What is financial accounting? Why is it the base for financial decisions?

This is one of the essential areas of accounting that involves identifying financial activities of organizations, recording them on the books, and preparing the financial statements. Basically, it chronicles the journey from recording a financial transaction to the preparation of financial statements.

The basic steps to creating a financial statement are;

Financial accounting

So, let’s discuss what is a financial statement and why is it even necessary to prepare one?

A financial statement is a phrase to describe;

1.Statement of financial position (also called Balance sheet)

    Presentation of assets, liabilities, and capital

2. Statement of profit and loss (also called income statement)

    Presentation of income and expenses

3. Statement of Cashflows

    Presentation of the cash movements

4. Statement of changes in equity

     Presentation of investment mix in the company

5. Any related notes for the above items

    To explain any relevant items

 

Why are we preparing this? Well, the financial statement is highly valuable to a number of stakeholders. It is exploited by a wide number of users for their own reasons.

Let’s start with external stakeholders;

1.Shareholders, current/potential investors

   Interested in the changes in the funds invested and to assess the use of resources by the management

2. Existing/Potential Lenders

    To assess the risk and appropriateness of granting a loan and the credibility of the client

 3. Government bodies, Security exchanges

    Taxes and reporting of the financial components

 4. Others

Lawyers, press, trade unions, statistical authorities, insurance companies

The second group is Internal stakeholder

1.Company’s management (Responsible for taking managerial decisions)

 Interested in assessing the need for financial resources, determine financial performance, the correctness of         investment decisions.

2. Others

    Board of Directors, Employees, head of divisions

 

While preparing these financial statements, a set of rules and regulations are followed. Most of the countries have their own accounting standards. However, with the globalization, there was a need for a common standard to make financial statement coherent and consistent across different countries.

In the international level, the International Accounting Standards Board (IASB) provides a broad regulatory framework of international financial reporting standards (IFRS) (previously known as International Accounting Standards – IAS)

On the national level, each country has its own accounting standards. Some of the examples are;

In the UK, the Financial Reporting Council (FRC) publishes UK Generally Accepted Accounting Principles (GAAP)

In Canada, the Accounting Standards Board (AcSB) publishes Canadian GAAP. AcSB adopted IFRS to be used by publicly accountable enterprises. Private and not-for-profit organizations choose to use IFRS or separately developed standards for those entities.

In Australia, the Australian Accounting Standards Board (AASB) monitors the implementation of accounting standards and interpretations (Domestic AASB Standards) and publishes Austrian GAAP. AASB adopted IFRS for domestic public and foreign companies.

In the US, the Financial Accounting Standards Board (FASB) develops and monitors the implementation of accounting standards – Generally Accepted Accounting Principles (US GAAP)

These financial statements must have certain qualitative characters to be considered useful information.

As per the IASB Framework, financial information is considered useful when it is

  • Relevant and
  • Faithfully represented

Other characteristics which enhance the usefulness of financial information are:

  • Comparability
  • Verifiability
  • Timely
  • Understandability

In conclusion, financial accounting is an area where accountants (CA, ACCA, CPAs) work towards recording financial transactions and prepare financial statements. Accountants follow set rules and regulations to ensure the transactions are recorded in accordance with the regulatory framework (IFRS or national GAAP). Further, while preparing these statements they exercise due care to ensure the financial statements are relevant and faithfully represented in the books so that it can be used by internal and external stakeholders to make financial decisions reliably.

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