Financial Accounting

Financial Accounting

Meaning & Definition:

Financial accounting is the process of recording, classifying, summarizing, interpreting, and communicating financial information about an economic entity in order to provide useful information for decision-making. This involves the preparation of financial statements that provide information about the performance and financial position of the business. Financial statements include the balance sheet, income statement, statement of cash flows, and statement of changes in equity. Financial accounting is primarily concerned with providing information for external users such as investors, creditors, and tax authorities.

Need & Importance:

• Financial accounting provides important information to various stakeholders in the business, such as shareholders, creditors, and regulators. 
• It helps in evaluating the performance and financial position of the business and in understanding the financial trends over time. 
• Financial statements provide a comprehensive view of the business’s performance and position, enabling stakeholders to make informed decisions. 
• They provide a basis for the assessment of risk and return, enabling investors to make sound investment decisions. 
• Financial accounting is also useful for assessing the financial health of the business and for providing information to creditors, who need to assess the creditworthiness of the business. 
• Financial accounting is also important for tax purposes, as it helps determine the amount of tax payable by the business. 
• Overall, financial accounting provides important information to stakeholders, enabling them to make informed decisions.

Functions:

Financial accounting is responsible for recording, classifying, summarizing, interpreting, and communicating financial information about an economic entity. The primary functions of financial accounting include: 

1. Recording – Recording involves the systematic recording of economic events in the form of transactions. This involves the preparation of journal entries and the posting of these entries to the ledger. 
2. Classifying – Classifying involves the grouping of similar transactions into accounts. This helps in organizing and summarizing the transactions. 
3. Summarizing – Summarizing involves the preparation of financial statements such as the balance sheet, income statement, statement of cash flows, and statement of changes in equity. This helps in providing an overview of the financial position and performance of the business. 
4. Interpreting – Interpreting involves the analysis of the financial statements to gain insights into the financial performance and position of the business. This helps in making informed decisions. 
5. Communicating – Communicating involves the sharing of financial information with external users such as investors, creditors, and tax authorities. This helps in providing useful information for decision-making.

Limitations:

• Financial accounting has certain limitations that should be kept in mind when interpreting financial information. 
• Firstly, financial accounting does not provide information about the future performance of the business, as it only provides information about the past performance. 
• Secondly, financial accounting is based on historical cost, which may not truly reflect the current value of the business. 
• Thirdly, financial accounting does not provide information about the quality of the assets and liabilities of the business. 
• Lastly, financial accounting is based on certain assumptions and conventions, which may not always be suitable for all businesses.

Internal and External Sources of Financial Accounting Information:

Internal Sources: 

1. Financial statements – Financial statements such as the balance sheet, income statement, statement of cash flows, and statement of changes in equity provide important information about the financial performance and position of the business. 
2. Accounting records – Accounting records such as ledgers, journals, and trial balances provide information about the transactions of the business. 
3. Bank statements – Bank statements provide information about the cash inflows and outflows of the business. 
4. Cost accounting records – Cost accounting records provide information about the cost of producing goods and services. 

External Sources: 

1. Credit reports – Credit reports provide information about the creditworthiness of the business. 
2. Market research – Market research provides information about the size and nature of the market and customer preferences. 
3. Government statistics – Government statistics provide useful industry-level information. 
4. Economic data – Economic data provide information about the macroeconomic environment in which the business operates.