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Financial accounting is the field of
accounting Accounting, also known as accountancy, is the measurement, processing, and communication of financial and non financial information about economic entity, economic entities such as businesses and corporations. Accounting, which has been calle ...
concerned with the summary, analysis and reporting of financial transactions related to a business. This involves the preparation of
financial statements Financial statements (or financial reports) are formal records of the financial activities and position of a business, person, or other entity. Relevant financial information is presented in a structured manner and in a form which is easy to un ...
available for public use.
Stockholder A shareholder (in the United States often referred to as stockholder) of a corporation is an individual or legal entity (such as another corporation, a body politic, a Trust law, trust or partnership) that is registered by the corporation as the ...
s, suppliers,
bank A bank is a financial institution that accepts deposits from the public and creates a demand deposit while simultaneously making loans. Lending activities can be directly performed by the bank or indirectly through capital markets. Beca ...
s,
employees Employment is a relationship between two party (law), parties Regulation, regulating the provision of paid Labour (human activity), labour services. Usually based on a employment contract, contract, one party, the employer, which might be a co ...
,
government agencies A government or state agency, sometimes an appointed commission, is a permanent or semi-permanent organization in the machinery of government that is responsible for the oversight and administration of specific functions, such as an Administratio ...
, 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 Publicly traded companies typically are subject to rigorous standards. Small and midsized businesses often follow more simplified standards, plus any specific disclosures required by their specific lenders and shareholders. Some firms operate on th ...
(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 International Financial Reporting Standards, commonly called IFRS, are accounting standards issued by the IFRS Foundation and the International Accounting Standards Board (IASB). They constitute a standardised way of describing the company's fina ...
(IFRS) is a set of 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 The International Accounting Standards Board (IASB) is the independent accounting standard-setting body of the IFRS Foundation. The IASB was founded on April 1, 2001, as the successor to the International Accounting Standards Committee (IASC). It ...
(IASB). 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 that is useful to existing and potential investors, lenders and other creditors in making decisions about providing resources to the reporting entity.
2. According to the European Accounting Association:
Capital maintenance is a competing objective of financial reporting.
Financial accounting is the preparation of financial statements that can be consumed by the public and the relevant stakeholders. Financial information would be useful to users if such qualitative characteristics are present. When producing financial statements, the following must comply: Fundamental Qualitative Characteristics: * Relevance: Relevance is the capacity of the financial information to influence the decision of its users. The ingredients of relevance are the predictive value and confirmatory value. Materiality is a sub-quality of relevance. Information is considered material if its omission or misstatement could influence the economic decisions of users taken on the basis of the financial statements. * Faithful Representation: Faithful representation means that the actual effects of the transactions shall be properly accounted for and reported in the financial statements. The words and numbers must match what really happened in the transaction. The ingredients of faithful representation are completeness, neutrality and free from error. Enhancing Qualitative Characteristics: * Verifiability: Verifiability implies consensus between the different knowledgeable and independent users of financial information. Such information must be supported by sufficient evidence to follow the principle of objectivity. * Comparability: Comparability is the uniform application of accounting methods across entities in the same industry. The principle of consistency is under comparability. Consistency is the uniform application of accounting across points in time within an entity. * Understandability: Understandability means that accounting reports should be expressed as clearly as possible and should be understood by those to whom the information is relevant. * Timeliness: Timeliness implies that financial information must be presented to the users before a decision is to be made.


Three components of financial statements


Statement of cash flows (cash flow statement)

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: *Cash inflow: $20 *Cash outflow:$7 *Opening balance: $5 *Closing balance: $20 – $7 + $5 = $18 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: *Cash inflow: $50 - ''How much WikiTables received in cash for the first table. They didn't receive cash for the second table (sold in credit terms).'' *Cash outflow: $50 - ''How much they'd originally bought the 2 tables for.'' *Opening balance: $0 *Closing balance: $50 – 2*$25 + $0 = $50–50=$0 - ''Indeed, the cash flow for the month of June for WikiTables amounts to $0 and not $50.'' 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 financial performance (income statement, profit & loss (p&l) statement, or statement of operations)

