meaning of presentation in accounting

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The International Accounting Standards Board (IASB) reissued IAS 1, Presentation of Financial Statements , in September 2007. The main changes are amendments to presentation and terminology. 

The reissue of IAS 1 affected all ACCA exam papers which referred to ‘balance sheets’ or ‘cash flow statements’, as the revised standard changed the name of these to ‘statement of financial position’ and ‘statement of cash flows’ respectively.

For ALL international papers* (excluding CAT Papers 6 and 8, and ACCA Qualification Papers F3, F7, F8, P2, and P7): ‘Balance sheet’ became ‘statement of financial position (balance sheet)’ in the June 2008 and December 2008 exams. From the June 2009 exams onwards, ‘balance sheet’ became ‘statement of financial position’.

• ‘Cash flow statement’ became ‘statement of cash flows’ from the June 2008 exam sitting onwards.

Examiners may choose to use a single ‘statement of comprehensive income’ – see Table 1 .

For F3 (INT), F7 (INT), F8 (INT), P2 (INT), and P7 (INT): For exam purposes, the following applies to all companies, partnerships, and sole traders:

• ‘Balance sheet’ became ‘statement of financial position’ from the June 2008 exam sitting onwards.

Another amendment resulting from the reissue of IAS 1 was a requirement to present ‘other comprehensive income’ items (such as revaluation gains and losses, and actuarial gains and losses), as well as the usual income statement items, on the face of the primary financial statements. IAS 1 allows this information to be presented in one ‘statement of comprehensive income’ (see Table 1), or in two separate statements; an ‘income statement’ and a ‘statement of comprehensive income’.

In an exam, whenever a ‘statement of comprehensive income’ is referred to, this always relates to the single statement format (see Table 1). (Please refer to the Study Guides for examinability of line items.)

If ‘income statements’ are referred to, this relates to the statement from ‘revenue’ to ‘profit for the year’ (see Table 1 (part a)).

Exams may also refer to the ‘other comprehensive income section’ of the ‘statement of comprehensive income’ (see Table 1 (part b) (similar to the previous ‘statement of recognised income and expense’ (SORIE)).

Law and tax variant papers Law and tax variant papers continue to use the relevant local terminology. However, Paper F4 (GLO) will adopt the international format, where relevant.

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INTRODUCTION TO ACCOUNTING

Nov 12, 2014

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INTRODUCTION TO ACCOUNTING. Definition of Accounting. Accounting is a system of dealing with financial information that provides information for decision-making. Accounting vs. Bookkeeping . ACCOUNTING The process of recording, analyzing, and interpreting the economic activities of a business

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Presentation Transcript

Definition of Accounting • Accounting is a system of dealing with financial information that provides information for decision-making

Accounting vs. Bookkeeping ACCOUNTING • The process of recording, analyzing, and interpreting the economic activities of a business BOOKKEEPING • A method of recording all transactions for a business in a specific format

Why is Accounting Important • Accountability • People who handle cash in the company are responsible for it • Budgeting • This allows businesses to estimate its future sales and expenses • Taxation • Records must be kept in order to pay taxes

Why is Accounting Important • Financial Statements • These are reports that summarize the financial performance of a business • These reports indicate the business’s economic health • Annual Reports • Financial statements are presented to shareholders and potential investors in the form of annual reports

An Information System What financial questions might you have about your business? • Is the business earning profit? • Are selling prices to high/low? • How much does ABC company owe me? • What is the value of my inventory? • How much did John Smith earn last year? • Do we have enough money to pay our bills?

An Information System Who else may want financial information about the business? • Government • Bankers • Lenders • Potential Investor • A Lawyer

OWNING A BUSINESS If you decide to operate your own business you will find yourself facing such accounting tasks as: • Banking • Payroll • Keeping track of amounts owed by and owed to customers • Keeping track of amounts owed to the government • Producing an income statement for income tax purposes

Categories of Accounting Work Routine Daily Activities • Processing Bills • Preparing Cheques • Daily Banking • Recording Transactions • Preparing Business Papers Periodic Accounting Activities (these activities occur at regular intervals) • Paycheques(bi-weekly) • Bank accounts (balanced monthly) • Financial reports (monthly, quarterly, yearly) • Income tax returns (yearly)

Categories of Accounting Work Miscellaneous Activities • Employee resignation • An advertisement is prepared • New capital equipment is purchased • A new loan • A new employee is hired

The Fundamental Accounting Equation • The fundamental accounting equation states that: ASSETS – LIABILITIES = OWNER’S EQUITY OR ASSETS = LIABILITIES + OWNER’S EQUITY

ASSETS • An asset is anything that the business owns that has value • What are some examples of personal assets? • House • Car • Cash • RRSP’s

LIABILITIES • A liability is anything that the business owes; any debts of the business • What are some examples of personal liabilities? • Credit Line • Mortgage • Owed to Parents • Credit cards

OWNER’S EQUITY • Owner’s Equity is also referred to as capital or net worth • It is the difference between the total assets and total liabilities of a business

PERSONAL NET WORTH Here is a list of my assets: • House • Car • Furniture • Cash in Bank • Savings • RRSP’s • Teachers Pension

PERSONAL NET WORTH Here is a list of my liabilities: • Mortgage • Credit card ( paid of every month, but still a potential liability) • Line of credit

PERSONAL NET WORTH • What do I need to do to calculate my net worth? • Take my total assets and subtract them from my total liabilities

PERSONAL NET WORTH • We can see how this looks by examining a Balance Sheet containing my personal assets, liabilities, and net worth

YOUR NET WORTH • Make a list of all of your assets and all of your liabilities • Calculate your total assets and your total liabilities • Now calculate your net worth (remember the fundamental accounting equation) • Make a new net worth statement for yourself for 10 years from now!

