intro to financial accounting

intro to financial accounting

Introduction to Financial Accounting: A Comprehensive Guide

1. 1. The Importance of Financial Accounting

An accounting system goes beyond merely making financial information available to those who need it. Accounting systems are also designed to provide internal controls that help administrators and managers carry out their responsibilities. Whereas cost accounting and other special-purpose personnel identify, measure, analyze, interpret, and communicate information about the business, the financial accounting system has the broader mission of providing information to all of the business’s external stakeholders. External stakeholders may include the following: suppliers, banks, other creditors, insurance companies, regulatory bodies, and government agencies that oversee the company’s operations and require statutory accounting reports and disclosure-related information from management.

This book gives you the most comprehensive coverage of financial accounting – the tools the accounting professional uses to record, summarize, and communicate a business activity’s financial results – for business majors and minors. This book should also be a valuable reference for business professionals who need reminders in their daily work on how to use these important tools. Financial accounting is needed by various parties – inside the company and outside the company – for business decision-making and control. This chapter will present some activities of various users of financial accounting and the reason financial accounting is needed to assist these different users in achieving their goals.

2. 2. Key Concepts and Principles of Financial Accounting

The application of these accounting principles is guided by a recognition that accounting is a convention-based discipline and that the principles are largely about recognizing what is currently acceptable by way of accounting practice and refined by discussing the problems with existing practice and methods of accounting. In the standard-setting process, if a better way is suggested, standard setters can consider changing their rules. These rules, moreover, if followed consistently, will ensure that accounting is fair and consistent. However, the standard-setting process is inherently political in that its outcome is the result of an interaction between various parties with conflicting interests and ideas and because of this, it is often difficult to find consensus and avoid becoming involved in complex rule-fitting.

The key concepts in financial accounting are historical cost (i.e. money has a value and a reliable measure of an entity’s financial performance, position, and cash flows is the increase or decrease in the amount of money brought in by way of revenues, cost in connection with production and distribution or the use of assets), going concern, accruals (i.e. economic activity is measured and recognized when transactions occur rather than when the cash is received or paid), consistency in the treatment of like items, comparability, and materiality (i.e. financial information is material if its inclusion or omission could influence the economic decisions of users). Upon these concepts are built the broader accounting principles, which are more qualitative in nature and designed to provide guidance for the sensible application of these concepts in the preparation of financial statements. Amongst other things, these principles are that the financial statements should show a true and fair view of the business, and that the financial information should reflect conscionable and prudent decisions which are arrived at after independent judgment and not influenced by the interest of others.

What are the concepts and principles underpinning financial accounting? The purpose of financial accounting is to produce information about the financial position, financial performance, and cash flows of an entity that is useful to a wide range of users – including existing and potential investors, creditors, donors, and grantors who need this information to make decisions. Financial accounting needs to be underpinned by some core concepts so that the financial statements reflect what they purport to reflect: i.e. an entity’s financial performance, financial position, and cash flows. These underpinning concepts are generally accepted accounting principles (GAAP).

3. 3. The Accounting Cycle: From Transactions to Financial Statements

Companies and other entities engage in defined business transactions such as the purchase and sale of goods and services, investment in securities, and borrowing and repayment of money. These, and completing other transactions, are routine aspects of our economic activities. As these transactions are recorded, summarized, and reported systematically according to specific accounting rules and procedures, accounting, as a profession, consolidates its status as the primary business communication solver. Information is prepared for decision-making and accountability from the transaction to the financial statements, as well as from the incarnation of the company to its economic termination. Statements are produced for one year of operations, based on concepts and principles that are derived from equally defined and accepted concepts in a finite audience. Statements are usually audited and serve as the financial transcript of business transactions.

This section will cover the accounting cycle and key elements of the accounting process. Transactions are measured in terms of money and appear in financial statements. Several sub-processes are employed to process transactions and summarize financial information. The revenue cycle tracks revenue, while journal entries record financial effects. Adjustments inform specialists about both the expense and revenue cycles. This part establishes the retention of earnings and dividends accounts and the change in retained earnings. Each sub-process is subject to internal control checks. The business cycle, attesting to the fact that each business transaction has two components, provides an overview of the financial statement timing.

4. 4. Financial Statement Analysis and Interpretation

In summary, the accountant often must carefully consider the potential measurement, timing, presentation, recognition, and disclosure differences in an in-depth financial statement analysis. The final goal is to analyze historical financial statements and other data, along with current management and other additional reports, to anticipate and make an informed judgment about the corporation’s financial prospects and how it may perform in the future. The accounting analysis financial measurements, policies, guidelines, and how they have evolved over time have a considerable influence on these critical assessments by all external stakeholders. It is an interesting and beneficial profession, it is both an art and science, and it is a science especially for those that thoroughly understand the financial report item formats, inter-relationships, and the potential effects that some alternative pharmaceuticals can have on certain financial measurement results. Be sure you center your analysis on the important, material report item analysis factors that predict the future.

Generally, the corporation’s income statement, balance sheet, and additional disclosure items provide the primary financial statement source data for financial ratio analysis. These reporting tools present a summary of current financial activity and a snapshot of the corporate resources, obligations, and owners’ investment. Ratio analysis can provide both an indication of the performance and the financial stability of the corporation. To find the important corporate insights, it is beneficial for accountants and financial analysts to dissect and analyze these ratio results. The timing, measurement, and financial reporting objectives, expectations, and policies under GAAP and IFRS accounting standards can significantly affect the results of this analysis. Significant accounting measurement guidelines, regulations, interpretations, and methods may have differences that can cause important differences in some key financial ratios and the related conclusions or decisions. A general word of caution is to make sure that reported accounting and financial results are comparable before conclusions and decisions are made.

5. 5. Ethical Considerations in Financial Accounting

The Role of the Accountant in Society Generally, the accounting profession is regarded as being responsible for the provision of reliable and relevant information to users (i.e. shareholders, creditors, etc.) who require information upon which to base their decisions. That is, those persons who have a financial interest in a company require information that is trustworthy for decision making. In the academic fraternity, accountants are expected to teach accounting methods that will enable practitioners to report reliable information to the users who have an interest in the financial affairs of the company.

Considering that the financial accounting report is a reflection of the financial performance of a company, the standards which form the basis of this report are of primary concern to accountants. When the annual reports of companies are released, showing their financial position, accountants are held personally responsible should there be errors in the reports. The fraudulent accounting practices of the past have served to point out the need for standards that would ensure that practitioners of accounting apply these standards in preparing their reports.