nature of financial statement anlysis

Nature of Financial Statement:

It is very well known that the financial statements basically refer to balance sheets and Income statements. Of course these two basic statements are supported by a number of schedules, supplementary statements, explanatory notes, etc. Therefore all these are financial statements. They show with supporting figures, earn or loss incurred during an accounting period and also the assets, liabilities and capital at the end of the last day of the accounting period. These statements reflect a combination of recorded facts, accounting convention and personal judgments. It is therefore obvious that the figure included in the financial statements is influenced by these factors. They are as follows-

RECORDED FACTS: Financial statements contain the fact relating to the business transaction already recorded in the book of accounts. The unrecorded facts, whatever important they might have not included in financial statements. The examples are human resources, which are not shown in these statements because they are not recorded in the books.

ACCOUNTING CONVENTION:Accounting convention implies certain accounting principle which has been satisfied by the long user. In other words they refer usages and customary practices in social and economic life of human being which have been generally accepted in building up the accounting principles. For examples, on account of convention of conservation provision is made for expected losses but expected profits are ignored. It means that the real business position of the firm is better than what is shown in the financial statements.

ACCOUNTING ASSUMPTION OR CONCEPTS:GAAPs or Generally Accepted Accounting Principles are in the form of guidelines and rules which are to be used as standard for recording business transaction in the book of accounts and their fair presentation in the financial statements. Because their statements have to prepare in conformity with GAAPs, these GAAPs include principles, concepts and assumption. Consequently the figures recorded in the financial statements are influenced by GAAP. For examples Inventory valuation states those year-end inventories are to be valued at lower of cost or market price. That means the value of year-end inventory which appears in the financial statements is influenced by these principles.

PERSONAL JUDGMENT:It is true that Generally Accepted Accounting Principles and concepts are followed in preparing financial statements but their application in most of the cases depends on personal judgment of the accountant. For examples, the choice of selecting methods of depreciation lies on the accountant. Similarly the method of valuing inventory also depends on the personal judgment of the accountant.