The statement of profit or income statement represents the changes in value of a company's accounts over a set period (most commonly one
fiscal year A fiscal year (or financial year, or sometimes budget year) is used in government accounting, which varies between countries, and for budget purposes. It is also used for financial reporting by businesses and other organizations. Laws in many ju ...
), 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 In business and Accountancy, accounting, net income (also total comprehensive income, net earnings, net profit, bottom line, sales profit, or credit sales) is an entity's income minus cost of goods sold, expenses, depreciation and Amortization ...
, 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 Cost of goods sold (COGS) is the carrying value of goods sold during a particular period. Costs are associated with particular goods using one of the several formulas, including specific identification, first-in first-out (FIFO), or average cost. ...
– selling, general, administrative expenses (SGA) –
depreciation In accountancy, depreciation is a term that refers to two aspects of the same concept: first, the actual decrease of fair value In accounting and in most schools of economic thought, fair value is a rational and unbiased Prediction, estim ...
/ amortization = earnings before interest and taxes ( EBIT) – interest and tax expenses = profit/loss


Statement of financial position (balance sheet)

The balance sheet is the financial statement showing a firm's
asset In financial accounting, an asset is any resource owned or controlled by a business or an economic entity. It is anything (tangible or intangible) that can be used to produce positive economic value. Assets represent value of ownership that c ...
s, liabilities and equity (capital) 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. This statement best demonstrates the basic accounting equation:
''Assets = Liabilities + Equity''
The statement can be used to help show the financial position of a company because liability accounts are external claims on the firm's assets while equity accounts are internal claims on the firm's assets. Accounting standards often set out a general format that companies are expected to follow when presenting their balance sheets.
International Financial Reporting Standards International Financial Reporting Standards, commonly called IFRS, are accounting standards issued by the IFRS Foundation and the International Accounting Standards Board (IASB). They constitute a standardised way of describing the company's fina ...
(IFRS) normally require that companies report
current Currents, Current or The Current may refer to: Science and technology * Current (fluid), the flow of a liquid or a gas ** Air current, a flow of air ** Ocean current, a current in the ocean *** Rip current, a kind of water current ** Current (stre ...
assets and liabilities separately from non-current amounts. A GAAP-compliant balance sheet must list assets and liabilities based on decreasing liquidity, from most liquid to least liquid. As a result, current assets/liabilities are listed first followed by non-current assets/liabilities. However, an IFRS-compliant balance sheet must list assets/liabilities based on increasing liquidity, from least liquid to most liquid. As a result, non-current assets/liabilities are listed first followed by current assets/liabilities. Current assets are the most liquid assets of a firm, which are expected to be realized within a 12-month period. Current assets include: *
cash In economics, cash is money in the physical form of currency, such as banknotes and coins. In bookkeeping and financial accounting, cash is current assets comprising currency or currency equivalents that can be accessed immediately or near-immed ...
- physical money *
accounts receivable Accounts receivable, abbreviated as AR or A/R, are legally enforceable claims for payment held by a business for goods supplied or services rendered that customers have ordered but not paid for. These are generally in the form of invoices raised ...
- revenues earned but not yet collected *Merchandise inventory - consists of goods and services a firm currently owns until it ends up getting sold * Investee companies - expected to be held less than one financial period * prepaid expenses - expenses paid for in advance for use during that year Non-current assets include fixed or long-term assets and
intangible asset An intangible asset is an asset In financial accounting, an asset is any resource owned or controlled by a business or an economic entity. It is anything (tangible or intangible) that can be used to produce positive economic value. Assets r ...
s: *''fixed (long term) assets'' **
property Property is a system of rights that gives people legal control of valuable things, and also refers to the valuable things themselves. Depending on the nature of the property, an owner of property may have the right to Consumables, consume, alte ...
**
building A building, or edifice, is an enclosed structure with a roof and walls standing more or less permanently in one place, such as a house or factory (although there's also portable buildings). Buildings come in a variety of sizes, shapes, and funct ...
**equipment (such as factory machinery) *''intangible assets'' **copyrights **trademarks **patents ** goodwill Liabilities include: *''current liabilities'' **trade accounts payable **
dividends A dividend is a distribution of Profit (accounting), profits by a corporation to its shareholders. When a corporation earns a profit or surplus, it is able to pay a portion of the profit as a dividend to shareholders. Any amount not distributed ...
payable **employee salaries payable **interest (e.g. on debt) payable *''long term liabilities'' **mortgage notes payable **bonds payable 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 A sole proprietorship, also known as a sole tradership, individual entrepreneurship or proprietorship, is a type of enterprise owned and run by one person and in which there is no legal distinction between the owner and the Types of business entity ...
,
partnership A partnership is an arrangement where parties, known as business partners, agree to cooperate to advance their mutual interests. The partners in a partnership may be individuals, business entity, businesses, interest-based organizations, schoo ...
, or a
corporation A corporation is an organization—usually a group of people or a company—authorized by the State (polity), state to act as a single entity (a legal entity recognized by private and public law "born out of statute"; a legal person in legal ...
. For a corporation, the owner's equity portion usually shows
common stock Common stock is a form of corporate equity (finance), equity ownership, a type of security (finance), security. The terms voting share and ordinary share are also used frequently outside of the United States. They are known as equity shares or or ...
, and retained earnings (earnings kept in the company). Retained earnings come from the retained earnings statement, prepared prior to the balance sheet.


