financial accounting examples

financial accounting examples

The Importance of Financial Accounting: Understanding Concepts Through Real-World Examples

1. Introduction to Financial Accounting

The information provided by financial statements is used by management, the board of directors, investors and potential investors, lenders, and professionals (for example, accountants and lawyers) as an aid to making prudent decisions. These decisions might involve buying or selling stock, making or evaluating loans, or determining whether an audit is necessary. The accounting information could also be used by legislators (for example, government agencies) and by other participants in the business capital markets (for example, the stock exchanges). One of the main objectives of financial accounting is the objective of providing information to decision makers. Without specific information about inventory levels, sales, and shipments, for example, management wouldn’t be able to make effective decisions related to inventory levels and product sales. The financial statements therefore help investors, creditors, and management to evaluate a company’s situation and prospects. That, in a nutshell, is what financial accounting is all about.

What is financial accounting? In short, accounting is the language of business. In this language, communication occurs in the form of financial statements. The financial statements communicated to people outside of the company are the financial statements used by people we would typically classify as accountants. These people could be members of the company’s board of directors, people who work with current and potential investors, current and potential lenders, clients or customers, employees, the Securities and Exchange Commission (SEC), the Internal Revenue Service, academicians, journalists, or people who simply want to know how well the company is performing as a citizen (residents of the company’s host community). These statements (income statement, balance sheet, changes in cash flow, and statement of stockholders’ equity) provide important information about a company’s economic activities.

2. Key Concepts in Financial Accounting

The simple subject matter of accounting, recording business transactions, is one of its core principles. It is very difficult to report accounting data if the item does not have an objective such as an expected benefit for not less than one year, generates transaction activity, has a profit advantage from obtaining these future cash flows, and company liability can be defined and resolved in terms of resources that are claimed against the company. Certain items have this manageable and objective nature are assets and liabilities. What is not an asset includes those items that are either immaterial or subjective, such as recipes, customer lists, and core versa. Another core of the simple accounting process is forming a balance sheet that allows an investor or analyst to determine a company’s financial position by analyzing data that is capable of withstanding as a true or actual amount.

Accrual Accounting recognizes revenues when the service is performed or the product is delivered, and expenses in the period in which they are used up or incurred, not when the company pays for them. In the standard accounting equation, assets are equal to liabilities plus owner’s equity. In a corporation, owners are called stockholders. Revenues are increases in assets from selling products or from performing services, and expenses are decreases in assets from using up assets or incurring liabilities in conjunction with earning revenues. Retained earnings is the portion of the business’s earnings that is retained in the business, and is not paid out in dividends to the stockholders. When revenues exceed expenses, net income is posted to the income statement. If expenses exceed revenues, a net loss appears on the income statement. Accounting is a resource of financial information for assessing the performance and condition of an organization. Financial analysis is the process of examining an organization’s accounting reports to make management decisions. The purpose of accounting is to provide a framework for concept and understanding the methods associated with the development of financial accounting information. Accounting practice is a subset of the full set of methods and the purpose of financial analysis is associated with a select group of decision-oriented application. Financial accounting and production are different. Financial accounting produces reports for external parties, such as regulators and government agencies, creditors and suppliers, and employee representatives and stockholders. Managerial accounting is a constructed quarterly report used by internal parties, such as middle and top management, to arrive at decisions in the budgeting process and in specific courses of action. Financial accounting reports are called general-purpose financial statements. They are prepared in accordance with generally accepted accounting principles (GAAP). Due to regulation and the allocation of expense, stockholders and members of management are permitted to rely on the GAAP.

Accounting is the process of recording, summarizing, analyzing, and interpreting financial (money-related) transactions of a business organization. Financial accounting focuses on the financial (monetary) events that occur in a company. It measures business activities, processes data into reports, and communicates results to decision makers. The decisions of managers are communicated to shareholders, potential investors, and others in the form of financial reports. Financial accounting is important because it is the language spoken among business people to communicate about company operations. Business decisions depend on knowing and analyzing company strengths and weaknesses. Because the outcome of most decision processes involve the flows of financial resources, and often at a specific point in time, money is the most common denominator used in determining the outcome of a business.

3. Real-World Examples of Financial Accounting in Action

In discussing events and transactions, we have referred specifically to the business activities of the company and the application of the economic model to the company’s financial accounting process. We might consider how management classifies and labels transactions in the financial accounting process. It would also be relevant to consider how management actually does in the “real world of application” compared with the model. That is, the economy subscribes to a model incorporating certain income measurement and recognition concepts. Inherent in these concepts are certain rules and principles which may be observed in practice. On occasion, we may not always reach a strict interpretation of these rules and principles. This might be termed the meeting of a compromise model. However, when the “compromise” results in the measurement and recognition of significant elements of the company’s revenue and expenses in a specific time frame, the implications can be substantial from the point of view of the capital market.

– The business (economic) event – The business transaction (the application of the event to the financial accounting process) – The accounting model (the rules or concepts governing the financial accounting process)

In our discussions of the financial accounting model, a number of concepts were introduced. In order to make these concepts more meaningful and relevant, it might be helpful to consider how a company’s management actually applies these concepts in the financial accounting environment. Our discussion has considered:

4. Analysis and Interpretation of Financial Statements

The preparation of financial statements includes the following steps: (1) analysis of the transaction and other events, (2) journalizing (recording or entering) the events, (3) preparing a trial balance, (4) making end-of-the-period adjustments, (5) preparing the financial statements, and (6) closing the accounts. The closing of accounts means transferring the revenue and expense accounts to an income summary or to owner’s capital. In addition, owner’s withdrawals are usually closed to the owner’s capital account. Financial statements show the results of business operations and the financial position at the end of an accounting period.

In order for financial statement information to be useful to users, it must be quantitative, accurate, and relevant to their decision-making needs. Quantitative means capable of being measured or counted. As we have seen in previous discussions, qualitative issues, such as poor or declining profits, have twice the impact of quantitative measures. The decision usefulness of financial statements is a qualitative concept. It implies that the financial data can influence (or be capable of influencing) decisions by enabling users to assess past, present, and future financial (and, where relevant, nonfinancial) performance.

5. Conclusion: The Value of Applying Financial Accounting Concepts

This discussion helps to answer the familiar question “If I apply an incorrect accounting principle when preparing financial statements, what can happen?” Business professionals frequently rely on their accountants to produce and interpret this information in accordance with the generally accepted accounting principles established by the AICPA and the FASB. However, it should be emphasized that accountants produce information based on a given set of accounting principles, but they may not have many of the answers. However, a workforce that applies and adopts principles that encourage these attributes will thrive. Accounting helps to encourage many attributes. It provides a framework for just and fair transactions and promotes decision-usefulness for businesses and the economy. Failure to appreciate this can leave a business vulnerable to misstating its earnings and staying solvent, and, over the long run, creating value for shareholders.

As professionals, we must constantly strive for improvement. Accounting may deal with numbers, but the concepts and rules employed are closely related to those that serve as a foundation for our lifestyle. Even when the basic method of recording transactions was standardized years ago, the profession continues to struggle in classifying and valuing an ever-changing array of business transactions. We lose sight of the principles that resulted in the set of principles that we use today. How do we, as business professionals, avoid being consumed with those day-to-day challenges? We do so by reminding ourselves why the profession relies on these rules and what attributes the profession tries to encourage by relying on them. When we apply concepts to real-life experiences, the underlying principles become clearer. This should help guide our actions when we are faced with challenges adjusting to the ever-changing business world.

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