Financial accounting is the process by which an organization's revenue, receivables, and expenses are collected, measured, recorded, and finally reported into a financial statement. This process is designed to accurately reflect business activity, help companies meet legal, fiscal, and statutory requirements, present financial accounts to business owners, allow for in-depth financial analysis, and facilitate efficient resource allocation. The main purpose of financial accounting is to allow third parties to assess the value of a company.
Across financial accounting, companies have two basic ways that they can structure their business’s accounting policy. Publicly traded companies must use the accrual accounting method which is standardized under generally accepted accounting principles (GAAP). The accrual method reports revenues as they are accrued as opposed to when they are received and expenses are reported as they are incurred rather than when they are paid. Many private companies also use GAAP but they are not required to do so. Private companies also have the option to use the cash accounting method.
The Purpose of Financial Statements
In a practical sense, the main objective of financial accounting is to accurately prepare an organization's financial accounts for a specific period, otherwise known as financial statements. The three primary financial statements are the income statement, the balance sheet, and the statement of cash flows.
A company’s financial statements serve several purposes. They provide important information to shareholders and loan creditors, which can help to improve investment interest. The financial statements are used internally by management to manage both the current operations and future activities of the firm. The financial statements also provide information for all types of investors to prepare an analysis using trends, ratios, and industry comparisons.
The American Institute of Certified Public Accountants (AICPA)
The American Institute of Certified Public Accountants (AICPA) is an industry-leading organization in the area of financial accounting. They have over 400,000 members worldwide. The AICPA is a leading source for research and alerts on topics of interest in the accounting profession. The AICPA is also responsible for developing and grading the Uniform CPA Exam.
In 1973, the AICPA released a study entitled "The Objectives of Financial Statements" which was conducted by the Trueblood Committee. The study was pivotal for the accounting industry with objectives adopted by the Financial Accounting Standards Board (FASB). The basis of the AICPA’s 1973 study reported that financial statements were primarily useful for helping multiple parties make financial decisions. The study was also released the same year that the FASB was created, which replaced the work of the AICPA in developing accounting standards for the accounting industry. Today financial accounting standards and objectives can be found through the FASB’s website.
Financial Reporting Standards
In the United States, financial reporting standards are set forth by the FASB and required under GAAP for publicly traded companies. The FASB is contracted out by the Securities and Exchange Commission (SEC) to control the approved methods and applications of financial accounting. Following these reporting standards makes it easier for individuals to understand the financial statements of various companies, as they are presented in the same manner and therefore easier to follow.
Financial accounting is normally performed by those individuals who have studied the methods, concepts, history, and laws related to its practice. In the U.S., these individuals are referred to as certified public accountants (CPAs). The SEC requires that public companies annually report their financial statements and that this reporting is done by an impartial third party, which is where CPAs come in to play. This ensures that the financial statements have been properly created under all required policies.