The Balance Sheet

BALANCE SHEET = a statement of financial position Liabilities (debts you owe) + Owners Equity (the owner’s share of the assets) Assets (Things owned) =

THE ACCOUNTING EQUATION • ASSETS = LIABILITIES + OWNERS EQUITY A=L+OE

BALANCE SHEET • A “freeze frame” or snapshot of what the business owns, owes and the owners invested interest. • A financial picture of the business at a point in time. • The balance sheet does not indicate whether a business has made a profit, only whether it is financially strong.

Features of the Balance Sheet • The Balance Sheet looks like the Fundamental Accounting Equation • A = L + OE • Assets are on the left side and the liabilities and owner’s equity are on the right side

Features of the Balance Sheet • A Three Line Heading is Used • WHO? – The name of the individual, business or other organization • WHAT? – The name of the financial statement (in this case the balance sheet) • WHEN? – The date on which the financial position is determined

What? WHO? – The name of the individual, business or other organization When?

CASH AND LIQUIDITY • Cash is arguably the MOST valuable asset of a business. • WHY?? • It can easily be exchanged for other assets • Liquidity – how easily an asset can be exchanged for any other asset or converted to cash.

ASSETS • Ownership (title- legal right to use) is separate from financing (source of funds used to purchase asset). • With ASSETS, an owner can: • Use • Sell • Give away • Leave to heirs • Whether bought for cash or on credit, the owner still has “title” to his/her property

CATEGORIZING ASSETS • Current Assets – things a business owns that disappear quickly, usually in less than one year. • Long-term Assets (Capital Assets or Fixed Assets) – assets that a business keeps for a long time.

ASSETS • In order of liquidity, assets include: • cash, bank balances, • accounts receivable (listed in alphabetical order), • inventory and supplies, and • furniture, equipment, fixtures, vehicles, property and buildings (listed in the order in which they will be used up).

ACCOUNTS RECEIVABLE • Customers of the business will often buy goods or services with the understanding that they will be paid for in the future • These debts owed represent a dollar value to the business, so the business has a right to include them among the assets on the balance sheet • Each of these customers that owes money to the business is one of its debtors

CURRENT ASSETS • Current Assets • Cash $ 50,000 • Accounts Receivable $ 30,000 • Inventory $120,000 • Supplies $ 15,000 • Total Current Assets $215,000 ORDER Of LIQUIDITY CLOSEST TO CASH FARTHEST FROM CASH

FIXED ASSETS • Fixed Assets • Land $ 200,000 • Building $ 1,100,000 • Equipment $ 950,000 • Furniture $ 225,000 • Vehicles $ 215,000 • Total Fixed Assets $ 2,690,000 IN ORDER OF REVERSE DEPRECIATION ONE THAT WILL BE AROUND THE LONGEST ONE THAT WILL BE AROUND THE LEAST AMOUNT OF TIME

LIABILITIES • Liabilities are the debts of a business. Businesses acquire debt in two main ways: 1) Accounts Payable – purchasing inventory and supplies on credit. 2) Loans Payable (Notes Payable) – acquired by borrowing money from investors, banks, etc.

CATEGORIZING LIABILITIES • Liabilities are listed in order of priority, or how quickly they need to be paid off. • Current Liabilities – debts such as invoices for merchandise inventory, that are paid off quickly. • Long-term Liabilities – debts such as a mortgage loan, that may not be repaid for decades.

ACCOUNTS PAYABLE • A business often purchases goods and services from its suppliers with the understanding that payment will be made later • These debts to suppliers represent a dollar obligation of the business, the business must include them among its liabilities • Each of the suppliers owed money by the business is one of its creditors

CURRENT LIABILITIES ORDER Of MATURITY* • Current Liabilities • Wages Payable $ 10,000 • Accounts Payable $ 80,000 • Other Liabilities $ 50,000 • Current Portion - Mortgage $ 15,000 • Total Current Liabilities $ 155,000 * Maturity – When a debt is “mature” it’s payment is due FIRST TO BE PAID LAST TO BE PAID

LONG TERM LIABILITIES • Long Term Liabilities • Vehicle Loans $ 150,000 • Equipment Loan $ 900,000 • Mortgage $ 850,000 • Total Long Term Liabilities $1,900,000 ORDER OF MATURITY* SHORTEST TERM LONGEST TERM

OWNER’S EQUITY ORDER SHOWN • Owner’s Equity • Owner’s Capital $ 750,000 • Plus: Net Income $ 150,000 • $ 900,000 • Less: Drawings ($ 50,000) • Total Owner’s Equity $ 850,000 CAPITAL +/(-) INCOME/ (LOSS) THEN SUBTOTAL SUBTRACT DRAWINGS AND THEN TOTAL

MEASURING SUCCESS WITH A BALANCE SHEET Working Capital = Current Assets – Current Liabilities • Working capital indicates a business’s ability to pay its short-term debts. • Working Capital has to be positive Current Ratio = Total Current Assets / Total Current Liabilities • Current Ratio shows how many dollars of liquid assets (cash or near cash) a business has for every dollar of short-term debt. • Current ratio has to be over 1.2

MEASURING SUCCESS WITH A BALANCE SHEET Total Debt to Total Asset Ratio = Short Term Debt + Long Term Debt/Total Assets • A metric used to measure a company's financial risk by determining how much of the company's assets have been financed by debt. Calculated by adding short-term and long-term debt and then dividing by the company's total assets.

Current Assets – Current Liabilities = (1150+2000+1400)-(1350)= 3200 Working Capital Current Ratio Current Assets/Current Liabilities = (1150+2000+1400)/(1350)= 3.37

The Income Statement

WHAT IS AN INCOME STATEMENT? • Remember: a Balance Sheet is a snapshot of a business on one day in time • An Income Statement shows what happens over a period of time in a business, it could be one month, six months, or a year • An Income Statement shows how much money a business made or lost over a period of time

THE INCOME STATEMENT • As a business operates it makes money from daily activities • Through these daily activities the business also accumulates expenses • What are some of the expenses of day to day operations for a business?