Statement of retained earnings (statement of changes in equity)

This statement is additional to the three main statements described above. It shows how the distribution of income and transfer of dividends affects the wealth of shareholders in the company. The concept of retained earnings means profits of previous years that are accumulated till current period. Basic proforma for this statement is as follows: Retained earnings at the beginning of period + Net Income for the period - Dividends = Retained earnings at the end of period.


Basic concepts


The stable measuring 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.”
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 Publicly traded companies typically are subject to rigorous standards. Small and midsized businesses often follow more simplified standards, plus any specific disclosures required by their specific lenders and shareholders. Some firms operate on th ...
of a respective country, which are typically issued by a national standard setter, or
International Financial Reporting Standards International Financial Reporting Standards, commonly called IFRS, are accounting standards issued by the IFRS Foundation and the International Accounting Standards Board (IASB). They constitute a standardised way of describing the company's fina ...
(IFRS), which are issued by the
International Accounting Standards Board The International Accounting Standards Board (IASB) is the independent accounting standard-setting body of the IFRS Foundation. The IASB was founded on April 1, 2001, as the successor to the International Accounting Standards Committee (IASC). It ...
(IASB). Financial accounting serves the following purposes: * producing general purpose financial statements * producing information used by the management of a business entity for decision making, planning and performance evaluation * producing financial statements for meeting regulatory requirements.


Objectives of financial accounting

* Systematic recording of transactions: basic objective of accounting is to systematically record the financial aspects of business transactions (i.e. book-keeping). These recorded transactions are later on classified and summarized logically for the preparation of financial statements and for their analysis and interpretation. * Ascertainment of result of above recorded transactions: accountant prepares profit and loss account to know the result of business operations for a particular period of time. If expenses exceed revenue then it is said that the business is running under loss. The profit and loss account helps the management and different stakeholders in taking rational decisions. For example, if business is not proved to be remunerative or profitable, the cause of such a state of affairs can be investigated by the management for taking remedial steps. * Ascertainment of the financial position of business: businessman is not only interested in knowing the result of the business in terms of profits or loss for a particular period but is also anxious to know that what he owes (liability) to the outsiders and what he owns (assets) on a certain date. To know this, accountant prepares a financial position statement of assets and liabilities of the business at a particular point of time and helps in ascertaining the financial health of the business. * Providing information to the users for rational decision-making: accounting as a ‘language of business’ communicates the financial result of an enterprise to various stakeholders by means of financial statements. Accounting aims to meet the financial information needs of the decision-makers and helps them in rational decision-making. * To know the solvency position: by preparing the balance sheet, management not only reveals what is owned and owed by the enterprise, but also it gives the information regarding concern’s ability to meet its liabilities in the short run (liquidity position) and also in the long-run (solvency position) as and when they fall due.


