What Is Financial Accounting? Financial accounting deals with the systematic analysis and documentation of various financial transactions pertaining to a company. This includes the preparation of periodic financial reports available for viewing by all stakeholders. These reports are used for decision making purposes by a company’s management and by other persons who can benefit from the information provided.
A company’s financial transactions are mainly characterized by three types of transactions: assets, liabilities and capital. The two categories are further subdivided into discrete units and then into components. Assets include fixed assets and equity securities. Liabilities consist of accounts receivable and accounts payable. A company also has inventory, operating leases and purchases.
Generally, financial accounting deals with the recognition, measurement, allocation, and treatment of financial information. This information is usually presented in a report filed by an entity such as a corporation, partnership, or the government. Financial statements are prepared for public distribution and are prepared on the basis of the recorded cash flows. To prepare financial information, accounting records are gathered and processed according to the instructions given by the Board of Accountancy or delegated accountant.
Statement of Financial Activity. The basic function of financial accounting is to prepare and keep accurate records of the cash flows in relation to the financial records. The most widely used systems in financial accounting are the single-entry and double-entry systems. Single-entry system uses only a single account, while double-entry system uses both a credit account and a debit account. The system that uses a single-entry system is called single-entry bookkeeping system while the system that uses double-entry bookkeeping system is called double-entry bookkeeping system. Every transaction is reported in the financial records at the end of the reporting period.
Auditing of Financial Statements. The process of auditing is to review and examine the financial records or the financial statements that indicate the financial activity of the entity. During the audit process, the auditor will confirm the accuracy of the recorded financial statements and will also verify if there are any incorrect entries. As part of the standard auditing procedure, the auditor will check the accuracy of the balance as well as the reported income and other related variables.
Accrual Accounting. Cash transactions are reported in the cash account during the period of actual cash transaction. In short term financing transactions, the cash account is closed when the debt instrument is repaid. Long-term financing transactions are reported in the sales account during the accumulation period or in the purchase, construction and other advance transactions. Under the normal operating procedures, the accrued amount is also reported in the revenue account at the end of the reporting period.
There are some standard accounting transactions that are included in the accounting statements. They are home-equity loan, depreciated capital assets, fair value of the difference (future vs. the date of sale) and realized capital gains. These transactions are required by law to be reported on the balance sheet. However, the accountant has the discretion to report an itemized statement only if he/she is satisfied that there is reliable evidence for it.
A knowledgeable accountant is an essential element in the success of the business entity. He/She is responsible for understanding the nature of the financial statements and for drawing conclusions based from them. The accountancy services provided by the professional accountant should be performed with utmost care and professionalism to ensure compliance with the accounting standards and for accurate and reliable financial reports.
The accountant composes financial statements which represent the operations of a business and display the results of operations and year-end balances for a single organization as a whole or a segment. There are three types of financial statements: income statement, balance sheet and statement of cash flows. The income statement displays all income-related charges such as expenses, revenues, and inventory inventories. The balance sheet provides information relating to the assets, liabilities, ownership equity, and surplus and also the debt and financing results.
The accuracy of the financial statements depends on the skill of the financial statements writer. Since the purpose of producing the financial statements is to provide company information to decision makers, it is important to comply with the accounting standards set forth by GAAP (Generally Accepted Accounting Principles). These standards require that all transactions be reported in the same way, for the same items, over the period of one year. The balance sheet must show the balance as of the end of the reporting period. GAAP requires the manager to prepare reports that are comparable to the financial reports prepared by persons who do not have the accounting background necessary to comply with the additional requirements of GAAP.
An important feature of the balance sheet is the statement of cash flows. This form is usually called the statement of cash flows because cash is considered a part of the assets. Cash is accumulated by following the net proceeds from the sales of products to the purchase of assets and then back to the end of the financial year. For many companies, the balance sheet is used as the basis for planning and forecasting future cash inflows and outflows. This form of financial accounting is also used to determine the availability of credit and to manage the relationships among customer debt, capital funding sources, the company’s retained earnings, and the company’s working capital. This form of accounting is also used to determine the cost of borrowing money and to evaluate the performance of the company’s debt and assets.