Financial Accounting | Definition, Principal & How It Works!

Financial Accounting is a very important part of accounting and it includes recording, summarizing, and reporting of financial transactions of a business. Financial Accounting involves the preparation of various financial statements that includes income statements, balance sheet, cash flow statement, etc.

Key Takeaways

• With the help of financial accounting, transactions are documented, summarized, and accessible in a fiscal report
• One key responsibility of financial accounting is to present a sufficient amount of information for others to evaluate the value of a company
• The Financial Accounting Standards Board (FASB) manages the accounting standards and postulates principles in the USA
• GAAP forms the basis of underlying principles and concepts such as the matching principle, going concerned, economic entity, etc.

What Is Financial Accounting

Financial accounting is a specialized branch of accounting that concerns a company’s financial transactions and related economics. Using consistent guidelines, the transactions are documented, summarized, and accessible in a fiscal report or financial statement such as a balance sheet, or an income statement.

Companies are concerned about financial statements on a routine schedule. The statements are considered peripheral because they are allotted for people outside of the company, with the main receivers being owners/stockholders, as well as firm lenders. 

Financial Accounting: How It Works 

A corporation’s stock can be publicly traded, but, its fiscal statements (and other financial reporting) are likely to be widely presented. And, information is likely to reach secondary receivers such as competitors, clients, employees, labor organizations, and asset analysts.

It’s vital that you point out that the purpose of financial accounting is not to include the value of a company. Rather, its purpose is to present a sufficient amount of information for others to evaluate the value of a company for themselves.

Because external fiscal statements are subject to a variety of people they’re a variety of ways, fiscal accounting has common rules known as accounting standards and is generally recognized as Accounting Principle.

Accounting Principles Of Finance

In the U.S., the Financial Accounting Standards Board (FASB) is the organization that manages the accounting standards and postulates principles. Corporations whose stock remains publicly traded must also concern the reporting requirements of the Securities and Exchange Commission (SEC). This is an agency of the U.S. government.

Double Entry And The Accrual Basis Of Accounting

At the center of financial accounting is the system that accountants call double-entry bookkeeping (or “double-entry accounting”). Each financial transaction that a company is concerned about becomes consistent by using this system.

The term “double-entry” refers that every transaction that concerns at least two accounts. For example, if a company owes $50,000 to its bank, the company’s Cash account increases, and the company’s Notes Payable account increases at the same time. 

The double entry also signifies that one of the accounts must have an amount included as a debit, and one of the accounts must have an amount given as a credit. For any given transaction, the debit amount must be equal to the credit amount entered.

The Advantage Of Double Entry Accounting Is This: At Any Given Time Are As Follows:

1. The balance of a company’s asset accounts will be consistent with the balance of its liability and stockholders’ (or owner’s) equity accounts. 

2. Financial accounting has to comply with the accrual basis of accounting (as opposed to the “cash basis” of accounting). 

3. Under the accrual system, revenues are recorded when they are earned, not when the money is received. Likewise, expenses are recorded when they are incurred, not when they are paid. 

For example, although a magazine publisher charges a $24 check for a customer for an annual subscription, the publisher reports as revenue a monthly sum of $2 (one-twelfth of the annual subscription amount). 

In the same way, it reports its property tax expense is recorded each month as one-twelfth of the annual property tax bill.

By following the accrual basis of accounting, a company’s profitability, assets, liabilities, and other financial information are required to follow economic reality.

Why Accounting Principles Is Important

If financial accounting is going to be useful, a credible company’s reports need is required. The report will be easy to understand, and comparable to those of other companies. To this end, financial accounting complies with a set of common rules known as accounting standards or generally acknowledged accounting principles. 

GAAP is what sets the base of accounting principles. GAAP forms the basis of underlying principles and concepts such as the matching principle, going concern, economic entity, conservatism, full disclosure, cost principle, relevance, and reliability.

GAAP Characteristics 

1. GAAP is not static

2. GAAP complies with very complex standards that were issued in response to some very complicated business transactions. 

3. GAAP also concerns accounting practices that may be exclusive to particular industries, such as utility, banking, and insurance. Often these practices become a response to changes made in government-level regulations of the industry.

4. GAAP concerns the Financial Accounting Standards Board (FASB) and its many specific pronouncements.

5. The FASB is a non-government group that bases accounting principles on current needs and develops accounting rules to meet those needs. 

Final Thought 

If you are learning about Accounting for the first time, you must familiarize yourself with Accounting Principles and Financial Accounting. They are major segments of Accounting as a subject. This is an introductory article written for Accounting. 

References:

1. https://www.investopedia.com/terms/f/financialaccounting.asp
2. https://www.freshbooks.com/hub/accounting/financial-accounting

Last Updated on November 3, 2022 by Magalie D.