a statement prepared primarily for the use of the owners may not be wholly useful to the other interests. For example, management may need more detailed information on matters considered critical by it, the investors and financial analysts are keen to see the projected image of the present state of affairs. Government would look for inadmissible items under the taxation laws, etc. Separate statements of accounting highlighting the information needed by the interested parties, other than the owners cannot be expected to be prepared in the ordinary course unless the same is specially called for. This makes the preparation of the financial statements more onerous because other users of the statement would use the information subject to such modifications and enquiry as would be considered necessary to meet their respective objective. But they must have an honest assurance that
the statements have been properly compiled, prepared and presented to adhere to the requirements of owners. The auditor can accomplish this by a process of examination and appraisal. Further, it may be noted that the management is responsible for establishing an accounting system to identify, measure, record and adequately disclose an entity’s transactions and other events that affect its financial position and results of operations. Management is responsible for selecting accounting principles that appropriately reflect events that occur and for making other accounting estimates and judgments. This responsibility is not lessened by an independent audit.