Here is the introduction of financial accounting:
Financial accounting is the branch of accounting that focuses on recording, summarizing, and reporting the financial transactions of a business for external users, such as investors, creditors, regulators, and other stakeholders.
• It is the oldest form of accounting.
• The primary purpose of financial accounting is to provide accurate and relevant financial information about an entity’s economic activities and financial position.
Note: Financial accounting is historical in nature since it records the past transactions. Therefore, it is also known as historical accounting.
Features of Financial Accounting:
Financial accounting encompasses several key features that distinguish it from other forms of accounting and contribute to its role in providing external stakeholders with relevant and reliable financial information.
Here are some essential features of financial accounting:
‣ Records the financial transactions only:
Financial accounting focuses on recording and summarizing only those transactions that involve monetary transactions. It captures economic events, such as sales, purchases, expenses, and investments, which have a direct impact on the entity’s financial position.
Non-financial transactions, like changes in management or employee morale, are generally excluded as they don’t directly involve monetary values.
‣ A continuous process:
Financial accounting is a continuous and ongoing process that systematically records, analyzes, and reports financial transactions. It is not a one-time activity but involves regular and systematic recording of transactions throughout the accounting period, typically a fiscal year.
‣ Analysis and interpretation:
Financial accounting goes beyond mere recording; it involves the analysis and interpretation of financial data to derive meaningful insights. This includes the preparation and presentation of financial statements, which are then analyzed to assess the financial health, performance, and position of the entity.
‣ Historic in nature:
Financial accounting is historical in nature, meaning it deals with events that have already occurred. It focuses on reporting past transactions and events during a specific accounting period. The resulting financial statements provide a historical record of the entity’s financial performance and position.
‣ Based on GAAP:
Financial accounting is based on Generally Accepted Accounting Principles (GAAP). This has enabled the preparation and presentation of financial accounting uniformly.
Objectives of Financial Accounting:
The objectives of financial accounting revolve around providing accurate, reliable, and relevant financial information to various stakeholders, facilitating informed decision-making and promoting transparency.
Here are the key objectives:
‣ To maintain the records of transactions:
One of the fundamental objectives of financial accounting is to systematically record and document all financial transactions of an entity. This involves capturing details of sales, purchases, expenses, investments, and other financial activities.
‣ To asertain the operating results:
Financial accounting aims to determine the operating results of an entity over a specific period. This objective is achieved through the preparation of the income statement, which summarizes revenues, expenses, and profits or losses.
‣ To evaluate the financial position:
Financial accounting provides a snapshot of the financial position of the entity through the balance sheet. This statement outlines the assets, liabilities, and equity at a specific point in time. Evaluating the financial position helps stakeholders understand the entity’s solvency, liquidity, and overall financial health.
‣ Provide Information for Decision-Making:
A crucial objective of financial accounting is to provide relevant and timely information to support decision-making by internal and external users. This includes management decisions, investment decisions by shareholders, and credit decisions by lenders.
‣ Ensure Accountability and Transparency:
Financial accounting contributes to accountability and transparency by providing a clear and accurate representation of the entity’s financial activities. It ensures that financial information is presented in a truthful and open manner.
Limitations of Financial Accounting:
Financial accounting, while valuable for many purposes, has certain limitations that should be recognized.
Here are some of the key limitations:
Records monetary transactions only:
Financial accounting is primarily concerned with recording and reporting monetary transactions. Non-monetary factors such as employee skills, brand reputation, and customer satisfaction, which contribute significantly to an entity’s success, are not recorded in financial statements.
Doesn’t Consider Current Market Conditions:
Financial accounting often relies on historical cost as the basis for valuing assets and liabilities. This means that the reported values may not accurately reflect current market conditions.
Subjectivity in Accounting Policies:
Companies have flexibility in selecting accounting policies and making estimates, introducing an element of subjectivity. Different entities may adopt different accounting methods for similar transactions, leading to variations in financial reporting. This subjectivity can affect the comparability of financial statements among different companies.
Not Forward-Looking:
Financial accounting is inherently backward-looking, focusing on historical data. It doesn’t provide a forward-looking perspective on an entity’s performance or future prospects.
No Consideration of Non-Financial Performance:
Financial accounting primarily concentrates on financial performance and doesn’t consider non-financial aspects such as environmental, social, or governance performance.
Scope of Financial Accounting:
The scope of financial accounting refers to the field or area where financial accounting is appicable.
Generally, the scope of financial accounting covers the following areas:
‣ For business organizations:
Financial accounting in business organizations ensures a systematic approach to recording all financial transactions, ranging from sales and purchases to expenses and investments. This systematic recording establishes a meaningful historical record, serving as the foundation for the preparation of financial statements to determine profits or losses, financial position.
‣ For non-profit organizations:
In the area of non-profit organizations, financial accounting serves a crucial role in maintaining accountability and transparency. The systematic recording of donations, grants, and expenses ensures clarity and transparency in financial activities. Moreover, it aids in donor accountability by providing a transparent overview of fund utilization, enhancing trust and credibility.
‣ For government and non-government organizations:
For both government and non-government organizations, financial accounting plays a fundamental role in managing public funds and maintaining fiscal responsibility. It involves systematic record-keeping of financial transactions, budgetary control, and compliance with specific accounting regulations. Financial accounting ensures transparency in reporting, allowing external stakeholders, including citizens and regulatory bodies, to scrutinize the allocation and utilization of public resources.
‣ For professionals and individuals:
Financial accounting is also useful to the professionals and individuals to know their professional and personal efficiency. This includes the systematic tracking of income, expenses, and investments to facilitate informed decision-making.
