Financial accounting

Financial accounting (or financial accountancy) is the field of accounting concerned with the summary, analysis and reporting of financial transactions pertaining to a business.[1] This involves the preparation of financial statements available for public consumption. Stockholders, suppliers, banks, employees, government agencies, business owners, and other stakeholders are examples of people interested in receiving such information for decision making purposes.

Financial accountancy is governed by both local and international accounting standards. Generally Accepted Accounting Principles (GAAP) is the standard framework of guidelines for financial accounting used in any given jurisdiction. It includes the standards, conventions and rules that accountants follow in recording and summarizing and in the preparation of financial statements. On the other hand, International Financial Reporting Standards (IFRS) is a set of passionable accounting standards stating how particular types of transactions and other events should be reported in financial statements. IFRS are issued by the International Accounting Standards Board (IASB).[2][3] With IFRS becoming more widespread on the international scene, consistency in financial reporting has become more prevalent between global organizations.

While financial accounting is used to prepare accounting information for people outside the organization or not involved in the day-to-day running of the company, managerial accounting provides accounting information to help managers make decisions to manage the business.

Objectives

Financial accounting and financial reporting are often used as synonyms.

1. According to International Financial Reporting Standards, the objective of financial reporting is:

To provide financial information about the reporting entity that is useful to existing and potential investors, lenders and other creditors in making decisions about providing resources to the entity.[4]

2. According to the European Accounting Association:

Capital maintenance is a competing objective of financial reporting.[5]

Qualities

Financial accounting is the preparation of financial statements that can be consumed by the public and the relevant stakeholders using either Historical Cost Accounting (HCA) or Constant Purchasing Power Accounting (CPPA). When producing financial statements, they must comply to the following:[6]

Three components of financial statements

Statement of cash flows

The statement of cash flows considers the inputs and outputs in concrete cash within a stated period. The general template of a cash flow statement is as follows: Cash Inflow - Cash Outflow + Opening Balance = Closing Balance

Example 1: in the beginning of September, Ellen started out with $5 in her bank account. During that same month, Ellen borrowed $20 from Tom. At the end of the month, Ellen bought a pair of shoes for $7. Ellen's cash flow statement for the month of September looks like this:

Example 2: in the beginning of June, WikiTables, a company that buys and resells tables, sold 2 tables. They'd originally bought the tables for $25 each, and sold them at a price of $50 per table. The first table was paid out in cash however the second one was bought in credit terms. WikiTables' cash flow statement for the month of June looks like this:

Important: the cash flow statement only considers the exchange of actual cash, and ignores what the person in question owes or is owed.

Statement of profit or loss (income statement or statement of operations)

The statement of profit or income statement reports the changes in value of a company's accounts over a set period (most commonly one fiscal year), and may compare the changes to changes in the same accounts over the previous period. All changes are summarized on the "bottom line" as net income, often reported as "net loss" when income is less than zero.

The net profit or loss is determined by:

Sales (revenue) – cost of goods sold – total expenses + total income – tax paid = profit/loss

Statement of financial position (balance sheet)

The balance sheet is the financial statement showing a firm's assets, liabilities and equity at a set point in time, usually the end of the fiscal year reported on the accompanying income statement. The total assets always equal the total combined liabilities and equity in dollar amount. The statement can be used to help show the status of a company.

Accounting standards often set out a general format that companies are expected to follow when presenting their balance sheets. International Financial Reporting Standards normally require that companies report current assets and liabilities separately from non-current amounts.[7][8]

Current assets include:

Non-current assets include fixed or long-term assets and intangible assets:

Liabilities include:

Owner's equity, sometimes referred to as net assets, is represented differently depending on the type of business ownership. Business ownership can be in the form of a sole proprietorship, partnership, or a corporation. For a corporation, the owner's equity portion usually shows common stock, and retained earnings (earnings kept in the company). Retained earnings come from the retained earnings statement, prepared prior to the balance sheet.[9]

Basic concepts

THE STABLE MEASURING UNIT ASSUMPTION One of the basic principles in accounting is “The Measuring Unit principle:

The unit of measure in accounting shall be the base money unit of the most relevant currency. This principle also assumes the unit of measure is stable; that is, changes in its general purchasing power are not considered sufficiently important to require adjustments to the basic financial statements.”[10]

Historical Cost Accounting, i.e., financial capital maintenance in nominal monetary units, is based on the stable measuring unit assumption under which accountants simply assume that money, the monetary unit of measure, is perfectly stable in real value for the purpose of measuring (1) monetary items not inflation-indexed daily in terms of the Daily CPI and (2) constant real value non-monetary items not updated daily in terms of the Daily CPI during low and high inflation and deflation.

UNITS OF CONSTANT PURCHASING POWER The stable monetary unit assumption is not applied during hyperinflation. IFRS requires entities to implement capital maintenance in units of constant purchasing power in terms of IAS 29 Financial Reporting in Hyperinflationary Economies.

