This literature review section aims to synthesize the main theoretical approaches and findings of previous authors on public accounting and financial reporting. The review seeks to address information on how accounting is defined and how it relates to financial reports. The main aim of Financial Accounting is to provide users of financial statements with information that is helpful in making good decisions on the management level.
According to the Financial Accounting Standards Board [1978, par. 34], financial reporting should provide information that is useful to present and potential investors and creditors and other users of accounting information in making rational investment, credit, and similar vital decisions. Annual accounts should be able to present to the firm any events that may affect progress of the entity. Bushman and Smith (2001, 2003) summarized the function of accounting in improving decisions involving investments. They affirm that “ the financial accounting information is a direct input to company control structures mostly designed to control managers so as to guide resources in the direction of projects regarded as good and away from the projects marked as bad, and to prevent managers from expropriating the possessions of the investors” that is quite a comprehensive summary.
According to Guenther and Young (2000), nations that pride themselves with having better quality of accounting, accounting income are more closely linked to the fundamental economic activity. This statement means that high-quality accounting procedures translate to better economic decisions. Other authors, such as Ball, Robin and Wu (2003), characterize these findings to the increased demand for financial reporting. In some ordinary law countries, political manipulation and control of family businesses decrease the demand for high quality financial reporting. In most cases, such a choice may negatively affect a country. As Young and Guenther (2003) found out, states with greater revelation of value-relevant accounting information have higher global capital mobility. A good financial reporting system is a qualification for the existence of the informative stock market (Black, 2000). According to (Holmstrom and Tirole, 1993, Dow and Gorton, 1997, dependable and consistent accounting information may progress the monitoring exercise. This may reduce deceitful plans and thereby, cut costs incurred by companies. Leuz and Verrecchia (2004) find that high accounting eminence allows managers to allocate assets more efficiently, because stock markets can forecast future cash flows more precisely and thereby, give some motivation to the managers. Bushman et al. (2004) find that costs of enlightening financial information are quite high without enough legal proprietary security. If the insider communication structure can trim down information evenly and effectively, solid financial environments may have more proprietary security. The desire for precise, reliable, well-timed and accessible financial and non-financial business information is crucial in so as to maintain corporate answerability (Barth & Schipper, 2008).
Despite the above conducted research and studies, no author has tackled the issues of public accounting in relation to financial reports and ultimately their effect on investment decisions. This study will dwell on the above mentioned topic and try to tackle it to exhaustion.
It may not be possible to define accounting with a single precise statement. This is because it involves a lot of things and therefore, mentioning a few of these things would be incorrect and inaccurate. However, accounting can be defined as a systematic action or organized process of keeping and maintaining business and financial accounting (Arnould, 1972). It is, therefore, the orderly reporting, recording and analyzing of day to day transactions of the business entity, financial institution, company or private investment that are then verified and summarized into easy-to-interpret statements. It is the presentation or settlement of applied accounting or work carried out during the accounting procedures. It may also be regarded as work carried by accountants. It involves recording and reporting any kind of business or financial grade of an institution. The word ‘accounting’, in addition to the above, may also refer to the department in a business, firm or institution that deals with accounting (Whittington, 2010). With regard to users of accounting information (shareholders, regulators, stakeholders, the government, public or owners of the business firm), we may define accounting as the action of identification, quantifying and communication of economic information to assist in the making of viable entity decisions.
With the definition of accounting in mind, we may now define financial accounting. It is the act of reporting the position and welfare of a firm financially. This is done using financial statements given to users of accounting information over a stipulated amount of time. Financial accounting mainly aims at providing information to the public (i.e. external users), thereby, acquiring the name public financial accounting. The field of financial accounting uses money to gauge the performance of a firm compared to other entities in an economy. It uses assets, liabilities, revenues and expenses at the end of the accounting period to measure progress. In accounting, the accounting period is the time interval reflected in a set of different financial statements. It is the time period when an institution prepares its accounts. The period is normally within a 12 month interval, but it may also be shorter like a quarter year or even a half year (Whittington. 2010). An accounting system is defined as an organized set of accounting methods, controls and general procedures brought about to collect information to be recorded, analyzed and presented in time for managerial and decision making purposes.