THE INCOME STATEMENT RECALL: • What is the difference between a cost and an expense? • Cost  • Expense 

Order of Entries on an Income Statement • Just like the Balance Sheet, the Income Statement has a three line heading: • Who? (the name of the business/individual) • What? (in this case, an Income Statement) • When? (period of time ending on a certain date)

The Income Statement • The sources of Revenue are listed next • These are listed in alphabetical order • Revenue (Sales or Income) is the money, or the promise of money, received from the sale of goods or services

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A commonly recognized set of rules and procedures governing corporate accounting and financial reporting

What is GAAP?

GAAP, or G enerally A ccepted A ccounting P rinciples, is a commonly recognized set of rules and procedures designed to govern corporate accounting and financial reporting  in the United States (US). The US GAAP is a comprehensive set of accounting practices that were developed jointly by the Financial Accounting Standards Board (FASB) and the Governmental Accounting Standards Board (GASB), so they are applied to governmental and non-profit accounting as well.

US securities law requires all publicly-traded companies , as well as any company that publicly releases financial statements, to follow the GAAP principles and procedures.

In addition, or as an alternative, are the International Financial Reporting Standards (IFRS) established by the International Accounting Standards Board (IASB). The IFRS rules govern accounting standards in the European Union, as well as in a number of countries in South America and Asia.

The Core GAAP Principles

GAAP is set forth in 10 primary principles, as follows:

• Principle of consistency: This principle ensures that consistent standards are followed in financial reporting from period to period.
• Principle of permanent methods: Closely related to the previous principle is that of consistent procedures and practices being applied in accounting and financial reporting to allow comparison .
• Principle of non- compensation : This principle states that all aspects of an organization’s performance, whether positive or negative, are to be reported. In other words, it should not compensate (offset) a debt with an asset.
• Principle of prudence : All reporting of financial data is to be factual, reasonable, and not speculative.
• Principle of regularity : This principle means that all accountants are to consistently abide by the GAAP.
• Principle of sincerity : Accountants should perform and report with basic honesty and accuracy.
• Principle of good faith : Similar to the previous principle, this principle asserts that anyone involved in financial reporting is expected to be acting honestly and in good faith.
• Principle of materiality : All financial reporting should clearly disclose the organization’s genuine financial position.
• Principle of continuity : This principle states that all asset valuations in financial reporting are based on the assumption that the business or other entity will continue to operate going forward.
• Principle of periodicity : This principle refers to entities abiding by commonly accepted financial reporting periods, such as quarterly or annually.

The Generally Accepted Accounting Principles further set out specific rules and principles governing such things as standardized currency units, cost and revenue recognition , financial statement format and presentation, and required disclosures. For example, it requires precise matching of expenses with revenues for the same accounting period (the matching principle ).

History of GAAP

Generally Accepted Accounting Principles were eventually established primarily as a response to the Stock Market Crash of 1929 and the subsequent Great Depression, which were believed to be at least partially caused by less than forthright financial reporting practices by some publicly-traded companies. The federal government began working with professional accounting groups to establish standards and practices for consistent and accurate financial reporting.

Generally Accepted Accounting Principles began to be established with legislation such as the Securities Act of 1933 and the Securities Exchange Act of 1934.

The GAAP has gradually evolved, based on established concepts and standards, as well as on best practices that have come to be commonly accepted across different industries.

Why is GAAP Important?

Generally Accepted Accounting Principles make financial reporting standardized and transparent, using commonly accepted terms, practices, and procedures. The consistency of presentation of financial reports that results from GAAP makes it easy for investors and other interested parties (such as a board of directors) to more easily comprehend financial statements and compare the financial statements of one company with those of another company.

GAAP also seeks to make non-profit and governmental entities more accountable by requiring them to clearly and honestly report their finances.

In short, GAAP is designed to ensure a consistent presentation of financial statements , making it easier for people to read and comprehend the information contained in the statements.

Applications in Financial Analysis

For financial analysts performing valuation work and financial modeling , it’s important to have a solid understanding of accounting principles. While this is important, financial models focus more on cash flow and economic value, which is not significantly impacted by accounting principles (other than for the calculation of cash taxes).

Alternatives to GAAP

GAAP is the set of standards and practices that are followed in the United States, but what about other countries? Outside the US, the alternative in most countries is the International Financial Reporting Standards (IFRS), which is regulated by the International Accounting Standards Board (IASB). While the two systems have different principles, rules, and guidelines, IFRS and GAAP have been working towards merging the two systems.

Additional Resources

Thank you for reading CFI’s guide to GAAP. To further your education, the following CFI resources will also be helpful:

• Accounting Ethics
• Audited Financial Statements
• Internal Controls
• Types of SEC Filings
• See all accounting resources

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IFRS Forums and IFRS Knowledge Base

Presentation of Financial Statements (IAS 1)

Last updated: 17 May 2024

IAS 1 serves as the main standard that outlines the general requirements for presenting financial statements. It is applicable to ‘general purpose financial statements’, which are designed to meet the informational needs of users who cannot demand customised reports from an entity. Documents like management commentary or sustainability reports, which are often included in annual reports, fall outside the scope of IFRS, as indicated in IAS 1.13-14. Similarly, financial statements submitted to a court registry are not considered general purpose financial statements (see IAS 1.BC11-13).

The standard primarily focuses on annual financial statements, but its guidelines in IAS 1.15-35 also extend to interim financial reports (IAS 1.4). These guidelines address key elements such as fair presentation, compliance with IFRS, the going concern principle, the accrual basis of accounting, offsetting, materiality, and aggregation. For comprehensive guidance on interim reporting, please refer to IAS 34 .

Note that IAS 1 will be superseded by the upcoming IFRS 18 Presentation and Disclosure in Financial Statements .

Now, let’s explore the general requirements for presenting financial statements in greater detail.