Financial accountants produce financial statements based on the accounting standards in a given jurisdiction. These standards may be the Generally Accepted Accounting Principles of a respective country, which are typically issued by a national standard setter, or International Financial Reporting Standards (IFRS), which are issued by the International Accounting Standards Board (IASB).

Financial accounting serves the following purposes:

Objectives of Financial Accounting

Graphic definition

The accounting equation (Assets = Liabilities + Owners' Equity) and financial statements are the main topics of financial accounting.

The trial balance, which is usually prepared using the double-entry accounting system, forms the basis for preparing the financial statements. All the figures in the trial balance are rearranged to prepare a profit & loss statement and balance sheet. Accounting standards determine the format for these accounts (SSAP, FRS, IFRS). Financial statements display the income and expenditure for the company and a summary of the assets, liabilities, and shareholders' or owners' equity of the company on the date to which the accounts were prepared.

Assets and expenses have normal debit balances, i.e., debiting these types of accounts increases them.

Liabilities, revenues, and capital have normal credit balances, i.e., crediting these increases them.

0 = Dr Assets                            Cr Owners' Equity                Cr Liabilities  
          .       _____________________________/\____________________________       .
          .      /    Cr Retained Earnings (profit)         Cr Common Stock  \      .
          .    _________________/\_______________________________      .            .
          .   / Dr Expenses       Cr Beginning Retained Earnings \     .            .
          .     Dr Dividends      Cr Revenue                           .            .
      \________________________/  \______________________________________________________/
       increased by debits           increased by credits


          Crediting a credit                         
Thus -------------------------> account increases its absolute value (balance)
           Debiting a debit                             


          Debiting a credit                         
Thus -------------------------> account decreases its absolute value (balance)
          Crediting a debit

When the same thing is done to an account as its normal balance it increases; when the opposite is done, it will decrease. Much like signs in math: two positive numbers are added and two negative numbers are also added. It is only when there is one positive and one negative (opposites) that you will subtract.

Versus cost accounting

  1. Financial accounting aims at finding out results of accounting year in the form of Profit and Loss Account and Balance Sheet. Cost Accounting aims at computing cost of production/service in a scientific manner and facilitate cost control and cost reduction.
  2. Financial accounting reports the results and position of business to government, creditors, investors, and external parties.
  3. Cost Accounting is an internal reporting system for an organisation's own management for decision making.
  4. In financial accounting, cost classification based on type of transactions, e.g. salaries, repairs, insurance, stores etc. In cost accounting, classification is basically on the basis of functions, activities, products, process and on internal planning and control and information needs of the organization.
  5. Financial accounting aims at presenting ‘true and fair’ view of transactions, profit and loss for a period and Statement of financial position (Balance Sheet) on a given date. It aims at computing ‘true and fair’ view of the cost of production/services offered by the firm.[12]

Many professional accountancy qualifications cover the field of financial accountancy, including Certified Public Accountant (CPA), Chartered Accountant (CA or other national designations) and Chartered Certified Accountant (ACCA).

See also

Further reading

Alexander, D., Britton, A., Jorissen, A., "International Financial Reporting and Analysis", Second Edition, 2005, ISBN 978-1-84480-201-2

References

  1. ↑ "Financial Accounting". Investopedia. Retrieved 4 September 2014.
  2. ↑ "Who We Are - January 2015" (PDF). IFRS.org. IFRS Foundation. Retrieved 28 April 2015.
  3. ↑ Ikpefan, Ochei Ailemen; Akande, A.O (July 2012). "International Financial Reporting Standard (IFRS) Benefits, Obstacles and Intrigues for Implementation in Nigeria" (PDF). Business Intelligence Journal. 5 (2): 299–307. Retrieved 4 September 2014.
  4. ↑ IFRS Conceptual Framework(2010) Par. OB2
  5. ↑ European Accounting Association, Response to Question 26, Comment Letter to the Discussion Paper regarding the Review of the Conceptual Framework, on Page 2 of comment letters, dated 2014-01-24
  6. ↑ Chew, Lynsie; Parkinson, Alan (2013). Making Sense of Accounting for Business. Harlow: Pearson. ISBN 9781782369295.
  7. ↑ "IAS 1 - Presentation of Financial Statements". Deloitte Global. Retrieved May 9, 2017.
  8. ↑ Larry M. Walther, Christopher J. Skousen, "Long-Term Assets", Ventus Publishing ApS, 2009
  9. ↑ Malhotra, DK; Poteau, Ray (2016). Financial Accounting I. Academic Publishing. ISBN 1627517308.
  10. ↑ Paul H. Walgenbach, Norman E. Dittrich and Ernest I. Hanson, (1973), Financial Accounting, New York: Harcourt Grace Javonovich, Inc. Page 429.
  11. ↑ "Basic accounting principles you should know", Cleverism
  12. ↑ Cost and Management Accounting. Intermediate. The Institute of Cost Accountants of India. p. 17.
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