What is financial accounting?
It is the process of compiling, analyzing, interpreting, recording and communicating information about economic events on an entity’s financial statements. The main objective behind the process according to Fintalent’s financial accounting consultants is to portray in the most objective way possible the true economic effects of transactions or other events in order to provide users with reliable information for making decisions.
Financial accounting includes two stages:
1 – Recording assets, liabilities etc.
2 – Preparing financial statements.
Financial accounting is called the language of business. It interprets and records economic events in a standardized manner, to provide information from which users can make decisions related to the economics of a business entity.
The modern era of financial accounting begins in the early industrial societies. During this time, manufacturing businesses needed methods to keep track of their assets and liabilities as well as stockholder’s equity as they expanded. The solution was to create financial accounting through the use of journals and ledgers for every company activity, or “everyday” use of transaction forms and ledgers.
Financial Accounting is a macro level accounting and the most important purpose of financial accounting is to keep track of assets, liabilities, owner’s equity, income and expenses, so that businesses could measure performance.
The objectives are as follows:
- Measure profit or loss, capitalization, liquidity and overall financial position.
- Monitor the effectiveness of sales policies and operating procedures and make reliable predictions about company performance in terms of profit or loss 3. Assist management in formulating strategies for accomplishing desired goals 4. Give shareholders/owners an understanding of the company to aid in their investment decision-making 5. Allow users to determine whether they have paid a fair price when acquiring goods or services from the company 6. Identify important trends that are related to the company’s ability to make a profit.
The financial statement package is usually published twice a year, in March and September.
Financial accounting changes with the times; for example, internet-based information systems have arisen to enable users across all industries and at all levels of the business spectrum to access information in real time. Among many other benefits, this allows users to react quickly to opportunities and threats. Using real-time information on transactions as they occur can: 1) increase performance by enabling managers to react quickly and 2) give senior executives timely information on performance trends that can be used as input when making business decisions or setting goals.
In addition to the main financial accounting and financial reporting functions, there are also auxiliary functions. Some of these are:
a. Recognizing, updating and communicating changes in assets, liabilities and owner’s equity – such as value of non-current assets, depreciation of long-lived assets, compensation expense for officers and former employees; b. Providing a coherent view of business information to managers through the use of consistent methodologies used in preparing financial statements; c. Making decisions about how much effort to expend on recordkeeping (called “internal control” functions) and taking action on internal control findings.
Financial accounting is also used as a tool for managerial decision making.
Financial accounting can also be employed to control business operations. This involves the use of internal controls and specific financial reporting requirements jointly designed with data processing departments to produce reports from the information systems used in recording transactions.
Financial accounting employs many techniques, including double-entry bookkeeping, accrual accounting and cost accounting. Understanding how these techniques are used is important for understanding financial statements.
A general ledger is a summary of all transactions affecting the assets and liabilities of an entity over a period of time such as a month, quarter or year. A typical ledger includes the following information:
- The entity’s name.
- The period covered by the transactions.
- The accounts affected by the transactions, such as cash, inventory and accounts payable (a summary of these accounts is called a chart of accounts).
- A column for each type of transaction such as purchases, sales and cash withdrawals (called a debit column and a credit column).
- The amount of each transaction, called debits and credits (the total of debits must equal the number of credits).
- The net amount of transactions, or the difference between total debits and total credits (this number is called the balance).
- Where applicable, accounting conventions such as last in first out (LIFO) or average cost flow assumptions are included.
Recording transactions in the ledger is called “posting. from a bank account (called columns for debit and credit).
- The figures on both sides of the transaction; that is, the amount debited (amount withdrawn from an account) and charged to each account is equal to the credit (amount added to an account).