Question

(Objective of Financial Reporting) Karen Sepan, a recent graduate of the local state university, is presently employed by a large manufacturing company. She has been asked by Jose Martinez, controller, to prepare the company’s response to a current Preliminary Views published by the Financial Accounting Standards Board (FASB). Sepan knows that the FASB has a conceptual framework, and she believes that these concept statements could be used to support the company’s response to the Preliminary Views. She has prepared a rough draft of the response citing the objective of financial reporting.Instructions

1. Identify the objective of financial reporting.
2. Describe the level of sophistication expected of the users of financial information by the objective of financial reporting.

Short answer

(a) The objective of financial reporting is to supply financial information about the reporting organization that is beneficial to current and potential lenders, equity investors, and other creditors in making decisions about supplying resources to the organization with the help of mortgages and equity investments or other forms of credit.

(b) The level of sophistication expected of the users of financial information isthat those investors and creditors are required to know the present financial health of the respective organization and predict the timing and ability of future cash flows.

Step-by-step solution

Meaning of financial reporting

Financial reporting is defined as the presentation of financial information, such as financial statements, to the users of financial statements like creditors and investors. Financial reporting includes press releases, management letters, analysis, auditor reports, financial statement notes, etc.

Objective of financial reporting

Objectives of financial reporting are as follows:

• The first objective of financial reporting is to supply beneficial information to the users of financial reports. The information should be beneficial in various forms, like whether to supply credit to a customer, whether to lend to a borrower, and whether to invest in a business.

• Secondly, to supply information about the cash flows to which the firm is subjected, consisting of the timing and unpredictability of cash flows. The information is crucial for ascertaining the solvency of the business and consecutively can be used to estimate whether the firm can proceed further as a going concern.

• Thirdly, to present the liabilities and financial resources of an organization.

Level of sophistication expected of the users of financial information

Standards are set to meet the information requirements of huge groups of external users like investors, creditors, and their delegates. Though the level of sophistication associated with business as well as financial accounting matters differs both within and between these groups of users, the users are anticipated to acquire a rational understanding of accounting concepts, financial statements, as well as business and economic activities and are anticipated to be eager to review and analyze the information with rational diligence.