FIN2603 – Finance for Non-Financial Managers (2023)
Study Unit 02: Understanding Financial Statements (PB: Chapter 2)
Financial statements may be used by both owners and managers of firms to assess their progress
towards their objectives. To this end they need accurate and reliable financial information at their
disposal. There are also several other users of financial statements.
• Financial statements must provide a fair presentation of the financial performance and
financial position of the firm.
• Income statement - measures the financial performance during a certain period.
• Balance sheet - indicates the financial position at a specific point in time.
• Cash flow statement - indicates what cash flows were generated.
Who uses financial statements:
➢ Shareholders - to assess the worth of their business.
➢ Management - to help plan and control activities.
➢ Lenders to (or creditors of) the business - to assess the likelihood of the repayment of their
funds or of default.
➢ Labour unions - for a basis to negotiate wages.
➢ Investment analysts - who are investing in the firm.
➢ The state - in terms of taxes.
➢ Credit bureaux - needed to issue credit ratings.
1. Key generally accepted accounting principles (GAAP)
The financial statements must be generated according to generally accepted accounting
principles (GAAP) to be reliable, understandable, and relatively consistent between
reporting periods.
The following GAAP are still applicable:
1. Accounting entity – For financial statements to be meaningful, the entity to which the
information pertains must be clearly defined. Only transactions concerning the specific
accounting entity must be recorded, and transactions that do not concern the entity must be
excluded.
2. Money measurement - is a universal accounting denominator used to express the assets,
liabilities and owners' equity so as to describe the financial position of a firm accurately.
3. Conservatism - the use of the most conservative approach of profit determination whenever
alternative procedures exists for the treatment of a transaction or event in the accounting
process.
4. Consistency concept - there must be consistency of accounting treatment of like items within
each accounting period and from one period to another. Any change in methods or policies
must be reported, together with the financial statements.
5. Materiality - transactions and events which are not material in relation to the nature and
scope of an entity's activities need not be taken into account if the cost and difficulty of
recording them are not justified by the resulting benefit.
Lyana Petzer Page 1 of 11
, FIN2603 – Finance for Non-Financial Managers (2023)
6. Historic cost - the phenomenon that assets are initially brought into account in the accounting
process at the cost the entity incurred in acquiring them.
7. The double-entry system - The assets are a reflection of the interests in them. The interests
refer to the liabilities and owners' interest, thus for every debit entry, there must be a credit
entry of the same amount of money (and vice versa)
8. The going-concern concept - gives the users of financial statements the assurance of the
continuity of the firm. The business entity will continue in operational existence for the
foreseeable future. This means in particular that the income statement and balance sheet
assume no intention or necessity to liquidate or significantly curtail the scale of operation.
9. Accounting period - Income and expenses incurred in generating income must be brought into
account during the same accounting period (say the same financial year). Revenue and costs are
accrued (i.e. recognised as they are earned or incurred, not as money is received or paid),
matched with each other insofar as their relationship can be established or justifiably assumed,
and dealt with in the statement of financial performance for the period to which they relate.
This is also referred to as the matching principle.
10. The realisation principle - income must have been earned and realised. Income is earned
when the party giving value has completed its obligation towards the party receiving value. To
be realised, income must be measurable and the ability to recover it must be reasonably certain.
11. The accrual principle - a principle whereby revenues are recognised at the point of sale
and expenses when they are incurred.
To provide up-to-date financial information about a business, it is necessary for an accountant to
record all daily business transactions. To this end he or she must:
• classify
• record
• summarise financial information.
2. Classification of Financial Information
A logical classification of the vast amount of financial information generated in a firm requires a system
of accounts. The accountant may use either a computerised system (for example, AccPac, Pastel, Baan
or SAP) or a manual system.
Regardless of the system used, it must provide for five types of accounts, namely:
• Assets account
• Liabilities account
• Owners’ equity account
• Revenue account
• Expense account
❖ The purpose of the asset, liability and owners' equity accounts is to determine the liquidity and
solvency of the firm by means of the statement of financial position and cash flow statement.
