What Is Financial Accounting?

Financial accounting is a specific branch of

accounting involving a process of recording,
summarizing, and reporting the myriad of
transactions resulting from business operations
over a period of time.
 These transactions are summarized in the
preparation of financial statements—including
the balance sheet, income statement, and cash
flow statement—that record a company’s
operating performance over a specified period.
Accrual Method vs. Cash Method
There are two primary types of financial
accounting:
 the accrual method and
 the cash method.
 The main difference between them is the
timing in which transactions are recorded.
 Financial Accounting
• Accrual Method
• Records transactions when benefit is received or liability is
incurred
• A more accurate method of accounting that depicts more-
realistic business operations
• Required for larger, public companies as part of external
reporting
• Cash Method
• Records transactions when cash is received or distributed
• An easier method of accounting that simplifies a company down
to what has already actually occurred
• Primarily used by smaller, private companies with low to no
reporting requirements
 Principles of Financial Accounting
Financial accounting is dictated by five
general, overarching principles that guide
companies in how to prepare
their financial statements.
They are the basis of all financial accounting
technical guidance.
These five principles relate to the accrual
method of accounting.
• 5 Principles that relate to the accrual of
Financial Accpunting
1. Revenue Recognition Principle – This states
that revenue should be recognized when it has
been earned.
• It dictates how much revenue should be
recorded, the timing of when that revenue is
reported, and circumstances in which revenue
should not be reflected within a set of financial
statements.
• 2. Cost Principle – This states the basis
for which costs are recorded. It dictates
how much expenses should be recorded
for (i.e. at transaction cost) in addition to
properly recognizing expenses over time
for appropriate situations (i.e. a
depreciable asset is expensed over its
useful life).
 3. Matching Principle – This states that
revenue and expenses should be recorded in
the same period in which both are incurred.
•It strives to prevent a company from
recording revenue in one year with the
associated cost of generating that revenue in
a different year.
•The principle dictates the timing in which
transactions are recorded.
• 4. Full Disclosure Principle – This states
that the financial statements should be
prepared using financial accounting
guidance that includes footnotes,
schedules, or commentary that
transparently report the financial position
of a company. It dictates the amount of
information provided within financial
statements.
• 5. Objectivity Principle – This states
that while financial accounting has
aspects of estimations and professional
judgement, a set of financial statements
should be prepared objectively. It
dictates when technical accounting
should be used as opposed to personal
opinion.
 Users of Financial
Accounting/Financial Statements
 The entire purpose of financial accounting is to
prepare financial statements, which are used by a
variety of groups and often required as part of
agreements with the preparing company.
 In addition to management using financial
accounting to gain information on operations, the
following groups use financial accounting
reporting.
• Investors – Before putting their money into a
company, investors often seek reports prepared
using financial accounting to understand how the
company has been doing and set expectations
about the company’s future.

• Auditors – Companies may be required to present

their financial position to auditors, who analyze the
financial statements and ensure that proper
financial accounting guidance has been used and
the reports are free from material misstatements.
• Regulatory Agencies – Public companies are required to
submit financial statements to governing bodies such as the
Securities and Exchange Commission.
• These financial statements must be prepared in accordance
with financial accounting rules, and companies face fines or
exchange delisting if they do not comply with reporting
requirements.

• Suppliers – Vendors or suppliers may ask for financial

statements as part of their credit application process.
Suppliers may require a credit history or evidence of
profitability, before issuing or increasing credit to a
• Banks – Lenders and other similar financial
institutions will almost always require financial
statements as part of the business loan
process.
• Lenders will need to see verifiable proof via
financial accounting that a company is in good
operational health prior to issuing a loan.
• The statements may also be used for
determining the cost, covenants, or interest
Financial Accounting vs. Managerial Accounting
 The key difference between financial and
managerial accounting is that financial accounting provides
information to external parties, while managerial accounting
helps managers within the organization make decisions.

 Managerial accounting assesses financial performance and

hopes to drive smarter decision-making through internal
reports that analyze operations. It is not an allowable basis
for financial statements.

Managerial accounting uses operational
information in specific ways to glean
information.
 For example, it may use cost accounting to
track the variable costs, fixed costs, and
overhead costs along a manufacturing process.
Then, using this cost information, a company
may decide to switch to a lower quality, less
expensive type of raw materials.
Who Uses Financial Accounting?
 Public companies are required to perform financial
accounting as part of the preparation of their financial
statement reporting.
 Small or private companies may also use financial
accounting, but they often operate with different
reporting requirements.
 Financial statements generated through financial
accounting are used by many parties outside of a
company, including lenders, government agencies,
auditors, insurance agencies, and investors.
The Bottom Line
 Financial accounting is the framework that sets the
rules on how financial statements are prepared.
 These guidelines dictate how a company translates
its operations into a series of widely accepted and
standardized financial reports.
 Financial accounting plays a critical part in keeping
companies responsible for their performance and
transparent regarding their operations.
END