IAS 1 requires that at the minimum, any business should prepare four types of financial statements. Balance sheets indicate what the entity owns and owes at that particular point in time. They include assets, shareholder’s equity and liabilities. Assets are the properties that the companies own that can be valued while liabilities are the amounts owed to others. Income statements are different in that they only indicate what the business entity has made and spent over a fixed period. Cash flow statements show the exchange or flow of cash between the business entity and the economy. The difference between an income statement and a cash flow statement is that the latter shows whether the company has generated cash while the former indicates whether it has made profits. The statement of shareholder’s equity shows the changes to the equity component of the balance sheet that includes shares, retained earnings and other forms of comprehensive income.
Analyzing financial statements is an important part of decision making because finances and the valuation of profits and losses are the most important drivers in business. They are used to diagnose weak spots in the current strategy in an internal perspective, key in making decisions to mitigate against such losses. For external decision makers, reviewing the components of financial statements are important in ascertaining the situation at the company, the effects of the current decision-making strategies. Such analysis can only be relevant when relevant data is used and when such data is correct and timely. The decision-maker should then make the decision in time to reinforce the strengths and solve the weak spots. Decision makers who use financial statements assess the effects of certain activities to reveal the internal forces within the company. They look for ways of increasing the effectiveness of the activity and the productivity of the factors of production. Horizontal analysis of financial statements is where the components are compared over a period. Vertical analysis, on the other hand, is whereas component is compared to another within the same accounting period.
The Sarbanes-Oxley Act (2002) was enacted as a response to financial scandals at WorldCom and Enron that resulted in loss of investments from shareholders. It applies to all public companies in the US as well as their subsidiaries, all foreign companies that trade shares in US stock exchange. Under this law, the ultimate responsibility of ascertaining the financial statements is placed on the CEO and the CFO. In Section 404, the Act also requires that these executives have control over the finances of the company and should therefore have evaluated the effectiveness of the current systems, process and measures for financial control.
The 11-Title Act addresses almost all aspects of financial reporting and control. It means that companies now have to ensure that any process that has a financial implication is correctly documented in real-time and accounted for. The standard data-entry system also means that an ethical and easy-to-understand financial practice is in place. The law also protects whistle-blowers, a key component which ensures that any fraud or illegal financial practices reported are handled with speed and care, and the whistle-blower is legally protected. The Act also imposed stiff penalties on any misinformation or incorrect reporting to the tune of 20 years imprisonment and a fine of $5 million.
Shakespeare, Catharine (2008). “Sarbanes–Oxley Act of 2002 Five Years On: What Have We Learned?” Journal of Business & Technology Law: 333.
Presentation of Financial Statements. Standard IAS 1 (n.d). International Accounting Standards Board. Retrieved from http://www.iasplus.com/standard/ias01.htm on 8 August 2011.