Financial accounting

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

Accounting measurement, processing and communication of financial information about economic entities

Accounting or accountancy is the measurement, processing, and communication of financial and non financial information about economic entities such as businesses and corporations. The modern field was established by the Benedikt Kotruljevic in 1458, merchant, economist, scientist, diplomat and humanist from Dubrovnik (Croatia), and Italian mathematician Luca Pacioli in 1494. Accounting, which has been called the "language of business", measures the results of an organization's economic activities and conveys this information to a variety of users, including investors, creditors, management, and regulators. Practitioners of accounting are known as accountants. The terms "accounting" and "financial reporting" are often used as synonyms.

A shareholder is an individual or institution that legally owns one or more shares of stock in a public or private corporation. Shareholders may be referred to as members of a corporation. Legally, a person is not a shareholder in a corporation until their name and other details are entered in the corporation's register of shareholders or members.

Bank financial institution

A bank is a financial institution that accepts deposits from the public and creates credit. Lending activities can be performed either directly or indirectly through capital markets. Due to their importance in the financial stability of a country, banks are highly regulated in most countries. Most nations have institutionalized a system known as fractional reserve banking under which banks hold liquid assets equal to only a portion of their current liabilities. In addition to other regulations intended to ensure liquidity, banks are generally subject to minimum capital requirements based on an international set of capital standards, known as the Basel Accords.

Contents

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] With IFRS becoming more widespread on the international scene, consistency in financial reporting has become more prevalent between global organizations.

International Financial Reporting Standards Technical standard

International Financial Reporting Standards, usually called IFRS, are accounting standards issued by the IFRS Foundation and the International Accounting Standards Board (IASB) to provide a common global language for business affairs so that company accounts are understandable and comparable across international boundaries. They are a consequence of growing international shareholding and trade and are particularly relevant for companies with shares or securities listed on a public stock exchange. They are progressively replacing the many different national accounting standards.

The International Accounting Standards Board (IASB) is the independent, accounting standard-setting body of the IFRS Foundation.

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.

Management accounting Field of business administration, part of the internal accounting system of a company

In management accounting or managerial accounting, managers use the provisions of accounting information in order to better inform themselves before they decide matters within their organizations, which aids their management and performance of control functions.

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. [3]

2. According to the European Accounting Association:

Capital maintenance is a competing objective of financial reporting. [4]


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:

Enhancing Qualitative Characteristics:

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 and loss (income statement or statement of operations)

The statement of profit or income statement represented 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

– selling, general, administrative expenses (SGA)

depreciation/ 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 assets, 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 in dollar amount. This statement best demonstrates the basic accounting equation: Assets = Liabilities + Equity. 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. [5] [6]

Current assets are the most liquid assets of a firm, which can be realized in 12 months period. 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. [7]

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. [8]

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.” [9]

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. [10]

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 (ACCA).

See also

Related Research Articles

Bookkeeping Recording of financial transactions

Bookkeeping is the recording of financial transactions, and is part of the process of accounting in business. Transactions include purchases, sales, receipts, and payments by an individual person or an organization/corporation. There are several standard methods of bookkeeping, including the single-entry and double-entry bookkeeping systems. While these may be viewed as "real" bookkeeping, any process for recording financial transactions is a bookkeeping process.

Financial statement formal record of the financial activities and position of a business, person, or other entity

Financial statements are formal records of the financial activities and position of a business, person, or other entity.

Balance sheet summary of the financial balances of a sole proprietorship, a business partnership, a corporation or other business organization

In financial accounting, a balance sheet or 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 business partnership, a corporation, private limited company or other organization such as Government or not-for-profit entity. Assets, liabilities and ownership equity are listed as of a specific date, such as the end of its financial year. A balance sheet is often described as a "snapshot of a company's financial condition". Of the four basic financial statements, the balance sheet is the only statement which applies to a single point in time of a business' calendar year.

Historical cost

In accounting, an economic item's historical cost is the original nominal monetary value of that item. Historical cost accounting involves reporting assets and liabilities at their historical costs, which are not updated for changes in the items' values. Consequently, the amounts reported for these balance sheet items often differ from their current economic or market values.

This page is an index of accounting topics.

In accounting, book value is the value of an asset according to its balance sheet account balance. For assets, the value is based on the original cost of the asset less any depreciation, amortization or impairment costs made against the asset. Traditionally, a company's book value is its total assets minus intangible assets and liabilities. However, in practice, depending on the source of the calculation, book value may variably include goodwill, intangible assets, or both. The value inherent in its workforce, part of the intellectual capital of a company, is always ignored. When intangible assets and goodwill are explicitly excluded, the metric is often specified to be "tangible book value".

Expenditure is an outflow of money to another person or group to pay for an item or service, or for a category of costs. For a tenant, rent is an expense. For students or parents, tuition is an expense. Buying food, clothing, furniture or an automobile is often referred to as an expense. An expense is a cost that is "paid" or "remitted", usually in exchange for something of value. Something that seems to cost a great deal is "expensive". Something that seems to cost little is "inexpensive". "Expenses of the table" are expenses of dining, refreshments, a feast, etc.

