Financial accounting
Branch of accounting for external financial reporting.
Financial accounting is the field that summarizes, analyzes, and reports a business's financial transactions. Its main output is a set of financial statements meant for public use. These reports are used by people outside the company's daily operations—such as stockholders, suppliers, banks, employees, government agencies, and business owners—to make decisions.
The rules for how transactions and events appear in these statements are set by the International Financial Reporting Standards (IFRS), which are created by the International Accounting Standards Board (IASB). This branch of accounting differs from managerial accounting, which helps internal managers run the business, and cost accounting, which focuses on calculating production or service costs, controlling expenses, and reducing them.
The goal of financial reporting (a term often used interchangeably with financial accounting) is, according to IFRS, to give useful financial information to current and potential investors, lenders, and other creditors when they decide whether to provide resources to the company. The European Accounting Association notes that maintaining capital is a competing objective.
Financial statements typically include three main components, plus an additional one:
The cash flow statement tracks actual cash coming in and going out over a set period. Its basic formula is: Cash Inflow minus Cash Outflow plus Opening Balance equals Closing Balance.
The income statement (or profit statement) shows how a company's accounts changed over a period, usually a fiscal year, and may compare these changes to the previous period. All changes are summarized on the bottom line as net income (or net loss if income is negative). Net profit or loss is calculated as: Sales minus cost of goods sold minus selling, general, and administrative expenses minus depreciation/amortization equals earnings before interest and taxes (EBIT), then minus interest and tax expenses equals profit or loss.
The balance sheet shows a firm's assets, liabilities, and equity at a specific point in time, typically the end of the fiscal year reported on the income statement. Total assets always equal total liabilities plus equity, reflecting the basic equation: Assets = Liabilities + Equity. Accounting standards set a general format. Under IFRS, companies usually separate current assets and liabilities from non-current
- field
- Accounting
- known_for
- Preparation of financial statements for external stakeholders
- standards
- International Financial Reporting Standards (IFRS) issued by the International Accounting Standards Board (IASB)
- key_statements
- Cash flow statement, income statement, balance sheet, statement of retained earnings
Lore & Background
Financial accounting focuses on reporting financial information to people outside an organization, such as investors, lenders, and government agencies. It is distinguished from managerial accounting, which provides information for internal managers, and cost accounting, which computes production or service costs for control and reduction. The International Financial Reporting Standards (IFRS), issued by the International Accounting Standards Board (IASB), set out how particular types of transactions and other events should be reported in financial statements.
Reader's Guide
Financial accounting is significant because it provides standardized financial information that external stakeholders rely on for decisions about providing resources to a business. Its objectives, as defined by the International Financial Reporting Standards, include providing useful financial information to existing and potential investors, lenders, and other creditors. The European Accounting Association notes that capital maintenance is a competing objective. The three main financial statements—cash flow statement, income statement, and balance sheet—each serve distinct purposes: the cash flow statement tracks cash inflows and outflows; the income statement summarizes changes in value over a period, culminating in net profit or loss; and the balance sheet shows assets, liabilities, and equity at a point in time, following the accounting equation Assets = Liabilities + Equity. IFRS and GAAP differ in balance sheet presentation: IFRS lists assets and liabilities from least liquid to most liquid, while GAAP lists from most liquid to least liquid. The statement of retained earnings, an additional statement, shows how net income and dividends affect shareholders' wealth. Financial accounting's legacy lies in its role as the primary means of communicating a company's financial health to the public, governed by international standards to ensure comparability and transparency.
Did You Know?
- Financial accounting and financial reporting are often used as synonyms.
- The International Financial Reporting Standards (IFRS) are issued by the International Accounting Standards Board (IASB).
- The balance sheet demonstrates the basic accounting equation: Assets = Liabilities + Equity.
- Under IFRS, a balance sheet must list assets and liabilities based on increasing liquidity, from least liquid to most liquid.
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