Financial accounting is the process by which an organization's revenue, receivables, and expenses are collected, measured, recorded and finally reported. 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.
Across financial accounting, companies have two basic ways they can structure their business’s accounting. Publicly traded companies must use the accrual accounting method which is standardized under generally accepted accounting principles (GAAP). Many private companies also use GAAP but they are not required to. Private companies also have the option to use the cash accounting method.
In a practical sense, the main objective of financial accounting is to accurately prepare an organization's final 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 for the firm. The financial statements also provide information for all types of investors to prepare analysis using trends, ratios, and industry comparisons.
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, replacing 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.
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).