Financial statements

Components of a complete set of financial statements.

Paragraph IAS 1.10 outlines the elements that make up a complete set of financial statements. Companies have the flexibility to use different titles for these documents, but each statement must be presented with equal prominence (IAS 1.11). The terminology used in IAS 1 is tailored for profit-oriented entities. However, not-for-profit organisations or entities without equity (as defined in IAS 32), may use alternative terminology for specific items in their financial statements (IAS 1.5-6).

Are you tired of the constant stream of IFRS updates? I know it's tough! That's why I created Reporting Period – a once-a-month summary for professional accountants. It consolidates all essential IFRS developments and Big 4 insights into one readable email. I personally curate every issue to ensure it's packed with the most relevant information, delivered straight to your inbox. It's free, with no spam, and if it turns out not to be right for you, you can unsubscribe with just one click.

Compliance with IFRS

Financial statements must include an explicit and unreserved statement of compliance with IFRS in the accompanying notes. This statement is only valid if the entity adheres to all the requirements of every IFRS standard (IAS 1.16). In many jurisdictions, such as the European Union, laws mandate compliance with a locally adopted version of IFRS.

IAS 1 does consider extremely rare situations where an entity might diverge from a specific IFRS requirement. Such a departure is permissible only if it prevents the presentation of misleading information that would conflict with the objectives of general-purpose financial reporting (IAS 1.20-22). Alternatively, entities can disclose the impact of such a departure in the notes, explaining how the statements would appear if the exception were made (IAS 1.23).

Identification of financial statements

The guidelines for identifying financial statements outlined in IAS 1.49-53 are straightforward and rarely cause issues in practice.

Going concern

The ‘going concern’ principle is a cornerstone of IFRS and other major GAAP. It assumes that an entity will continue to operate for the foreseeable future (at least 12 months). IAS 1 mandates management to assess whether the entity is a ‘going concern’. Should there be any material uncertainties regarding the entity’s future, these must be disclosed (IAS 1.25-26). IFRSs do not provide specific accounting principles for entities that are not going concerns, other than requiring disclosure of the accounting policies used. One of the possible approaches is to measure all assets and liabilities using their liquidation value.

See also this educational material at IFRS.org.

Materiality and aggregation

IAS 1.29-31 emphasise the importance of materiality in preparing user-friendly financial statements. While IFRS mandates numerous disclosures, entities should only include information that is material. This concept should be at the forefront when preparing financial statements, as reminders about materiality are seldom provided in other IFRS standards or publications.

Generally, entities should not offset assets against liabilities or income against expenses unless a specific IFRS standard allows or requires it. IAS 1.32-35 offer guidance on what can and cannot be offset. Offsetting of financial instruments is discussed further in IAS 32 .

Frequency of reporting

Entities are required to present a complete set of financial statements at least annually (IAS 1.36). However, some Public Interest Entities (PIEs) may be obliged to release financial statements more frequently, depending on local regulations. However, these are typically interim financial statements compiled under IAS 34 .

IAS 1 also allows for a 52-week reporting period instead of a calendar year (IAS 1.37). This excerpt from Tesco’s annual report serves to demonstrate this point, showing that the group uses 52-week periods for their financial year, even when some subsidiaries operate on a calendar-year basis:

If an entity changes its reporting period, it must clearly disclose this modification and provide the rationale for the change (IAS 1.36). It is advisable to include an explanatory note with comparative data that aligns with the new reporting period for clarity.

Comparative information

As a general guideline, entities should present comparative data for the prior period alongside all amounts reported for the current period, even when specific guidelines in a given IFRS do not require it. However, there’s no obligation to include narrative or descriptive information about the preceding period if it isn’t pertinent for understanding the current period (IAS 1.38).

If an entity opts to provide comparative data for more than the immediately preceding period, this additional information can be included in selected primary financial statements only. However, these additional comparative periods should also be detailed in the relevant accompanying notes (IAS 1.38C-38D).

IAS 1.40A-46 outlines how to present the statement of financial position when there are changes in accounting policies, retrospective restatements, or reclassifications. This entails producing a ‘third balance sheet’ at the start of the preceding period (which may differ from the earliest comparative period, if more than one is presented). Key points to note are:

• The third balance sheet is required only if there’s a material impact on the opening balance of the preceding period (IAS 1.40A(b)).
• If a third balance sheet is included, there’s no requirement to add a corresponding third column in the notes, although this could be useful where numbers have been altered by the change (IAS 1.40C).
• Interim financial statements do not require a third balance sheet (IAS 1.BC33).

IAS 8 also requires comprehensive disclosures concerning changes in accounting policies and corrections of errors .

Statement of financial position

IAS 1.54 enumerates the line items that must, at a minimum, appear in the statement of financial position. Entities should note that separate lines are not required for immaterial items (IAS 1.31). Additional line items can be added for entity-specific or industry-specific matters. IAS 1 permits the inclusion of subtotals, provided the criteria set out in IAS 1.55A are met.

Additional disclosure requirements are set out in IAS 1.77-80A. Of particular interest are the requirements pertaining to equity (IAS 1.79), which begin with the number of shares and extend to include details such as ‘rights, preferences, and restrictions relating to share capital, including restrictions on the distribution of dividends and the repayment of capital.’ While these kinds of limitations are common across various legal jurisdictions (for example, not all retained earnings can be distributed as dividends), many companies neglect to disclose such limitations in their financial statements.

For guidance on classifying assets and liabilities as either current or non-current, please refer to the separate page dedicated to this topic.

Statement of profit or loss and other comprehensive income

IAS 1 provides two methods for presenting profit or loss (P/L) and other comprehensive income (OCI). Entities can either combine both P/L and OCI into a single statement or present them in separate statements (IAS 1.81A-B). Additionally, the P/L and total comprehensive income for a given period should be allocated between the owners of the parent company and non-controlling interests (IAS 1.81B).

