Scope of financial reporting and stakeholder needs
This chapter introduces the fundamental concepts of financial reporting, explains how financial accounting differs from management accounting, and identifies the stakeholder groups that rely on financial statements to make economic decisions.
Learning objectives
By the end of this chapter, you should be able to:
- Define the nature, principles, and scope of financial reporting.
- Identify and compare the main types of business entity.
- Identify the users of financial statements and state and differentiate between their information needs.
Scope of financial reporting
Accounting includes different branches. The two main branches used by business entities are:
- Financial accounting
- Management accounting
Financial accounting follows established standards such as Generally Accepted Accounting Principles (GAAP) or International Financial Reporting Standards (IFRS). These guidelines support consistency, transparency, and comparability of financial information across organisations and jurisdictions.
The management accounting branch is concerned with presenting financial information in a way that helps management make well-informed decisions.
Management accounting typically provides flexible and forward-looking information. This helps management plan and control the organisation’s resources, improve operational efficiency, and strengthen overall financial performance.
It’s also useful to note that cost accounting, another branch of accounting, is an important part of management accounting.
Differences between financial accounting and management accounting
| Basis of difference | Management accounting | Financial accounting |
|---|---|---|
| Reporting frequency | Could be daily, weekly, monthly, etc | Usually annually or semi-annually |
| Regulations | No compliance with regulations | Strict compliance with regulations such as GAAP, IFRS, IAS, etc. is required |
| Time focus | Usually future-oriented | Usually concerned with historical records |
| Users | Used by management and other internal users | Normally used by external users |
| Statutory requirements | Not required by law | Required by law |
| Format | Flexible and usually tailored to the needs | Prescribed by accounting standards |
| Purpose | Decision-making, planning, and control | Stewardship and statutory reporting |
| Verification | Not subject to external audit | Subject to external audit for many entities |
Note: Although the focus of this course is financial accounting, you’ll want to understand the other branches as well. In practice, accountants may work in different branches depending on their role and specialisation.
Types of business entity
Businesses are organised under different legal structures, and the structure chosen affects how the business is owned, controlled, financed, and regulated.
| Feature | Sole trader | Partnership | Limited liability company |
|---|---|---|---|
| Separate legal entity | No | No | Yes |
| Owner liability | Unlimited | Unlimited, joint and several | Limited to share capital |
| Ownership and control | One owner, who also manages | Shared among partners | Shareholders own; directors manage |
| Ability to raise finance | Limited to owner’s resources | Limited to partners’ combined resources | Can raise finance by issuing shares or debt |
| Regulation and disclosure | Minimal | Minimal | Companies Act filing, and often audit |
| Continuity | Ends when owner stops trading | May end when a partner leaves, unless agreed otherwise | Continues regardless of changes in ownership |
- Sole trader: easy and cheap to set up, and the owner keeps full control, but unlimited liability puts personal assets at risk and the business can’t easily raise large amounts of finance.
- Partnership: shares the workload, capital, and risk between partners, but each partner can be liable for the others’ actions, and disagreements can disrupt the business.
- Limited liability company: owners’ liability is limited and it’s easier to raise finance, but it faces more regulation, including statutory filing and audit requirements.
Stakeholders’ needs
Financial accounting focuses on reporting summarised financial information in the form of financial statements, mainly for external users.
A person or institution with an interest in a business is called a stakeholder. Many stakeholders are not involved in the day-to-day operations of the business. Because of this, they depend on financial statements to understand what is happening in the business. For many entities - especially large companies - there are also regulatory obligations to provide this information.
The IASB’s Conceptual Framework states that the objective of general purpose financial reporting is to provide financial information about the reporting entity that is useful to existing and potential investors, lenders, and other creditors in making decisions about providing resources to the entity. Other users, such as employees, customers, government, and the public, may also find financial reports useful, but the reports aren’t mainly aimed at them.
So who are these users, and what do they typically need from financial statements?
Users of accounting information and their information needs
The following table lists the main users of financial statements, their main information need, and the typical decision each user makes based on that information.
| User | Main information need | Typical decision |
|---|---|---|
| Existing shareholders | Profitability, dividends, and return on their existing investment | Hold or sell their shares |
| Potential investors | Profitability, growth, and risk, to judge likely returns | Whether to invest |
| Managers | Operational performance and financial position | Resource allocation, budgeting, and strategy |
| Suppliers | Creditworthiness and ability to pay for goods received | Whether, and on what terms, to extend credit |
| Employees | Profitability and financial stability | Job security and expectations about pay and benefits |
| Lenders | Ability to repay interest and capital, gearing, and security | Whether, and on what terms, to lend |
| Tax authorities | Accuracy of reported income and tax liabilities | Assessing and collecting tax due |
| Customers | Stability and ability to keep supplying products or services | Whether to rely on the business long-term |
| The government | Economic trends and industry performance | Economic planning and policy-making |
| The public | Economic and social impact of the business | Views on the business’s role in the community |