'Financial statements reflect a combination of recorded facts, accounting conventions and personal judgements'. Discuss.
Financial statements are indeed a combination of recorded facts, accounting conventions and personal judgements. This nature of financial statements can be explained as follows:
Recorded Facts: Financial statements are prepared on the basis of facts in the form of cost data recorded in the accounting books. The original cost or historical cost is the basis of recording transactions. The figures of various accounts such as cash in hand, cash at bank, trade receivables, fixed assets, etc., are taken as per the figures recorded in the accounting books. Assets purchased at different times and at different prices are put together and shown at costs. Since these are not based on market prices, financial statements do not show the current financial condition of the concern.
Accounting Conventions: Financial statements are prepared following accounting concepts, conventions, accounting policies, accounting standards and requirements of Law. These conventions guide how transactions are recorded and presented. For instance, the convention of conservatism influences how assets and income are reported to avoid any possibility of overstatement.
Personal Judgements: Under more than one circumstance, facts and figures presented through financial statements are based on personal opinion, estimates and judgements. The depreciation is provided taking into consideration the useful economic life of fixed assets. Provisions for doubtful debts are made on estimates and personal judgements. In valuing inventory, cost or market value, whichever is less, is being followed. While deciding either cost of inventory or market value of inventory, many personal judgements are made based on certain considerations.
Conclusion: Since financial statements are the outcome of recorded facts, accounting concepts and conventions used, and personal judgements made in different situations by the accountants, bias may be observed in the results. The financial position depicted may not be realistic. Hence, these statements need proper analysis before their use in decision-making.
Explanation
This question tests students' understanding of the nature of financial statements. The answer must cover all three aspects mentioned in the question: recorded facts, accounting conventions, and personal judgements. The textbook context provides clear explanations for each element with relevant examples like depreciation, provisions for doubtful debts, and inventory valuation. Students should also mention that these elements can lead to bias in financial statements.