Minimum contents in P/L and OCI

IAS 1.82-82A specifies the minimum items that must appear in the P/L and OCI statements. These items are required only if they materially impact the financial statements (IAS 1.31).

Entities are permitted to add subtotals to the P/L statement if they meet the criteria specified in IAS 1.85A. Operating income is often the most commonly used subtotal in P/L. This practice may be attributed to the 1997 version of IAS 1, which mandated the inclusion of this subtotal—although this is no longer the case. IAS 1.BC56 clarifies that an operating profit subtotal should not exclude items commonly considered operational, such as inventory write-downs, restructuring costs, or depreciation/amortisation expenses.

Profit or loss (P/L)

All items of income and expense must be recognised in P/L (or OCI). This means that no income or expenses should be recognised directly in the statement of changes in equity, unless another IFRS specifically mandates it (IAS 1.88). Direct recognition in equity may also result from intra-group transactions . IAS 1.97-98 require separate disclosure of material items of income and expense, either directly in the income statement or in the notes.

Expenses in P/L can be presented in one of two ways (IAS 1.99-105):

• By their nature (e.g., depreciation, employee benefits); or
• By their function within the entity (e.g., cost of sales, distribution costs, administrative expenses).

When opting for the latter, entities must provide additional details on the nature of the expenses in the accompanying notes (IAS 1.104).

Other comprehensive income (OCI)

OCI encompasses income and expenses that other IFRS specifically exclude from P/L. There is no conceptual basis for deciding which items should appear in OCI rather than in P/L. Most companies present P/L and OCI as separate statements, partly because OCI is generally overlooked by investors and those outside of accounting and financial reporting circles. The concern is that combining the two could reduce net profit to merely a subtotal within total comprehensive income.

All elements that constitute OCI are specifically outlined in IAS 1.7, as part of its definitions.

Reclassification adjustments

A reclassification adjustment refers to the amount reclassified to P/L in the current period that was recognised in OCI in the current or previous periods (IAS 1.7). All items in OCI must be grouped into one of two categories: those that will or will not be subsequently reclassified to P/L (IAS 1.82A). Reclassification adjustments must be disclosed either within the OCI statement or in the accompanying notes (IAS 1.92-96).

To illustrate, foreign exchange differences arising on translation of foreign operations and gains or losses from certain cash flow hedges are examples of items that will be reclassified to P/L. In contrast, remeasurement gains and losses on defined benefit employee plans or revaluation gains on properties will not be reclassified to P/L.

The practice of transferring items from OCI to P/L, commonly known as ‘recycling’, lacks a concrete conceptual basis and the criteria for allowing such transfers in IFRS are often considered arbitrary.

Tax effects

OCI items can be presented either net of tax effects or before tax, with the overall tax impact disclosed separately. In either case, entities must specify the tax amount related to each item in OCI, including any reclassification adjustments (IAS 1.90-91). Interestingly, there is no such requirement to disclose tax effects for individual items in the income statement.

Statement of changes in equity

IAS 1.106 outlines the minimum line items that must be included in the statement of changes in equity. Subsequent paragraphs specify the disclosure requirements, which can be addressed either within the statement itself or in the accompanying notes. It’s crucial to note that changes in equity during a reporting period can arise either from income and expense items or from transactions involving owners acting in their capacity as owners (IAS 1.109). This means that entities cannot adjust equity directly based on changes in assets or liabilities unless these adjustments result from transactions with owners, such as capital contributions or dividend payments, or are otherwise mandated by other IFRSs.

Statement of cash flows

The statement of cash flows is governed by IAS 7 .

• Explanatory notes

Structure of explanatory notes

The structure for explanatory notes is detailed in IAS 1.112-116. In practice, there are several commonly adopted approaches to organising these notes:

Approach #1:

• Primary financial statements (P/L, OCI, etc.)
• Statement of compliance and basis of preparation
• Accounting policies

Approach #1 is logically coherent, as understanding accounting policies is crucial before delving into the financial data. However, in reality, few people read the accounting policies in their entirety. Consequently, users often have to navigate past several pages of accounting policies to reach the explanatory notes.

Approach #2:

• Primary financial statements (P/L, OCI, etc)

In Approach #2, accounting policies are treated as an appendix and positioned at the end of the financial statements. The advantage here is that all numerical data is clustered together, uninterrupted by extensive descriptions of accounting policies.

Approach #3:

• Explanatory notes integrated with relevant accounting policies

Approach #3 pairs accounting policies directly with the associated explanatory notes. For example, accounting policies relating to inventory would appear alongside the explanatory note that breaks down inventory components.

Management of capital

IAS 1.134-136 outline the disclosures related to capital management. These provisions apply to all entities, whether or not they are subject to external capital requirements. An important note here is that entities are not obligated to disclose specific values or ratios concerning capital objectives or requirements.

IAS 1.137 mandates disclosure of dividends proposed or declared before the financial statements were authorised for issue but not recognised as a distribution to owners during the period. Furthermore, entities are required to disclose the amount of any cumulative preference dividends not recognised.

Disclosure of accounting policies

IAS 1 specifies the requirements for disclosing accounting policy information which are discussed here .

Disclosing judgements and sources of estimation uncertainty

IAS 1 mandates disclosing judgements and sources of estimation uncertainty .

Other disclosures

Additional miscellaneous disclosure requirements are detailed in paragraphs IAS 1.138.

IFRS 18 Presentation and Disclosure in Financial Statements

On 9 April 2024, the IASB issued IFRS 18 Presentation and Disclosure in Financial Statements , which replaces IAS 1 and amends IAS 7. This new standard will be effective from 2027 with early application permitted.