Lyana Petzer Page 2 of 11
Study Unit 02: Understanding Financial Statements (PB: Chapter 2)
Financial statements may be used by both owners and managers of firms to assess their progress
towards their objectives. To this end they need accurate and reliable financial information at their
disposal. There are also several other users of financial statements.
• Financial statements must provide a fair presentation of the financial performance and
financial position of the firm.
• Income statement - measures the financial performance during a certain period.
• Balance sheet - indicates the financial position at a specific point in time.
• Cash flow statement - indicates what cash flows were generated.
Who uses financial statements:
➢ Shareholders - to assess the worth of their business.
➢ Management - to help plan and control activities.
➢ Lenders to (or creditors of) the business - to assess the likelihood of the repayment of their
funds or of default.
➢ Labour unions - for a basis to negotiate wages.
➢ Investment analysts - who are investing in the firm.
➢ The state - in terms of taxes.
➢ Credit bureaux - needed to issue credit ratings.
1. Key generally accepted accounting principles (GAAP)
The financial statements must be generated according to generally accepted accounting
principles (GAAP) to be reliable, understandable, and relatively consistent between
reporting periods.
The following GAAP are still applicable:
1. Accounting entity – For financial statements to be meaningful, the entity to which the
information pertains must be clearly defined. Only transactions concerning the specific
accounting entity must be recorded, and transactions that do not concern the entity must be
excluded.
2. Money measurement - is a universal accounting denominator used to express the assets,
liabilities and owners' equity so as to describe the financial position of a firm accurately.
3. Conservatism - the use of the most conservative approach of profit determination whenever
alternative procedures exists for the treatment of a transaction or event in the accounting
process.
4. Consistency concept - there must be consistency of accounting treatment of like items within
each accounting period and from one period to another. Any change in methods or policies
must be reported, together with the financial statements.
5. Materiality - transactions and events which are not material in relation to the nature and
scope of an entity's activities need not be taken into account if the cost and difficulty of
recording them are not justified by the resulting benefit.
Lyana Petzer Page 1 of 11
, FIN2603 – Finance for Non-Financial Managers (2023)
6. Historic cost - the phenomenon that assets are initially brought into account in the accounting
process at the cost the entity incurred in acquiring them.
7. The double-entry system - The assets are a reflection of the interests in them. The interests
refer to the liabilities and owners' interest, thus for every debit entry, there must be a credit
entry of the same amount of money (and vice versa)
8. The going-concern concept - gives the users of financial statements the assurance of the
continuity of the firm. The business entity will continue in operational existence for the
foreseeable future. This means in particular that the income statement and balance sheet
assume no intention or necessity to liquidate or significantly curtail the scale of operation.
9. Accounting period - Income and expenses incurred in generating income must be brought into
account during the same accounting period (say the same financial year). Revenue and costs are
accrued (i.e. recognised as they are earned or incurred, not as money is received or paid),
matched with each other insofar as their relationship can be established or justifiably assumed,
and dealt with in the statement of financial performance for the period to which they relate.
This is also referred to as the matching principle.
10. The realisation principle - income must have been earned and realised. Income is earned
when the party giving value has completed its obligation towards the party receiving value. To
be realised, income must be measurable and the ability to recover it must be reasonably certain.
11. The accrual principle - a principle whereby revenues are recognised at the point of sale
and expenses when they are incurred.
To provide up-to-date financial information about a business, it is necessary for an accountant to
record all daily business transactions. To this end he or she must:
• classify
• record
• summarise financial information.
2. Classification of Financial Information
A logical classification of the vast amount of financial information generated in a firm requires a system
of accounts. The accountant may use either a computerised system (for example, AccPac, Pastel, Baan
or SAP) or a manual system.
Regardless of the system used, it must provide for five types of accounts, namely:
• Assets account
• Liabilities account
• Owners’ equity account
• Revenue account
• Expense account
❖ The purpose of the asset, liability and owners' equity accounts is to determine the liquidity and
solvency of the firm by means of the statement of financial position and cash flow statement.
Lyana Petzer Page 2 of 11
