Financial accounting entails recording, classifying, summarizing and reporting business transactions. Financial accounting also helps reveal overall profits of a business and is governed by local and international standards.
Accounting for external stakeholders such as stockholders, investors, banks and suppliers differs from cost/managerial accounting in its focus on internal reporting and decision-making processes.
Definition
Financial accounting entails creating reports to show the company’s finances to those outside, including shareholders, lenders and potential customers. Reports such as an income statement, balance sheet or statement of cash flow help measure a business’s performance while helping stakeholders make rational decisions regarding its future.
Financial accounting’s key principle of faithful representation should always be observed; this means all information reported should be accurate and pertinent without any evidence of bias or other forms of distortion. Contrary to managerial accounting which documents transactions solely for internal use, financial accounting reports to external audiences as well.
Financial accounting utilizes double entry bookkeeping procedures and GAAP (Generally Accepted Accounting Principles) standards in order to accurately reflect reality. GAAPs primary principles are full disclosure, objectivity and relevance – with full disclosure requiring that every transaction is recorded correctly using appropriate accounts, money units and reporting periods.
Purpose
Financial accounting is the practice of recording, classifying and summarizing financial data to present an accurate picture of a company’s position to external stakeholders such as investors or creditors. Financial accounting also gives an invaluable view into past performance and can give insight into future successes for any given venture.
Financial accounting’s primary function is to prepare reports that inform outside parties, such as investors, lenders, and tax authorities, of a business’s current financial status so that informed economic decisions may be made.
Financial accounting produces reports such as balance sheets, income statements and cash flow statements to provide a comprehensive record of transactions involving assets and liabilities of a company. They utilize double-entry bookkeeping practices that require each transaction be recorded with both debits and credits being recorded simultaneously; this ensures a paper trail for every dollar spent and discourages fraudsters by making it harder to hide activities from internal auditors or management.
Methods
Financial accounting involves the systematic recording, classifying and summarizing of a company’s financial transactions for external users. Financial accounting’s primary goal is to provide timely information about a company’s performance to investors, lenders and other interested parties who require access.
Financial accounting is guided by several fundamental principles. One is disclosure, to ensure transparency and accountability; another principle requires companies to abide by Generally Accepted Accounting Principles, or GAAP, which is a set of rules outlining basic concepts like the going concern principle, full disclosure concept, accrual concept matching concept matching concept and monetary unit assumption.
Selecting an accounting method that meets your business needs is vitally important, since it affects both tax filing and decision making. For example, cash versus accrual can have significant effects on how revenue is reported for tax purposes, as well as on how accurately growth forecasting models work based on true income numbers.
Stakeholders
Stakeholders are individuals or groups with an investment in the outcome of business decisions, such as stockholders, investors, creditors, governmental agencies and suppliers. Treating stakeholders fairly while creating innovative product and service solutions will lead to long-term profits and business success.
Since human memories can only store so much data, financial accounting provides an effective tool to keep accurate records of expenditure and income earned for use when formulating organizational policies.
Financial accounting also serves to inform outside stakeholders of a firm’s financial standing. Prospective investors and creditors, like banks, rely on periodic financial statements as part of the assessment of creditworthiness for loans to inventory purchase companies. Employees, suppliers and customers all play important roles as stakeholders who may try to influence decisions made by management through expressing their opinions or providing input into decision making processes.