Debits and credits

In double entry bookkeeping, debits and credits are entries made in account ledgers to record changes in value resulting from business transactions. Generally speaking, if cash is spent in a business transaction, the cash account is credited, and conversely, when cash is obtained in a business transaction, it is described as a debit. Debits and Credits can occur in any account. For simplicity it is often best to view Debits as positive numbers and Credits as negative numbers. When all the debits and credits that are transacted in each account are added up the resulting account total could be a net Debit or a net Credit. If the total of the account is in a net Debit position (positive), it is generally classified in the Asset section of the balance sheet, whereas accounts that total to a net Credit (negative) are shown in the liability section of the balance sheet. Accounts that relate to the company's profit are totaled to yield company earnings and are classified in the Equity section of the balance sheet. When recording incoming cash (revenue) a Debit will be made to Cash or equivalent Assets and a Credit will be made on the revenue account in the income statement. If a company has a positive Net Income, the Retained Earnings will receive a Credit when closing out the Income Statement for the year, while a Net Loss will result in a Debit to the Retained Earnings. A net Credit (negative) balance in Retained Earnings in the Equity Section demonstrates that the company has been profitable over time, whereas a Debit (positive) balance in the Equity section, would demonstrate that the company has been unprofitable. In most companies the following accounts end-up in Credit positions: accounts payable, share capital, loans payable; while Debit accounts typically include Equipment, Inventory, Accounts Receivable. Debits must equal Credits (negatives) in each transaction; individual transactions may require multiple debit and credit entries.

Income statement

An income statement or profit and loss account is one of the financial statements of a company and shows the company’s revenues and expenses during a particular period.

Cash flow statement financial statement that shows how changes in balance sheet accounts and income affect cash and cash equivalents, and breaks the analysis down to operating, investing, and financing activities

In financial accounting, a cash flow statement, also known as statement of cash flows, is a financial statement that shows how changes in balance sheet accounts and income affect cash and cash equivalents, and breaks the analysis down to operating, investing, and financing activities. Essentially, the cash flow statement is concerned with the flow of cash in and out of the business. As an analytical tool, the statement of cash flows is useful in determining the short-term viability of a company, particularly its ability to pay bills. International Accounting Standard 7, is the International Accounting Standard that deals with cash flow statements.

The retained earnings of a corporation is the accumulated net income of the corporation that is retained by the corporation at a particular point of time, such as at the end of the reporting period. At the end of that period, the net income at that point is transferred from the Profit and Loss Account to the retained earnings account. If the balance of the retained earnings account is negative it may be called accumulated losses, retained losses or accumulated deficit, or similar terminology.

Chart of accounts

A chart of accounts (COA) is a created list of the accounts used by an organization to define each class of items for which money or its equivalent is spent or received. It is used to organize the entity’s finances and segregate expenditures, revenue, assets and liabilities in order to give interested parties a better understanding of the entity’s financial health.

Statement of changes in equity

A Statement of changes in equity and similarly the statement of changes in owner's equity for a sole trader, statement of changes in partners' equity for a partnership, statement of changes in Shareholders' equity for a Company or statement of changes in Taxpayers' equity for Government financial statements is one of the four basic financial statements.

The fundamental accounting equation, also called the balance sheet equation, represents the relationship between the assets, liabilities, and owner's equity of a person or business. It is the foundation for the double-entry bookkeeping system. For each transaction, the total debits equal the total credits. It can be expressed as furthermore:

Provision (accounting) account which records a present liability of an entity

In financial accounting, a provision is an account which records a present liability of an entity. The recording of the liability in the entity's balance sheet is matched to an appropriate expense account in the entity's income statement. The preceding is correct in IFRS. In U.S. GAAP, a provision is an expense. Thus, "Provision for Income Taxes" is an expense in U.S. GAAP but a liability in IFRS. 

The following outline is provided as an overview of and topical guide to accounting:

A foreign exchange hedge is a method used by companies to eliminate or "hedge" their foreign exchange risk resulting from transactions in foreign currencies. This is done using either the cash flow hedge or the fair value method. The accounting rules for this are addressed by both the International Financial Reporting Standards (IFRS) and by the US Generally Accepted Accounting Principles as well as other national accounting standards.

Liability (financial accounting) future sacrifices of economic benefits that an entity is obliged to make to other entities as a result of past transactions or other past events

In financial accounting, a liability is defined as the future sacrifices of economic benefits that the entity is obliged to make to other entities as a result of past transactions or other past events, the settlement of which may result in the transfer or use of assets, provision of services or other yielding of economic benefits in the future.

International Financial Reporting Standards requirements

This article lists some of the important requirements of International Financial Reporting Standards (IFRS).

References

  1. "Financial Accounting - Definition from KWHS". The Wharton School. 28 February 2011. Retrieved 13 July 2018.
  2. "Who We Are - January 2015" (PDF). IFRS.org. IFRS Foundation. Archived from the original (PDF) on 1 May 2015. Retrieved 28 April 2015.Cite uses deprecated parameter |deadurl= (help)
  3. IFRS Conceptual Framework(2010) Par. OB2
  4. 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 Archived 2014-07-29 at the Wayback Machine
  5. "IAS 1 - Presentation of Financial Statements". Deloitte Global . Retrieved May 9, 2017.
  6. Larry M. Walther, Christopher J. Skousen, "Long-Term Assets", Ventus Publishing ApS, 2009
  7. Malhotra, DK; Poteau, Ray (2016). Financial Accounting I. Academic Publishing. ISBN   978-1627517300.
  8. Fred., Phillips (2011). Fundamentals of financial accounting. Libby, Robert., Libby, Patricia A. (3rd ed.). Boston: McGraw-Hill Irwin. ISBN   9780073527109. OCLC   457010553.
  9. Paul H. Walgenbach, Norman E. Dittrich and Ernest I. Hanson, (1973), Financial Accounting, New York: Harcourt Grace Javonovich, Inc. Page 429.
  10. Cost and Management Accounting. Intermediate. The Institute of Cost Accountants of India. p. 17.

Further reading