We live in a world of limited resources in which people try to use those resources most effectively. By providing accurate and timely measures of performance that can be used by investors to determine how best to invest their limited capital resources, accounting fulfills an essential function in the capital allocation process.
The accounting function produces financial reports that can be used by investors to analyze the financial results of a company’s operations. The financial statements are historical reports presented in money terms based on rules designed to make the reports as consistent and comparable as possible from one company to another.
By providing historical financial reports that are timely, consistent and comparable, accounting facilitates an efficient and effective capital allocation process. Investors can make informed decisions regarding in which companies to invest their limited capital resources.
Without historical financial reports that are timely, consistent and comparable investors would not have the information necessary for making good investment decisions. As a result, the capital allocation process would become very inefficient and haphazard. Investors would have a much more difficult time determining where to invest their money and investment risk would increase enormously.