Accounting involves the process of ‘collecting, analyzing and communicating financial information’ in order to make more informed decisions (Atril and McLaney, 2008 page 2). This information helps various users to assess different courses of action relating to the financial performance and position of the organization (FASB 2012). The information is used to make decisions by internal users for example managers and employees and external users, for example, Investors, creditors, government, and customers. This essay will critically discuss the usefulness and importance of accounting information of these users and how it helps make informed decisions.
The majority of these users treat the financial statements as the main source of information in order to make decisions. The full disclosure principle states that if the information is important, useful, and has the ability to help users make decisions, then it should be disclosed (FRC Limited 2012). Disclosing information that is relevant and clear for users can improve decision making. This is supported by PWC (2014), claiming that providing company-specific information will help to produce useful information and reduce an overload of information.
The various users of accounting information have different purposes, however, the quality and standards of the information presented must stay consistent. (Alexander et al., 2011), states that faithful representation and relevance are the fundamental characteristics for accounting information to be useful. For the information to be relevant, it should contain a confirmatory and predictive value. (IFRS Foundation 2010), states that if accounting information is relevant, this can give users certainty and accuracy in order to make effective decisions. The concept of faithful representation is concerned about making sure financial statements are free from bias, neutral, and complete. (Atril and McLaney, 2008) argues that accounting information should enable users to make useful decisions which can be achieved by neutral information and not unreliable information. Moreover, (IFRS Foundation 2010) identified four main qualitative characteristics that can enhance relevant and faithful reports including timeliness, verifiability, comparability and understandability. (Bazley, Nikolai, and Jones, 2009), states that decision usefulness should be the overall characteristic in judging the quality of accounting information. Also, accounting information should provide information in which the benefits outweigh the costs (Atrill and Mclaney, 2008).
Investors make decisions regarding whether or not to invest in a company. This requires the use of accounting information to understand the entity’s economic resources and financial performance during a period. They are concerned with the risk and return on investment and the ability of the entity to pay dividends (England and instit2011). Accounting information is used to determine whether they should buy, sell or hold shares. European surveys revealed that the income statement is the most effective form of accounting information for investors (Cascino et al., 2014). This is because investors are interested in their potential profits and this can be estimated from the company’s past performance as shown in the income statement. Recently, Pearson PLC announced a 30% fall in shares, a decrease of £60million in profit and a cut on dividends (BBC, 2017). Investors would view this as a bad indication of the performance of the company. Investors are interested if a company can pay dividends and accounting information is useful. (BskyB Ltd 2015) stated, a 3% increase in dividend. This would increase attraction from investors, therefore, accounting information is useful in decision making.
Although financial statements provide information useful to investors, they have some limitations. A critical assumption is that using information from the past will predict the future. This is usually true, however, there is no guarantee that the company would perform as expected. In order to make well-informed decisions about the company, financial statements should be transparent. For example, Enron was declared bankrupt in 2001 due to a lack of transparency. This creates a problem for investors because without knowing the amount of debt owed, investors will not be able to assess their vulnerability to bankruptcy. This lack of transparency made investors lose shares of up to $11billion (Li, Y. (2010). (M. Bushman and J. Smith, 2003), States the importance of transparency because less information means more uncertainty for users especially investors, therefore managers and owners should report reliable information. (Eccles et al., 2002) supports this view by arguing companies with full disclosures win more trust from investors, thus making effective and better informed decisions.
Creditors including Lenders and Suppliers are external users. Lenders such as financial institutions provide finance on a long term basis. (Alexander and Nobes, 2013), states that the balance sheet enables lenders to see if the organization has the ability to repay loans and interest when it is due or if it is creditworthy to borrow additional funds. Lenders are able to assess the sustainability and liquidity of the borrower from financial statements and can impose loan covenants for businesses which can limit their borrowing. Financial statements prove to be useful as it can provide evidence if the loan covenant conditions are being met. However, (Elliott and Elliott, 2013) suggests that accounting information may not be so much useful because of the different timescales of users. For example, a lender would need to see if a business can repay the money within three months but the information is on an annual basis.
The balance sheet allows suppliers to decide if they want to sell to the entity or if it is likely that amounts owing to them will be paid when due (ICAEW, 2011). For example, if a company orders 50,000 units from a supplier, the supplier needs to know if the company is able to pay for these units before the suppliers incur the expense of producing them. The amount due is called a trade payable. The supplier can make a decision based on the balance sheet to see if the business is able to make payments. However, the balance sheet can be used for the wrong purposes by companies. For example, in 2016, it was revealed in the statement that Tesco avoided paying suppliers just to improve its own financial position (Simpson, 2016).
Customers have an interest in the accounting information for assessing the financial position of a business, as it enables to maintain a steady source of business for the future. Customers want to know if the entity has enough resources to survive. The financial statements provide useful confirmation of the reliability of the entity itself as a continuing source of supply. For example, Domino’s Pizza annual report of 2014 states under the going concern principle, that groups have adequate resources to continue in existence for the foreseeable future. (Domino’s Pizza Inc. 2014). This relates to one of the main objectives of accounting, to provide enough and useful information.
Governments require information for decision-making purposes. (Elliott and Elliott, 2013) states accounting information is used to regulate the activities of entities, assess taxation, to allocate resources and provide a basis for national income. HMRC which acts on behalf of the UK government collects company’s annual accounts as a basis to make useful and effective decisions. This information is used to see whether the company complies with tax laws and if it has paid the right amount (Alex et al). Moreover, (Chen and Vijayaram, 2013) states that governments also use accounting information to financially assist companies that provide social activities known as Corporate social responsibility. This is largely beneficial for the entire society.
The internal users of accounting information are referred to as the individuals who are directly involved in the day to day activities of the business organization such as managing, operating, planning and controlling. These include managers and employees. Managers need accounting information to analyze the company’s performance and position. (Alexander and Nobes, 2013) states, the information is useful for them because it will help them more easily to manage the business efficiency, to take effective control and plan decisions in the future. Not only is the information useful but it can be very detailed and specific to their needs which can improve decision making and usefulness.
Employees are interested in information about the economic stability and profitability of their employers. Employees use financial information about the business for fair and open collective bargaining such as wage negotiations and to assess the companies present and future job security. Much of this also requires specialized and detailed information. It may be necessary that the business stays profitable so that customer’s needs are satisfied. For the information to be useful, it must be clear and understandable. Also, it may be useful to supply information on a frequent basis rather than waiting for an annual report which is slow to arrive and more general in nature.
To conclude, this essay has reviewed the various users of accounting information and their purposes of using it. It can be concluded that the significance of using accounting information is useful for decision making. The usefulness of information must be evaluated in relation to the purposes to be served and the objectives of financial reporting are focused on the use of accounting information in decision making.