Financial accounting can be defined as a process of designing and operating an information system for collecting, information in order to make financial decisions. (Andrew Thomas 2009). It is said to collect accurate financial data and other financial information, and to accumulate and combine it in an organized and systematic way, according to the principles and rules of accounting, for reporting purpose.
Financial accounting is objective in the sense that it is not biased which means it is true and fair in review. It is very importance for any organisation because the information gathered through financial accounting can be used to make financial or economic decision making. One of the purposes of financial accounting is to provide information about the performance of the company to external people as well as internal managers within the organisation. The external people can be in form of stakeholders, creditors, suppliers, tax authorities etc. The financial information gathered will help external investors to make the right investment decisions in such an organisation.
On the other hand, financial accounting provides relative economic data about the past year or the current financial position. This helps the manager’s plan for future.
In the theory of accounting and finance, it is assumed that the objective of the business is to maximise the value of a company. Put simply, this means that the managers of a business should create as much wealth as possible for the shareholders. Given this objective, any financing or investment decision that is expected to improve the value of the shareholder’s stake in the business is acceptable. In short, the objective for managers running a business should be profit maximisation both in the short and long-term.
Objectivity in accounting is essential for accountants of an organisation for when reporting of the financial worth of the business. The value set of a final accounts presented to managements depends so much on basic assumptions which has been presented by the accountant. “Accounting like any other form of human activity is governed by different principle” Edward J. (1964). It is importance for accountants to disclose an accurate review of accounting information, in most cases the fairness of disclosed information are been judged by external people. Critics may point out that this is sufficient reason why accounting cannot be objective. Agreeably a wide range of basic assumptions and predictions may be made when preparing the financial information and the emotional factors which may determine an observer’s attitude do create difficulties. However, for objectivity to be effective these difficulties can be overcome by examining all evidence objectively prior to addition in the accounting system.
Objectivity as a property of accounting measurement does have an appeal. It is a complex concept to explain, in some cases it leads to confusion and disagreement. “It is far more realistic to define objectivity simply as the consensus among a given group of observers” (Yuji Ijiri, 1967). Objectivity depends mainly on the measurer. For instance, measuring the net profit of an organisation accountant will have to produce a high level of consensus rather than evaluating through a layman’s point of view or economist.
Long term assets are shown in accounting statements at their cost to the entity, less aggregate depreciation to date, irrespective of the date at which the cost was established, and stock of current assets are valued at ascertained cost, without regards to known present or likely future realisable values. Objectivity in this sense means that verifiable evidence must be used in order to back up the contrast to subjectivity.
It is generally acceptable for accountants to report different types of financial information for different purpose, but as long as the quality of information provided is reliable.
All information must be maintained objectively, which means that it is free of bias and subject to verification. Objectivity is closely tied to reliability. Objective evidence consists of anything that can be physically verified such as a bill, check, invoice, or bank statement. In the event something cannot be supported objectively, a number of subjective methods are used to develop an estimate. The determination of items such as depreciation expense and allowance for doubtful accounts are based on subjective factors. Still even subjective factors are influenced by objective evidence such as past experience.
In ASBJ (2006) the objective of financial reporting is to measure and disclose the position of the entity’s investments and the results of those investments as part of the disclosure system that assists investors in making decisions, so that it is the disclosure of the financial situation of the entity that assists investors in predicting the performance of the entity and in estimating its value8. Investors decide what funds to invest in entities at their own will, with the expectation of obtaining uncertain future cash flow. Those who predict the performance of the entity and estimate its value are investors and the decisions they make are own.
Therefore, net income should continue to be positioned as an independent and separate element of financial statements
We explained that objectivity in the sense that an element or value exists independently of the observer is neither workable nor desirable in accounting.
Subjective goodwill is assumed to be the difference of the value in use and the market price. Value in use is a present value of the future cash flow expected from the best use of the asset, discounted by the discount rate as of the measurement date, while a market price represents a price quoted in the distribution market for an asset. Value in use reflects the subjective value estimated by the reporting entity, and it consists of a market price and intangible (subjective) goodwill, which is defined as the excess of value in use over the market price23. In the present system subjective goodwill is excluded from financial reporting, and this exclusion is supported by many researchers24. However, it is necessary to examine the “common sense” that subjective goodwill should not be recognized. Arguments’ outlining what the exclusion of subjective goodwill means, and to what extent it should be eliminated from accounting earnings and the financial reporting system are not entirely verified.
Subjective goodwill can also be the difference between value in use and the market price of the asset. Future cash flow is realised from the best value of an asset which is has already being discounted by using a discount rate as at date.
Determine the liquidity of a company
The financial managers use these reports to assess the financial position of the company through various financial management tools and then the financial position can be compared to, or benchmarked against, the industry norms. The four different financial statements used for the purpose of reporting and analysis are
Statement of Retained Earnings (or Shareholders’ Equity Statement)
In financial accounting, assets are recorded on the basis of historical costs in the balance sheet, i.e., the assets are recorded at their original purchase price. Of course, the depreciation on the asset is duly subtracted from its original value as the asset remains in use of the business.
However, in financial management, book value is seldom used and financial managers consider the market value and the intrinsic value of assets.