financial accounting information

financial accounting information

The Importance of Financial Accounting Information in Decision-Making

1. Introduction to Financial Accounting Information

Doctrines of financial accounting establishment continue to govern the conduct of business activities, the writing of transactions, and dealing with the need to analyze activities that have occurred because of the baseline that is exhibited by the historians of the economic lives of trading entities. These doctrines provide a knowledge base of the principles that have emerged and sustain the discipline throughout its research and development tradition and have the potential to actually mature into the profession of accounting.

Accounting can be described as a fundamental system that serves as an important mechanism for evaluating and monitoring the performance of specific decision-making activities. More particularly, accounting can be demonstrated as the most important form of good governance as a means for validating user-generated information. The major observations note that accounting can be envisioned as the keystone of contemporary-day capitalism as the process of matching and comparing revenues and expenses to determine the distribution of wealth and the management of capital to maintain and enhance production capabilities, as well as the efficient allocation of goods and services.

2. Key Components of Financial Accounting Information

Current assets and current liabilities are both expected future value of cash items. The difference between current assets and current liabilities provides both the operating and financing cash needs of the entity. Exchange transaction current items consist of cash, inventory, short-term investments, accounts receivable, and accounts payable. These components are operating cash inflows and large direct operating cash outflows. Hence, management should be concerned about any potential reductions in these asset and liability items since these sources donate to lost financial flexibility in financing both operations and long-term investments. The most relevant consideration in linking current assets to current liabilities is to let the asset maturity structures reflect the long-term financing arrangements. Conversely, each account should display some level of short-term/long-term liability mix in financing. Finally, this requires management to actively match the maturities of the asset and liability items.

Financial accounting information utilizes two types of measurements as the foundation for its quantitative data. The initial equation uses the interaction of the specific measurement components to reflect how transactions and events affect the components of the basic accounting equation. Therefore, both provide similar information, but it is up to management as to which component measurement definition will be selected as the criteria for the information provided. Often, a balance exists between a range of measurements that will provide both quantitative and qualitative evaluation needs of users. The more complex the component definition, the more data is available for decision-making purposes. Once users express their information quality needs, the primary goal for constructing the financial information system could be related to linking the identified financial measurements to help economic models. These critical economic models can explain corporate financial behavior in a comprehensive way.

3. The Role of Financial Accounting Information in Decision-Making

With regards to the shareholders of the company, one would presume that the most important utilization of accounting information is in decision-making within capital markets, which includes investment decisions. For investment decisions, potential investors would examine the financial statements to determine whether a company would yield a sufficient return on their investment. They would also examine financial statements for indicators of management performance and potential problems that they could encounter.

The primary role of financial accounting is to provide financial information to various parties for decision-making purposes. This information is used by external parties as the basis for making decisions whether to deal with the company (for example, shareholders, suppliers, and banks) and by parties within the company to make decisions about its operations. The function of financial accounting is to provide data in the form of financial statements to enable the stakeholders of the company to make informed judgments and decisions.

4. Challenges and Limitations of Financial Accounting Information

Grieve and Whittington identify a number of challenges facing financial accounting information, including the pace of change in the former, technological developments, convergence of national accounting models, the public interest role of accountancy, and finally where stakeholder priorities lie. Sullivan explores a number of questions associated with the ability of historical financial accounting data to reflect and provide a basis for decision-making. One is at what stage in the life cycle of a company does financial accounting information become irrelevant and not useful for decision-making. Another is whether relevance decreases over time and hence decreases in value for decision-making purposes. Grieve argues that while the development of an individual country’s accounting systems will have an impact on the ability of the accounting profession to act in the public interest, the accounting profession will also have an impact on the development process.

The literature cites several challenges and limitations of financial accounting information. These challenges and limitations call into question the utility of financial accounting information in decision-making processes. The most commonly cited challenges and limitations include the subjectivity employed in many accounting measurements, the lack of forward-looking information associated with historical financial accounting data, and the conservatism inherent in accounting to ensure reliability and minimize earnings manipulation. There is also the issue that many intangible assets are not currently recorded in the balance sheet due to the requirements of historical cost. This has led to concerns over whether financial accounting information is relevant and of appropriate quality for decision-making purposes.

5. Emerging Trends in Financial Accounting Information

Researchers have confirmed that historical financial accounting information supply displacement theoretical relation remains stronger and least volatile compared to those of other attributes. Furthermore, empirical regularities of historical financial accounting information that have been produced and confirmed spanning standardized reporting requirements regardless of company size such as the inverse relation between accounting quality and future firm performance seasonality of financial information observation windows, endogenous earnings perception, and demand for environmental responsibility disclosure, amongst others, have led to incremental demand for institutional trading mechanisms that generate earnings-based covered calls and economic policy concerns that justify minimum profitability levels for corporations. Given highly interconnected and integrated global markets in a deregulated, privatized, redistributive, and reliant fiscal environment, it should not be surprising that corporations reflect financial accounting information demands expressed by their stakeholders in their corporate governance practices.

I have surveyed the accounting practice literature to identify newly emerging financial accounting information demands of various users and found that despite the qualitative review studies and case studies which seem to indicate a trend toward increased demand for forward-looking, non-financial, and industry-specific information, in the main, external report users continue to demand not only historical trend and standards-compliant information. With respect to the latter, the importance of increasingly demanding global standards and high audit quality seem to be particularly relevant requirements of financial accounting information during the past decade and beyond. It is the historical financial accounting information, however, that remains comparatively more well-tested, well-researched, and well-criticized information source and is therefore the choice information source of both internal investors and external investors.