Financial Accounting is reporting of the financial position and performance of a firm through financial statements issued to external users on a periodic basis. Financial accounting 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.
Financial accounting 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.
Double Entry Accounting
Financial accounting is the system known as double entry bookkeeping/double entry accounting. Each financial transaction that a company makes is recorded by using this system.
Double entry means that every transaction affects at least two accounts. For example, if a company borrows $60,000 from its bank, the company's Cash account increases, and the company's Notes Payable account increases. Double entry also means that one of the accounts must have an amount entered as a debit, and one of the accounts must have an amount entered as a credit. The advantage of double entry accounting is this: at any given time, the balance of a company's asset accounts will equal the balance of its liability and stockholders' (or owner's) equity accounts.
Financial Statements
Financial accounting generates the following general-purpose, external, financial statements:
Income statement/results of operations/earnings statement/profit and loss [P&L] statement
Balance sheet/statement of financial position
Statement of cash flows/cash flow statement
Statement of stockholders' equity
Income Statement
The income statement reports a company's profitability during a specified period of time. The period of time could be one year, one month, three months, 13 weeks, or any other time interval chosen by the company.
Income statement includes revenues, expenses, gains, and losses. Revenues includes sales, service revenues, and interest revenue. Expenses include the cost of goods sold, operating expenses (salaries, rent, utilities, advertising), and nonoperating expenses (interest expense). If a corporation's stock is publicly traded, the earnings per share of its common stock are reported on the income statement.
Balance Sheet
The balance sheet is organized into three parts: (1) assets, (2) liabilities, and (3) stockholders' equity at a specified date
Assets section of the balance sheet reports the company's assets and includes cash, accounts receivable, inventory, prepaid insurance, buildings, and equipment. Liabilities section reports the company's liabilities; these are obligations that are due at the date of the balance sheet. The stockholders section is stockholders' equity, defined as the difference between the amount of assets and the amount of liabilities.
Statement of Cash Flows
The statement of cash flows explains the change in a company's cash (and cash equivalents) during the time interval indicated in the heading of the statement. The change is divided into three parts: (1) operating activities, (2) investing activities, and (3) financing activities.
The operating activities section explains how a company's cash (and cash equivalents) have changed due to operations. Investing activities refer to amounts spent or received in transactions involving long-term assets. The financing activities section reports such things as cash received through the issuance of long-term debt, the issuance of stock, or money spent to retire long-term liabilities.
Statement of Stockholders' Equity
The statement of stockholders' (or shareholders') equity lists the changes in stockholders' equity for the same period as the income statement and the cash flow statement. The changes will include items such as net income, other comprehensive income, dividends, the repurchase of common stock, and the exercise of stock options.
Financial Reporting
In addition to the financial statements, financial reporting includes the company's annual report to stockholders, its annual report to the Securities and Exchange Commission (Form 10-K), its proxy statement, and other financial information reported by the company.
