Problems and Assumptions

Problems and Assumptions

A basic assumption underlying communication theory is that there is a clear separation between the transmitter and the receiver of information. This is acknowledged also in financial reporting as regards the distinction which is drawn between the function of the accountant as the transmitter of information and the external user as the receiver of information. The external user relies upon the accountant to provide him with a significant supply of information for making economic decisions. It is for each user to evaluate and interpret this information in the course of formulating decisions which only he may make. It is not the objective of either the accountant or of financial reports to make such evaluations and draw conclusions for the external user. Consequently, it is not the function of the accountant to value a firm for the external user: on the contrary, it is for the investor to establish the value of the firm as an investment and to bear the risk involved in acting on such a valuation. The function of the accountant in this analysis is to assist the external user in valuing the firm by the provision of such information as is necessary for that purpose.

In line with this reasoning, we consider in this part the problems associated with the production of financial accounting information. We examine how data is selected from the environment, and the manner in which it becomes an input into the financial accounting system. We discuss also the manner in which the output of the financial accounting system is formulated as financial reports. We shall examine in Part 4 the relevance of these reports to the decisions which shareholders and investors wish to make.

We have limited our analysis of financial accounting information to those aspects which we consider important and relevant to the textbook as a whole. We have divided this part into three sections. In Section 1, we examine financial accounting method to gain an understanding of its nature and of the principles underlying its procedures. In our Planning Section, we analyse the process of periodic measurement, which is one of its main applications. In our Control Section, we select for closer analysis the application of financial accounting procedures to the production of financial statements for corporate enterprises.

One important application of financial accounting method relates to the use of accounting records for the day-to-day control of assets and liabilities. These technical aspects of control are treated as a 'background subject' in this text, so as not to detract from the important theoretical and practical aspects of the accountant's role in providing information for decision-making purposes.

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Insofar as business firms are concerned, a distinction is normally made between financial accounting, which is the activity of recording and analysing the financial results of transactions as a means of arriving at a measure of the firm's success and financial soundness, and management accounting, which is the activity of providing information to enable management to make efficient decisions as regards the use and allocation of the firm's resources. In this part, the traditional practices of financial accounting based on historical... see: Financial Accounting-the Historical Cost Approach