Here are the key changes under IFRS 18:

• Two new subtotals have been added to the income statement: ‘Operating Profit’ and ‘Profit Before Financing and Income Taxes’. This change requires companies to categorise income and expenses into operating, investing, and financing activities.
• A new requirement mandates the reconciliation of non-GAAP measures with IFRS-specified subtotals, but this only applies to P/L measures such as adjusted profit. Other metrics like free/organic cash flow or net debt are not included.
• The statement of cash flows will start with operating profit for the indirect method, and the classification of cash flows related to interest and dividends has been standardised. Typically, dividends and interest paid will fall under financing activities, while those received will be recorded under investing activities.

While many IAS 1 provisions remain under IFRS 18, others, including the basis of financial statement preparation and disclosure of accounting policies, have moved to IAS 8, which will be retitled Basis of Preparation of Financial Statements . For further insights, see the IASB Project Summary .

© 2018-2024 Marek Muc

The information provided on this website is for general information and educational purposes only and should not be used as a substitute for professional advice. Use at your own risk. Excerpts from IFRS Standards come from the Official Journal of the European Union (© European Union, https://eur-lex.europa.eu). You can access full versions of IFRS Standards at shop.ifrs.org. IFRScommunity.com is an independent website and it is not affiliated with, endorsed by, or in any other way associated with the IFRS Foundation. For official information concerning IFRS Standards, visit IFRS.org.

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Four Steps to Delightful Accounting Presentations

By Charles Hall | Technology

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In this article, I provide you with four steps to delightful accounting presentations–even if you are a CPA. Yes, this can be done!

If you’ve read the book  Presentation Zen , you know that many speakers –without intending to– hide their message . In watching CPE presentations and board presentations, I have noticed that (we) CPAs unwittingly hide our message. How? We present slide decks that look like intermediate accounting textbooks–chock full of facts, but too much to digest. And do we really believe that those attending will take those slides back to the office and study them?

Probably not.

My experience has been those slides end up in the office dungeon, never to be seen again. We  have one chance to communicate–in the session.

It is the presenter’s duty to cause learning .  So how can we  engage our audience (even those sitting on the back row playing with their cell phones)?   Let’s start with the slide deck.

1. Make Simple Slides

Make simple slides.

I try to have no more than two points per slide , and I leave out references to professional standards (at least on the slides).

What happens when you see a slide that looks like it contains the whole of War and Peace ? If you’re like me, you may think, “Are you kidding? You want me to consume all of that in the next three minutes. Forget it. I will not even try.” And then you begin to think about your golf game or your next vacation. So, how much information should you include on a slide?

Nancy Duarte recommends the glance test for each slide . “People should be able to comprehend it in three seconds.”

2. Include a picture related to the topic

Include a picture.

For example, if I am presenting to auditors, I might display a picture of someone being bribed. Verbal information is remembered about ten percent of the time. If a picture is included, the figure goes up to sixty-five percent. Quite a difference.

3. Tell a story (and ask questions)

Tell a story and ask questions.

People love stories. If your presentation is about bribes and you have not audited a bribery situation, Google bribes, and you will find all the stories you need. If you can’t find a story, use a hypothetical. Why? You are trying to draw your audience in–then maybe they will put that cell phone down (your most triumphant moment as a speaker!).

Telling your story at the right pace and volume is also important.

Also engage your audience with questions. Stories get the juices going; questions make them dig. And, if they answer you, there is dialog. And what’s the result? Those talking learn, the audience learns, and, yes, you learn.

Move. Not too much, but at least some.

A statue is not the desired effect. Moving like Michael Jackson is also not what you desire (moonwalking was never in my repertoire anyway). But movement, yes. I walk slowly from side to side (without moonwalking) and will, at times, move toward the audience when I want to make a point. So, am I constantly roaming? No. Balance is important.

Now, let me provide a few thoughts about presentation software and handouts.

Presentation Software and Handouts

Presentation Software

If you have an Apple computer, let me recommend Keynote  as your presentation software . I do think PowerPoint (for you Windows users) has improved, but personally, I prefer Keynote.

Another option—though there is a cost—is using Canva to create your slide deck . Your creativity is almost unlimited with this software—pictures, graphics, templates, colors, resizing, and more. Once the slides are created, you can download them as a PDF. Then present the slides (in the PDF) using the full screen option in Adobe Acrobat . I’ve done this a lot lately. Love it. 

Here’s a sample Canva slide:

If you need to provide detailed information, give your participants handouts (examples of what you are discussing).

I prefer not to provide copies of slides. Why? Your participants will read ahead. You want to keep your powder dry. If they already know what you’re going to say, they’ll stop listening.

Your Presentation Tips

What do you do to make your presentations sizzle?

About the Author

Charles Hall is a practicing CPA and Certified Fraud Examiner. For the last thirty-five years, he has primarily audited governments, nonprofits, and small businesses. He is the author of The Little Book of Local Government Fraud Prevention, The Why and How of Auditing, Audit Risk Assessment Made Easy, and Preparation of Financial Statements & Compilation Engagements. He frequently speaks at continuing education events. Charles consults with other CPA firms, assisting them with auditing and accounting issues.

Amit, I have seen Prezi on the Internet, but I have not used it myself – though it looks inviting. Have you tried it or have you seen anyone use it?

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Financial Reporting - Fair presentation - Problems with fairness

From a UK perspective, such an overriding requirement for fairness is neither new nor controversial. However, when the 'true and fair view' principle was introduced into the law of other EU member states, it proved problematic: in some states an overriding 'true and fair' requirement conflicts with legal traditions or with accounting rules strongly influenced by tax law. As a result Germany, Austria and Sweden did not implement 'true and fair' as an overriding requirement. Further, 'true and fair view' is not interpreted in the same way in different national environments.

It has been claimed to exist independent from any framework of rules - we cannot determine its meaning from the contents of the Companies Act or EU directives.

To apply it, we have to draw on local customs and notions of 'fairness', on user needs and objectives of financial statements. In Germany, conformity with law and quasi-legal rules is assumed to result in a 'true and fair view', even if these rules permitted, for example, accelerated depreciation not reflecting economic reality.

