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 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:
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Financial accounting
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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 organizations 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 organization’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 specialization.
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 International Accounting Standards Board (IASB) explains that the objective of financial reporting is to provide information about the financial position, performance, and changes in financial position of an entity that is useful to a wide range of users in making economic decisions.
So who are these users, and what do they typically need from financial statements?
Users of accounting information and their information needs
- Owners or Shareholders are interested in evaluating the company’s profitability and potential for future growth. They need to understand the return on their investment, dividend potential, and overall company performance. Financial statements help them assess the effectiveness of management, make decisions about holding or selling their shares, and evaluate the company’s ability to generate long-term value and sustainable returns.
- Managers use financial statements to assess the company’s operational performance, financial position, and strategic direction. They need detailed insights to make informed decisions about resource allocation, budgeting, cost control, and future investments. Financial statements help managers evaluate departmental performance, identify areas for improvement, benchmark against past performance, and develop strategies to enhance organizational efficiency and profitability
- Suppliers rely on financial statements to evaluate a company’s creditworthiness and financial stability before extending credit or entering long-term business relationships. They assess the company’s ability to pay for goods and services, analyze payment patterns, and determine the risk of doing business.
- Employees use financial statements to understand the company’s financial health, job security, and potential for future growth. They are interested in the organization’s profitability, which can impact salary increases, job stability, and potential bonuses or benefits. Financial statements help employees gauge the company’s performance and make informed decisions about their career prospects and long-term employment.
- Lenders analyze financial statements to assess a company’s creditworthiness and ability to repay loans. They evaluate financial ratios, cash flow, debt levels, and overall financial stability to determine lending risk and appropriate interest rates. Financial statements help lenders make informed decisions about providing credit, setting loan terms, and monitoring the company’s financial performance throughout the loan period.
- Investors use financial statements to evaluate a company’s potential for investment, expected returns, and financial stability. They analyze profitability, growth trends, financial ratios, and risk factors to make informed investment decisions. Financial statements help investors compare different companies, assess potential returns, and determine the attractiveness of investing in a particular organization
- Tax authorities use financial statements to verify tax reporting accuracy, assess tax liabilities, and ensure regulatory compliance. They examine financial information to confirm proper tax calculation and detect potential tax evasion.
- Customers assess financial statements to evaluate a company’s stability and reliability. They seek assurance of the organization’s ability to provide ongoing products, services, and support, ensuring long-term business continuity
- The Government uses financial statements for economic planning, policy-making, and regulatory purposes. They analyze financial data to understand economic trends, monitor industry performance, and develop appropriate economic policies.
- The Public examines financial statements to understand a company’s economic impact, social responsibility, and community contribution. They assess the organization’s role in job creation, economic development, and broader societal implications.