Explain The Purpose Of Financial Accounting
Introduction to Financial Accounting
Financial accounting is a specialized branch of accounting that keeps track of a company’s financial transactions. Using standardized guidelines, the transactions are recorded, summarized, and presented in a financial report or financial statement such as an income statement or a balance sheet.
Companies issue financial statements on a routine schedule. The statements are considered external because they are given to people outside of the company, with the primary recipients being owners/stockholders, as well as certain lenders. If a corporation’s stock is publicly traded, however, its financial statements (and other financial reportings) tend to be widely circulated, and information will likely reach secondary recipients such as competitors, customers, employees, labor organizations, and investment analysts.
It’s important to point out that the purpose of financial accounting is not to report the value of a company. Rather, its purpose is to provide enough information for others to assess the value of a company for themselves.
Because external financial statements are used by a variety of people in a variety of ways, financial accounting has common rules known as accounting standards and as generally accepted accounting principles (GAAP). In the U.S., the Financial Accounting Standards Board (FASB) is the organization that develops the accounting standards and principles. Corporations whose stock is publicly traded must also comply with the reporting requirements of the Securities and Exchange Commission (SEC), an agency of the U.S. government.
What Is the Purpose of Financial Accounting?
As one of the most stable markets in the current economy, the demand in financial accounting remains very strong. In fact, it is practically impossible to find a field that parallels the job security levels that are often witnessed in this market. And rightly so. After all, accounting as a profession ensures that a couple of different areas are properly administered including auditing, attestation engagements, and taxes. Well, since there will pretty much always be the need to pay taxes and verify companies’ financial statements, it comes as no surprise that the financial accounting profession continues to soar.
Providing the Necessary and Truthful Information to Investors
The reason why a lot of the major laws such as the Securities Act of 1933 are in existence is based on a reactive approach. In translation, the government reacted to major incidents in history and tried to prevent them from ever repeating again through legislative action. Well, when the Great Depression in the 1930s took place, the lack of proper financial reporting was deemed to be among the main reasons for the downturn in the economy. Due to that, every public corporation that is trading its stocks on one of the stock exchanges must comply with strict rules governing financial accountancy.
Therefore, according to Accounting Coach, financial accounting is responsible for the proper representation of the financial statements. In other words, it ensures that the amounts presented by entities are actually correct. Just consider, for example, if there was absolutely no financial reporting in the market. Odds are, every business would just state whatever they want without ever backing any of their claims up. Consequently, investing would be non-existent and most of the markets would collapse due to the corporate inability to raise funds.
The purpose of financial statements
The general purpose of the financial statements is to provide information about the results of operations, financial position, and cash flows of an organization. This information is used by the readers of financial statements to make decisions regarding the allocation of resources. At a more refined level, there is a different purpose associated with each of the financial statements. The income statement informs the reader about the ability of a business to generate a profit. In addition, it reveals the volume of sales, and the nature of the various types of expenses, depending upon how expense information is aggregated. When reviewed over multiple time periods, the income statement can also be used to analyze trends in the results of company operations.
The purpose of the balance sheet is to inform the reader about the current status of the business as of the date listed on the balance sheet. This information is used to estimate the liquidity, funding, and debt position of an entity, and is the basis for a number of liquidity ratios. Finally, the purpose of the statement of cash flows is to show the nature of cash receipts and cash disbursements, by a variety of categories. This information is of considerable use, since cash flows do not always match the sales and expenses shown in the income statement.
As a group, the entire set of financial statements can also be assigned several additional purposes, which are:
- Credit decisions. Lenders use the entire set of information in the financials to determine whether they should extend credit to a business, or restrict the amount of credit already extended.
- Investment decisions. Investors use the information to decide whether to invest, and the price per share at which they want to invest. An acquirer uses the information to develop a price at which to offer to buy a business.
- Taxation decisions. Government entities may tax a business based on its assets or income, and can derive this information from the financials.
- Union bargaining decisions. A union can base its bargaining positions on the perceived ability of a business to pay; this information can be gleaned from the financial statements.
Financial Reporting Standards
In the United States, financial reporting standards are set forth by the FASB and required under GAAP for publicly traded companies. The FASB is contracted out by the Securities and Exchange Commission (SEC) to control the approved methods and applications of financial accounting. Following these reporting standards makes it easier for individuals to understand the financial statements of various companies, as they are presented in the same manner and therefore easier to follow.
Financial accounting is normally performed by those individuals who have studied the methods, concepts, history, and laws related to its practice. In the U.S., these individuals are referred to as certified public accountants (CPA). The SEC requires that public companies annually report their financial statements and that this reporting is done by an impartial third party, which is where CPAs come in to play. This ensures that the financial statements have been properly created under all required policies.
The final purpose that should be mentioned ties to comparability between different markets. If an entity in the service sector is being compared with someone in the product-based market, the only thing that will tie them together is the financial statements. Expectedly, those statements will have to be made utilizing the said methods of accounting.
Ultimately, there are many other important roles that proper reporting portrays when it comes to transparency, consistency, accountability, and legality. Nonetheless, simply understanding that financial accounting is the reason why businesses can continue to serve customers in a responsible manner is a great starting point!