Controversial issues

In spite of problems with the interpretation and application of 'fairness', the IASB has retained the requirement for 'fair presentation'. But it has given rise to three controversial issues: a framework for the interpretation of 'fair presentation' is now provided; 'fair presentation' and the override have lost in significance; and an escape clause is provided for the override requirement.

This is, arguably, not a bad thing. However, it seems that the IASB has succumbed to US influences. While the Framework refers to 'true and fair view' and 'present fairly',

The US has previously objected to the 'fair presentation' override in

Finally, financial statements claiming to comply with IFRSs must comply with all provisions. While the old

If such differential treatments are permitted with regard to 'fair presentation', this seems to open the door for differential treatment in other areas. Which suggests we may end up with very different interpretations of fairness.

For a fuller discussion of these issues, see Accountancy and Business Research, Volume 33, Number 4, pp 311-325. To subscribe call 0870 2404388.

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Accounting taxonomy to be updated for ifrs 18 rollout, staff costs hit £49.5m at ifrs foundation, ifrs 18 standard will improve accounting disclosure, frc calls for disclosure improvements in ifrs 17.

What Is Accounting? The Basics Of Accounting

Updated: Jun 12, 2024, 8:06pm

Table of Contents

What is accounting, types of accounting, ways to manage your business accounting, effective accounting practices to adopt immediately, frequently asked questions (faqs).

Accounting is the process of keeping track of all financial transactions within a business, such as any money coming in and money going out. It’s not only important for businesses in terms of record keeping and general business management, but also for legal reasons and tax purposes. Though many businesses leave their accounting to the pros, it’s wise to understand the basics of accounting if you’re running a business. To help, we’ll detail everything you need to know about the basics of accounting.

Accounting is the process of recording, classifying and summarizing financial transactions. It provides a clear picture of the financial health of your organization and its performance, which can serve as a catalyst for resource management and strategic growth.

Accounting is like a powerful machine where you input raw data (figures) and get processed information (financial statements). The whole point is to give you an idea of what’s working and what’s not working so that you can fix it.

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Why Accounting Is Important

Accounting information exposes your company’s financial performance; it tells whether you’re making a profit or just running into losses at the end of the day.

This information is not just available to you, but also to external users such as investors, stakeholders and creditors who would want to be enlightened about your business, to figure out whether it’ll be a good choice to invest in and what they can expect in returns.

Besides playing a key role in providing transparency for stakeholders, accounting also ensures you make informed decisions backed by data.

Accountant vs. CPA vs. Tax Pro

In accounting, you’ll come across certain titles which appear to bear similar duties but actually have unique job descriptions. In this section, we’ll briefly review the roles of accountants vs. CPAs and tax professionals.

An accountant is a professional with a bachelor’s degree who provides financial advice, tax planning and bookkeeping services. They perform various business functions such as the preparation of financial reports, payroll and cash management.

A certified public accountant (CPA) is a type of professional accountant with more training and experience than a typical accountant. Aspiring CPAs are expected to have a bachelor’s degree, more than two years of public accounting work experience, pass all four parts of the CPA exam and meet additional state-specific qualifications if required. In the U.S., licensed CPAs must have earned their designation from the American Institute of Certified Public Accountants (AICPA).

Tax professionals include CPAs, attorneys, accountants, brokers, financial planners and more. Their primary job is to help clients with their taxes so they can avoid paying too much or too little in federal income or state income taxes.

As a general note, CPAs are considered to be more qualified than tax professionals when it comes to preparing taxes on an individual basis as they are trained to analyze business and personal finances to maximize savings and minimize taxes. It’s also worth noting that while all CPAs are accountants, not all accountants are CPAs.

Accounting can be broken down into several categories ; each category deals with a specific set of information, or documents particular transactions. In this section, we discuss four of the most common branches of accounting:

Financial Accounting

This is the practice of recording and reporting financial transactions and cash flows. This type of accounting is particularly needed to generate financial reports for the sake of external individuals and government agencies. These financial statements report the performance and financial health of a business. For example, the balance sheet reports assets and liabilities while the income statement reports revenues and expenses. Financial accounting is governed by accounting rules and regulations such as U.S. GAAP (Generally Accepted Accounting Principles) and IFRS (International Financial Reporting Standards).

Managerial Accounting

This focuses on the use and interpretation of financial information to make sound business decisions. It’s similar to financial accounting, but this time, it’s reserved for internal use, and financial statements are made more frequently to evaluate and interpret financial performance.

Cost Accounting

This is the process of tracking, analyzing and understanding the costs involved in a specific business activity. This includes all direct and indirect expenses associated with your business’s day-to-day operations. Cost accounting is particularly important because it helps you ensure that you are spending money on things that benefit your business’s bottom line.

Tax Accounting

This is the act of tracking and reporting income and expenses related to your company’s taxes. You don’t want to be in a situation where you have to pay more income tax than is normally required by the Internal Revenue Service (IRS).

So far, we’ve seen the types and benefits of accounting. This leads us to the next question of knowing how to carry out accounting efficiently. There are many ways to manage your business accounting. They include:

Outsource to Professionals

You can outsource your accounting work to outside professionals who specialize in bookkeeping and tax preparation. Outsourcing can offer many advantages because it allows you to take advantage of specialized skill sets that may not be available when hiring someone in-house. It’s also flexible and generally costs less.

Using Accounting Software

Accounting software allows you to do basic tasks such as tracking inventory, invoicing and payments, and generating reports on sales and expenses. It’s useful for small businesses and freelancers who don’t have the resources to hire an accountant or bookkeeper. Besides, this frees up time so you can focus on running your business smoothly. Check out our recent piece on the best accounting software for small businesses .

