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Answer – 1) Financial statements are a main source of financial information for an organization. Users analyse these statements to evaluate the ability of an organization to use its resources efficiently and effectively and form expectations about risks and returns by studying the changes in assets, liabilities, earnings and cash flows over time.

A balance sheet shows the assets, liabilities and owners' equity at a point in time, for example a balance sheet prepared on March 31st, 2011 provides a snapshot of the assets, liabilities and owners' equity for that entity at that point in time. The income statement and statement of cash flows help explain the changes in balance sheet accounts during a period of time. Balance sheets for the beginning and ending of a fiscal period reveal changes in an entity's resources and finances.

Examining an entity's income statement and statement of cash flows will reveal major events that caused these changes. The relationship between financial statements can be attributed to the manner in which the numbers on one statement explain numbers on other statements.

Even though financial statements provide a wealth of information, their usefulness is limited because of certain constraints in the reporting process.  These constraints exist mainly due to costs associated with reporting financial information. Information is a resource, and it is costly to provide. For information to be valuable, its cost must be less than the benefits it provides to its users.

Therefore, the amount and type of reported information are constrained by costs and benefits. Users should keep these limitations in mind when interpreting financial statement information. Some of these limitations are briefly explained below.

Financial statements are many times based on numbers derived from estimates and allocations. For example, when calculating depreciation, one has to estimate the cost of an asset that was used up during a fiscal period and allocate that...