PURPOSE OF FINANCIAL STATEMENTS

Purpose of Financial Statements

Purpose of Financial Statements

Introduction

The purpose of the paper is to analyse the statement given below:

Given that the purpose of financial statements is to communicate information about an entity that would enable users (investors) to predict future cash flows, it has been argued that the corporate financial report is irrelevant because it provides information on historic transactions

By analyzing the statement it can be said that the primary function of financial accounting is to provide relevant financial information to users external to the business enterprise. The focus of financial accounting is on the information needs of investors and creditors. These users make critical resource allocation decisions that affect the nation's economy (Spiceland, Sepe, & Tomassini, 2001).

Most contemporary accounting textbooks contain similar statements that declare the primacy of user needs and user decisions (often referred to as decision usefulness) as a guide in the construction of external financial statements. Indeed, these financial statements are said to exist primarily to serve user information needs. To individuals trained in or teaching accounting during the last two decades, statements such as these about the purposes for accounting are perhaps unremarkable. However, connections between financial statement users, decision usefulness and standard-setting were forged relatively recently and were initially controversial.1 More than 60% of the respondents to the FASB's (1974) discussion memorandum on the objectives of financial reporting opposed adopting the provision of information for economic decision making as an objective for accounting (Armstrong, 1977, Schuetze, 1983 and Van Riper, 1994). In part the opposition arose from an emphasis in accounting practice that defined an acceptable accounting in terms of “what accountants do” with relatively little effort expended on examining the logic or “usefulness” of accounting practices (Spiller, 1964, p. 851). However, even prominent academics such as Moonitz explicitly rejected usefulness as a purpose for accounting reports. In Accounting Research Study No. 1, he argued that an emphasis upon the “pragmatic aspect of accounting” required answering to whom it was to be useful and for what purpose:

And herein lies the danger. We could easily be trapped into defining accounting and formulating its postulates, principles, and rules in terms of some special interest … We cannot proceed on the premise that accounting is the monopoly of any one group whether that group is concerned mainly with the development of the accounting process or with its end-product in the form of financial statements and reports (Moonitz, 1961, p. 4).

Despite initial resistance, the significance of users as a guide in shaping financial accounting standards has achieved a taken-for-grantedness in the intervening years. Particular accounting requirements are frequently justified by references to user needs or wants or interests. However, these assertions are rarely connected to specific evidence. As Agrawal (1987, p. 175) has noted usefulness tends to be asserted rather than based on “systematic study of user decision models and needs.” Indeed, Miller (1990, p. 31) has advocated the adoption of a different objective for financial statements as it would provide “relief for FASB from dependence ...