Graphic definition

The
accounting equation Accounting, also known as accountancy, is the measurement Measurement is the quantification (science), quantification of variable and attribute (research), attributes of an object or event, which can be used to compare with other objec ...
(
Asset In financial accounting, an asset is any resource owned or controlled by a business or an economic entity. It is anything (tangible or intangible) that can be used to produce positive economic value. Assets represent value of ownership that c ...
s = Liabilities + Owners' Equity) and financial statements are the main topics of financial accounting. The
trial balance A trial balance is a list of all the general ledger accounts (both revenue and capital) contained in the ledger of a business. This list will contain the name of each nominal ledger account and the value of that nominal ledger balance. Each nomin ...
, 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 In financial accounting, a balance sheet (also known as statement of financial position or statement of financial condition) is a summary of the financial balances of an individual or organization, whether it be a sole proprietorship, a busine ...
. 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.
Asset In financial accounting, an asset is any resource owned or controlled by a business or an economic entity. It is anything (tangible or intangible) that can be used to produce positive economic value. Assets represent value of ownership that c ...
,
expense An expense is an item requiring an outflow of money, or any form of Wealth, fortune in general, to another person or group as payment for an item, service, or other category of costs. For a leasehold estate, tenant, renting, rent is an expense. Fo ...
, and
dividend A dividend is a distribution of Profit (accounting), profits by a corporation to its shareholders. When a corporation earns a profit or surplus, it is able to pay a portion of the profit as a dividend to shareholders. Any amount not distributed ...
accounts have normal debit balances (i.e., debiting these types of accounts increases them). Liability,
revenue In accounting, revenue is the total amount of income generated by the sale of goods and services related to the primary operations of the business. Commercial revenue may also be referred to as sales or as turnover. Some companies receive rev ...
, and equity accounts have normal credit balances (i.e., crediting these types of accounts increases them).
0 = Dr
Asset In financial accounting, an asset is any resource owned or controlled by a business or an economic entity. It is anything (tangible or intangible) that can be used to produce positive economic value. Assets represent value of ownership that c ...
s Cr Owners' Equity Cr Liabilities . _____________________________/\____________________________ . . / Cr Retained Earnings (profit) Cr
Common Stock Common stock is a form of corporate equity (finance), equity ownership, a type of security (finance), security. The terms voting share and ordinary share are also used frequently outside of the United States. They are known as equity shares or or ...
\ . . _________________/\_______________________________ . . . / Dr
Expenses An expense is an item requiring an outflow of money, or any form of Wealth, fortune in general, to another person or group as payment for an item, service, or other category of costs. For a leasehold estate, tenant, renting, rent is an expense. Fo ...
Cr Beginning Retained Earnings \ . . . Dr
Dividend A dividend is a distribution of Profit (accounting), profits by a corporation to its shareholders. When a corporation earns a profit or surplus, it is able to pay a portion of the profit as a dividend to shareholders. Any amount not distributed ...
s Cr
Revenue In accounting, revenue is the total amount of income generated by the sale of goods and services related to the primary operations of the business. Commercial revenue may also be referred to as sales or as turnover. Some companies receive rev ...
. . \________________________/ \______________________________________________________/ increased by
debit Debits and credits in double-entry bookkeeping are entries made in Account (accountancy), account ledgers to record changes in Value (economics), value resulting from business transactions. A debit entry in an account represents a transfer of v ...
s increased by
credit Credit (from Latin verb ''credit'', meaning "one believes") is the Trust (social sciences), trust which allows one Party (law), party to provide money or resources to another party wherein the second party does not reimburse the first party im ...
s 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.
However, it is important to note that there are instances of accounts, known as contra-accounts, which have a normal balance opposite that listed above. Examples include: * Contra-asset accounts (such as accumulated depreciation and allowances for bad debt or obsolete inventory) * Contra-revenue accounts (such as sales allowances) * Contra-equity accounts (such as
treasury stock A treasury stock or reacquired stock is Share capital, stock which is bought back by the issuing company, reducing the amount of outstanding stock on the open market ("open market" including insiders' holdings). Share repurchase, Stock repurcha ...
)


Financial accounting versus cost accounting

#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. #Financial accounting reports the results and position of business to government, creditors, investors, and external parties. #Cost Accounting is an internal reporting system for an organisation's own management for decision making. # 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. # 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.


Related qualification

Many professional accountancy qualifications cover the field of financial accountancy, including Certified Public Accountant CPA, Chartered Accountant (CA or other national designations, American Institute of Certified Public Accountants AICPA and
Chartered Certified Accountant Founded in 1904, the Association of Chartered Certified Accountants (ACCA) is the global professional accounting body offering the Chartered Certified Accountant qualification (ACCA). It has 240,952 members and 541,930 future members worldwid ...
( ACCA).


See also

*
Constant item purchasing power accounting Constant purchasing power accounting (CPPA) is an accounting model that is an alternative to model historical cost accounting under high inflation and hyper-inflationary environments. It has been approved for use by the International Accounting St ...
* DIRTI 5 * Historical cost accounting * Philosophy of accounting * Accounting analyst, whose job involves evaluating public company financial statements *
Management accounting In management accounting or managerial accounting, managers use accounting information in decision-making and to assist in the management and performance of their control functions. Definition One simple definition of management accounting is th ...
, the other main division of accounting *
Bookkeeping Bookkeeping is the recording of financial transactions, and is part of the process of accounting in business and other organizations. It involves preparing source documents for all transactions, operations, and other events of a business. Tr ...


References


Further reading

* David Annand
Introduction to Financial Accounting
Athabasca University,
Financial Accounting
(2015) * Johnny Jackson
Introduction to Financial Accounting
Thomas Edison State University. * Alexander, D., Britton, A., Jorissen, A., "International Financial Reporting and Analysis", Second Edition, 2005, {{Authority control