Financial Statements for Internal Reporting vs. External Reporting Purposes

Financial Statements for Internal Reporting Purposes vs. Financial Statements for External Reporting Purposes It is common in most companies to maintain two set of financial statements; one being used/presented for internal reporting purposes and another for reporting externally. Internal reports are used primarily to aid management in the decision making process throughout the course of the business. These are subject to internal audit to make sure that all information reported are fair and correct, safeguard the assets of the company, assure compliance to laws and regulations, etc.

The company employs the internal accountants and therefore, unregulated, although there are international standards for internal auditing. External Reports on the other hand, are to provide information on the financial position, performance and changes in the financial position of the company for a variety of users such as the government, shareholders, financial institutions, employees, vendors, and the public itself. These reports should be very understandable, and are assumed to be read by users who have reasonable knowledge on financials and business, and for those who are willing to study the information diligently.

Most of the external users depend completely on these reports for their decision making. The reports are expected to be reliable so the companies should employ external auditors that are independent from the company. This is to avoid conflict of interests and bias towards the information presented by the company. Ideally, the financial statements that are audited by the internal auditors should be the same as the statements that would be subject to external audit.

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The problem arises when the company decided to report financial statements that are entirely different from the internally used and that of externally used. But still the intention of the company why it reported two different reports should be considered as well because that is where the ethical issue starts. If the company’s primary intention is to conceal the truth to avoid tax penalties, attract more investors, or lure a vendor to give a high credit limit, then the ethical standard of utilitarianism, rights and duties as well as the fairness and equity are violated.

For utilitarianism approach, the external users will surely not benefit from the concealment. Their investments, assets, as well as the benefits from taxes are at risk. Only the company will benefit from it. In terms of the rights and duties approach, the shareholders has all the rights to know the true standing of the company and the duty of the company is to provide them the truth. The issue on fairness and equity is that other users may be able benefit from some concealment while others may not.

Maintaining two sets of Financial Records/Statement has been a long practice for almost all if not all major companies worldwide. An example of which is the manner of reporting sunk costs. Companies do recognize sinking cost in the Financial Statement. While this could be creditable as expense for tax accounting purposes, the said cost is no longer relevant for management decision thus no longer required in the books for Internal Purposes. Keeping two books would allow company executives to better examine items that matter to them especially those which affect the company in the future.

There is nothing wrong in maintain two sets of books specially if the reports are in accordance the accounting guidelines such as the GAAP or other statutory requirements required by the government where the company operates and are prepared in accordance with the Bureau of Internal Revenue regulations. As explained above, the books for internal management are for their use only and need not be shown to the public or used in taxation purposes.

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