Accounting can be described as the recording, controlling, reporting, and analyzing an entity’s business transactions that occur every day so that the related stakeholders could use that financial information for their own interest.
It is the channel through which parties interested in the business that is both the shareholders and stakeholders share information they are interested in and understand each other.
It is also the means of communication between and among accountants, i.e., noting the daily transactions of the firm and recording them in the daybooks, and then preparing the financial statements at the end of the financial year after summarizing them.
Accounting is the process of documenting, organizing, and summarizing business transactions and events which are monetary in nature, understanding them, and making conclusions.
It generally entails recording in an orderly manner useful information of economic worth. The interested parties in the business use this organized information to make decisions.
Accounting is a broad area and can be subdivided into the following key specializations:
- Financial accounting
- Tax accounting
- Cost accounting
- Managerial accounting
What is financial accounting?
Financial accounting is a branch of accounting that deals with the gathering, processing, and reporting of accounting data to both the shareholders and stakeholders of the company.
Financial accounting analysis and summarizes the transactions that occur daily in the entity’s business.
The financial accounting reporting framework is governed by the International Financial Reporting Standards (IFRS) and the Generally Accepted Accounting Principles (GAAP). IFRS states how certain types of occurrences and transactions should be reported.
IFRS ensures consistency in financial reporting. GAAP is used in a given jurisdiction and contains the guidelines to follow.GAAP includes the rules accountants follow when preparing financial statements.
Financial accounting though closely related to management accounting differs in that management accounting provides accounting information to the internal users. In contrast, financial accounting is mainly concerned with making information available to external users.
Users of financial information:
- Management –management needs accounting information to make informed decisions like investment, growth, and expansion. This is because the information shows the available funds. The management can also use accounting information to make forecasts and set targets.
- Investors –the present investors need financial information to estimate the risk levels and the returns they will get as a result of investing in the firm. They need the information to know whether to dispose of their shares or increase them. The potential investors use the financial accounting information to know how profitable the business it and make decisions whether to invest in the business or not.
- Employees. They are interested in how stable the business is to know how secure their jobs are. Employees also consider the profitability of the business to evaluate if they are remunerated fairly.
- Lenders. They need to know if the business is capable of meeting its obligations when due.
- Customers. They use financial accounting information to predict price fluctuations. If the price fluctuations don’t favour them then they may look for alternative supply sources.
- The government. They are interested in the accounting information of the firm to determine how to tax it. They can also consider this when giving subsidies or a set of policies such as price ceilings and floors.
Characteristic of financial information:
Financial accounting is concerned especially with external users such as the government, investors, and creditors. Thus, information should be organized.
The information provided should have the following characteristics:
- Understandability. The information should be clearly presented and organized for the users to understand it with ease. Lack of understandability will lead to bad decisions that can cost the users.
- Relevance. The information needs to be useful to the end-users so as to assist them in making their economic decisions. Different users require information for different purposes and therefore the information should meet the diverse needs of the end-users.
- Reliability. Accounting information should be credible, truthful, and actually represent what it claims to represent.
- Comparability. This means that information should be presented using the same methods in different financial years. This makes it easier to compare information from different sources.
- Timely: information should be made available to the end-users at the time they require it. Failure to provide information at the right time may render it useless.
Recording phases in accounting
Financial accounting, a branch of accounting, follows the same phases as general accounting, which are as follows;
- Recording phase: this refers to the process of mechanical writing of transactions of the businesses and daybook accounts. The other name for the recording phase is an original entry.
- Classifying phase: this refers to placing the same transactions into various classes and posting the transactions into ledger. Ledger refers to accounts that are similar whereby the accounting records are recorded. Further, the decrease and increase in various assets, liability, and expense accounts.
- Summarizing phase: this refers to financial statement preparation and is basically done from time to time. For instance on an annual basis or monthly basis.
- Interpretation: this entails analysis of information regarding accounting. The financial information is communicated and assists the users in decision making and therefore this is the reason behind the name language of business.
Financial accounting also produced the entity’s financial statements as required by management, directors, shareholders, and regulators.
These statements provide different entities ‘ financial information to the stakeholders. For example, the statement of financial position provides the entity’s financial position like liabilities, assets, and equity. The users could also know what the entity’s current assets and non-current assets are.
The income statement provides the entity’s financial performance, like how much an entity makes revenues and spends during the period.
And the users could understand how well the entity’s cash flow is. Users gain many benefits from the entity’s financial statements for making the correct decision.