Several documents are included under the name financial statements and the combination of all reports provides a true and fair view of a small or medium company’s assets, financial position and results. Looking at all of them, the management is able to make the best decisions for the organization, as they provide information not only on its legal form but also on its financial status.
Among the documents legally comprised in the financial statements, the most significant are:
The Balance Sheet, which shows the assets (i.e. property and rights) held by the company, and the liabilities, which are the obligations undertaken by the company and its resources, also known as “equity”.
The Profit and Loss Account , which has two columns: the debit, listing all costs and expenses for the year, and the credit, showing the revenues. The difference between both is the profit or loss for the year.
The Statement of Changes in Equity informs of any changes in equity caused by:
The total balance of recognized income and expense.
The changes in equity caused by transactions with company shareholders or owners when acting in such capacity.
Any other changes in equity. o Information must also be provided on any changes in equity due to changes in accounting criteria or corrections of errors.
The Annual Report, whose purpose is to complete, expand on or comment upon the information in the balance sheet and in the profit and loss account.
Briefly summarizing the legal regulations, financial statements must be clearly drafted so that the information provided is understandable and useful to users. Whenever complying with accounting requirements, principles and criteria is not enough to show a true and fair view of the company, the report will include additional accurate information to achieve this goal.
For any exceptional matters, where compliance is conflicting with the true and fair principle, such application will be considered inappropriate. In such cases, the report will sufficiently substantiate this circumstance and explain how it impacts the company’s equity, financial situation and profit.
Information to be included in the company’s financial statements
The information included in the company’s financial statements must be relevant and complete. This means, it must help to assess past, present or future events or to validate or correct prior evaluations. In order to meet this obligation, financial statements must specifically and appropriately show the risks faced by the company. Also, financial statements must be free of any material errors and be objective (have no bias), so that users can be certain that is the true and fair view of the company.
Additionally, the information must be comparable and clear. Comparability must be a principle present both in a company’s financial statements over time, as well as in that of different companies at the same time and for the same period of time. Thus, their real status and profitability can be verified. This involves a similar procedure for any transactions or financial events occurring in similar circumstances.
Regarding clarity, the stakeholders in SMEs financial statements, based on a prudent understanding of the company’s business, accounting and finance, must be able to form an opinion which allows them to make a decision easily after a quick analysis of the information.
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The company’s accounting records and, particularly, the recognition and valuation of the items included in the financial statements, must be entered according to the following accounting principles:
1. Company in operation. Unless otherwise proved, the company will be presumed to continue in operation in the foreseeable future. Therefore, the application of accounting principles and criteria does not intend to determine the value of equity for the purpose of transferring it in full or in part, nor an eventual liquidation amount.
2. Accrual. The effects of transactions or financial events must be recognized when they occur and allocated to the financial year the financial statements refer to, as well as the revenue and expenditure affecting it, regardless of their date of payment or collection.
3. Consistency. A criterion must be chosen from in the options allowed, and it must always be followed and applied similarly for all transactions, events and comparable situations, provided the assumptions that led to the election do not change. If these assumptions vary, the criterion adopted may also vary. Such variations must be included in the report, indicating the event and a qualitative and quantitative valuation of the variation in the financial statements.
4. Prudence. Companies must be prudent in appraising and valuating items when under uncertain conditions. Prudence does not justify an appraisal of assets which does not show the true and fair view expected from financial statements.
a) Also, regarding the application of the fair value method, only profit obtained up to the year-end date may be accounted for. However, all risks (whether for the current or for prior years) must be considered as soon as they become known, even if they only become known between the year-end date and the date the financial statements are prepared. In such case, sufficient information must be provided in the report. Exceptionally, if risks become known between the year-end date and the date the financial statements are prepared and they materially affect the true and fair view of the company, financial statements must be redrafted. b) Depreciation and impairment losses on assets must also be considered.
5. No offsetting. Unless otherwise provided for expressly, no assets or liabilities or revenue or expenditure may be offset, and the elements included in the financial statements must be separately appraised.
6. Materiality. Some accounting principles and criteria may be applied inaccurately if the relative value of the variation in quantitative or qualitative terms is minimal and, therefore, does not affect the true and fair view of the company. The items or amounts whose relative value is insignificant may be grouped together with others similar in nature or function.
If there is a conflict between two accounting principles, the principle better presenting the true and fair view of the company’s assets, financial position and results will prevail. As mentioned before, these principles allow to adequately value the items making up the financial statements.
Items in the financial statements
Assets are property, rights and other resources which are financially under the company’s control and which result from past events. Assets are expected to generate profit or financial returns for the company in the future.
Liabilities are the current obligations resulting from past events. In order to settle a liability, the company is expected to dispose of some resources which may generate profit or financial returns for the company in the future. For these purposes, provisions are included in this category.
Finally, there is net equity, which is the remaining assets of the company, once liabilities have been deducted. Included are all contributions made, whether at the time of incorporation or later, by its shareholders or owners, which are not considered liabilities, as well as the profit (or loss) carried forward from previous years and any other variations affecting it.
Generally accepted accounting principles and standards are the provisions contained in:
The Commercial Code and any commercial legislation.
The National Chart of Accounts for Small and Medium Enterprises.
The National Chart of Accounts and its sectoral adaptations.
The developing regulations determined by the Spanish Accounting and Account Audit Institute.
Any specifically applicable Spanish legislation.
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