Financial accounting is the branch of accounting that deals with the summary, analysis, and reporting of a company’s financial activities. This involves the preparation of financial statements. People who are interested in obtaining such information for decision-making purposes include stockholders, suppliers, banks, employees, regulatory agencies, business owners, and other stakeholders.
Both local and international accounting rules regulate financial accounting. The framework of financial accounting principles followed in any country is known as Generally Accepted Accounting Principles (GAAP). It encompasses the accounting standards, practices, and procedures that accountants adhere to when recording, summarizing, and preparing financial statements.
Objectives of Financial Accounting
Relevance: The ability of financial data to impact the decisions of its users is referred to as relevance. Relevance has a sub-quality called materiality. Information is considered material (significant) If its absence or misrepresentation has the potential to affect users’ economic decisions based on financial statements. Therefore, Financial statements should not contain any material misstatements.
Faithful Representation: The actual effects of the transactions must be appropriately accounted for and disclosed in the financial accounts. The words and numbers in the transaction must reflect what really occurred. Completeness, neutrality, and error-free representation are essential aspects of faithful representation.
Comparability: The Financial accounts prepared by an entity should be as per the prescribed rules and regulations of the government and similar to other entities in the same industry. Users of the financial accounts should be able to compare the entity’s accounts with other entities in the same industry.
Verifiability: When it comes to financial information, verifiability refers to a level of cooperation among many informed and independent users. To meet the principle of neutrality, such information must be backed up with enough evidence.
Understandability: Understandability means that financial accounts should be prepared and expressed clearly and without any unnecessary data. Financial accounts should be prepared in such a way that it is understandable to their users.
Timeliness: Timeliness means that financial data must be supplied to users before a decision is taken.
Why is Financial Accounting Important?
Financial accounting is important because:
- Regulatory Compliances
For registered firms, financial statements such as the balance sheet, income statement, and cash flow statement are needed by law. In most cases, these statements are included in a company’s annual report.
- Importance of Financial accounts to different users
Financial statements are frequently used as a reference by persons and businesses both within and outside of a corporation, and they include:
The financial statements enable a company’s management to troubleshoot monetary problems and prepare for the future.
Investors will want to examine the data before deciding whether or not the firm is worth investing in.
The financial accounts are the main component of auditing. Auditing itself is the process of verifying financial accounts.
If a lawsuit or other legal action involving a company’s income or expenditures is filed, lawyers will need to be able to analyse this data.
Prior to delivering products or services, suppliers may want to know a company’s financials to guarantee that they will be able to pay their invoices.
When a firm applies for a loan, the bank may ask for financial statements. This will help the organization demonstrate that they have the financial means to repay the loan in a timely manner.
Difference between Financial Accounting and Cost Accounting.
We can distinguish between Financial Accounting and Cost Accounting on the following basis: –
- Objective- The objective of Cost accounting is to record the cost of producing a good or rendering a service whereas in financial accounting the objective is to provide information about the financial performance of an enterprise.
- Area – Cost Accounting only deals with the ascertainment of cost whereas financial accounting shows the profit and loss of the entity as a whole.
- Recording of Data- Cost accounting uses both past and present figures whereas financial accounting records historical data.
- Development- The development of cost accounting is related to the industrial revolution whereas financial accounting was developed to meet the needs of its users (shareholders, creditors, government and other agencies).
The financial statements of an entity are critical in portraying the organization’s current position, financial health, and future viability. Financial statements reflect on a number of comparable components, including assets, liabilities, and equity, regardless of industry. The same may be said for school districts and other government entities.