What you need to know about financial statement basics
Beginner Stock Market Investing
In the United States, companies whose stock is publicly held need to file financial statements that periodical intervals with the Securities and Exchange Commission (SEC). The most important statements are the following:
- The annual report comprising of audited financial statements, management discussion and analysis and the relevant schedules within 60 days of the fiscal year ending.
- The quarterly report which consists of an audited financial statements and the management discussion and analysis. This has to be filed within 35 days of the fiscal quarter closing.
The SEC controls the content of the statements and has, in turn, authorized the Financial Accounting Standards Board (FASB) to update accounting rules as and when it is required. FASB is an independent non-governmental body and, whenever a rule change is considered, they consult a wide range of accounting professionals. Once a rule change has been notified, it becomes mandatory and forms part of the Generally Accepted Accounting Principles (GAAP).
Generally Accepted Accounting Principles (GAAP) a complete set of accounting standards that provides the basis for the preparation of financial statements. They take into account such key issues as materiality (which indicates how important any particular transaction is in the overall context) and verifiability (which means how experts agree to measure the transaction). The objective of GAAP is to provide all concerned (which includes investors and the public) with “relevant, reliable and useful” information. Because it is a general framework, it needs to be modified continuously in the light of prevailing business conditions.
Clearly, what are important for everyone concerned are both the relevance and the reliability of the information. Often it is difficult to achieve both in full measure. For instance, take the case of real estate which is carried on the balance sheet. Real estate is shown at historical cost (in other words the price paid to acquire it) because this value is both relevant and reliable. Clearly the current market value would be both more useful and relevant but such value would be less reliable. One of the problems faced in modern-day accounting is this move from the more reliable historical costs to the less reliable current market value. You should also note that GAAP varies from country to country and you should keep this in mind while analyzing the financial statements of companies outside the US.
The other accounting problem arises because the financial statements have to relate to the operating performance for a particular fiscal period (whether year or quarter) and a number of adjustments have to be carried out in order to accomplish this. For instance, fixed assets have been depreciated at a certain rate to show the effect of usage and wear and tear on the historical cost of these assets. A number of these adjustments have to be based on judgment and it is anybody’s guess as to how accurate and reliable this judgment is in the absence of an objective outside measure. The preparation of a reliable and relevant set of financial statements will always have to be a trade-off between what an ideal statement is and what is practicable in the real world.
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