Hiring an In-House Accountant

You can choose to manage your business accounting by hiring an in-house accountant or CPA . This can be a great option if you want to ensure your books are in order, and that your company’s financial information is accurate, but it does come with some drawbacks. For one thing, the cost of hiring someone like this can be a substantial burden on your business’s finances.

There are many ways to do accounting, but there are also certain practices that make it easier to keep track of your finances. Some best practices include:

• Keep your personal finances separate from that of your business to get an accurate view of your company’s financial health. This applies a lot to small businesses just getting started with accounting.
• Pay attention to details. Make sure that all transactions are accounted for and properly totaled to facilitate accurate reporting at year-end.
• Hire an accounting professional if you don’t have the time to learn accounting software. This will save you stress and give you the needed time to focus on other important parts of your business.
• Keep adequate records of all assets, liabilities and cash flows for tax purposes. Pay attention to tax laws and regulations. Stay up to date on current news so you can know what’s happening in the financial world.

Bottom Line

Accounting is popularly regarded as “the language of business” because it doesn’t just help you keep track of your money, but also helps you make informed decisions about your business. To speed up action, you may hire accounting professionals or purchase accounting software to ensure accurate financial audits and reporting.

What is accounting in simple terms?

Accounting is the process of keeping track of your business’s financial transactions. It helps you to understand how money comes in and how it goes out.

Why is accounting important?

Accounting helps a business understand its financial position to be able to make informed decisions and manage risks.

What is the simplest accounting software?

Freshbook is one of the easiest accounting software systems to use. Its interface is very intuitive, making it very easy to learn. Another easy to use option that’s perfect for self-employed entrepreneurs who need an affordable accounting solution is Neat. Learn more about the best accounting software .

Are bookkeeping and accounting different?

Bookkeeping focuses on recording and organizing financial data, including tasks, such as invoicing, billing, payroll and reconciling transactions. Accounting is the interpretation and presentation of that financial data, including aspects such as tax returns, auditing and analyzing performance.

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John Iwuozor is a freelance writer with expertise in the technology field. He has written for a host of top tech companies, the likes of Technologyadvice, Tripwire amongst others. He's an avid chess lover and loves exploring new domains.

Faithful Representation

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What Is Financial Accounting?

• How It Works

Financial Statements

Accrual method vs. cash method.

• Why It Matters
• Users of Financial Accounting
• Financial vs. Managerial Accounting
• Professional Designations
• Financial Accounting FAQs

The Bottom Line

• Corporate Finance

Financial Accounting Meaning, Principles, and Why It Matters

• Accounting Explained With Brief History and Modern Job Requirements
• Accounting Equation
• Current and Noncurrent Assets
• Accounting Theory
• Accounting Principles
• Accounting Standard
• Accounting Convention
• Accounting Policies
• Principles-Based vs. Rules-Based Accounting
• Accounting Method
• Accrual Accounting
• Cash Accounting
• Accrual Accounting vs. Cash Basis Accounting
• Financial Accounting Standards Board (FASB)
• Generally Accepted Accounting Principles (GAAP)
• International Financial Reporting Standards (IFRS)
• IFRS vs. GAAP
• US Accounting vs. International Accounting
• Understanding the Cash Flow Statement
• Breaking Down The Balance Sheet
• Understanding the Income Statement
• Financial Accounting CURRENT ARTICLE
• Financial Accounting and Decision-Making
• Cost Accounting
• Certified Public Accountant (CPA)
• Chartered Accountant (CA)
• Accountant vs. Financial Planner
• Tax Accounting
• Forensic Accounting
• Chart of Accounts (COA)
• Double Entry
• Closing Entry
• Introduction to Accounting Information Systems
• Inventory Accounting
• Last In, First Out (LIFO)
• First In, First Out (FIFO)
• Average Cost Method

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.

Work opportunities for a financial accountant can be found in both the public and private sectors. A financial accountant’s duties may differ from those of a self-employed accountant who works for many clients preparing their accounts, tax returns, and possibly auditing other companies.

Key Takeaways

• Financial accounting is the framework that dictates the rules, processes, and standards for financial recordkeeping.
• Nonprofits, corporations, and small businesses use financial accountants to prepare their books and records and generate their financial reports.
• Financial reporting occurs through the use of financial statements, such as the balance sheet, income statement, statement of cash flow, and statement of changes in shareholder equity.
• Financial accounting differs from managerial accounting, as financial reporting is for reporting to external parties, while managerial accounting is for internal strategic planning.
• Financial accounting may be performed under the accrual method (recording expenses for items that have not yet been paid) or the cash method (only cash transactions are recorded).

Investopedia / Laura Porter

How Financial Accounting Works

Financial accounting utilizes a series of established principles. The accounting principles used depend on the business's regulatory and reporting requirements. Companies and organizations often have an accounting manual that details the pertinent accounting rules.

U.S. public companies are required to perform financial accounting in accordance with generally accepted accounting principles (GAAP) . Their purpose is to provide consistent information to investors, creditors, regulators, and tax authorities.

The statements used in financial accounting cover the five main classifications of financial data, which are:

• Revenues – Included here is income from sales of products and services, plus other sources, including dividends and interest.
• Expenses – These are the costs of producing goods and services, from research and development to marketing to payroll.
• Assets – These consist of owned property, both tangible (buildings, computers) and intangible (patents, trademarks).
• Liabilities – These are all outstanding debts, such as loans or rent.
• Equity – If you paid off the company’s debts and liquidated its assets, you would get its equity, which is what a company is worth.

Revenues and expenses are accounted for and reported on the income statement, resulting in the determination of net income at the bottom of the statement. Assets, liabilities, and equity accounts are reported on the balance sheet, which utilizes financial accounting to report ownership of the company’s future economic benefits.

International public companies also frequently report financial statements in accordance with International Financial Reporting Standards (IFRS) .

Balance Sheet

A balance sheet reports a company’s financial position as of a specific date. It lists the company’s assets, liabilities, and equity, and the financial statement rolls over from one period to the next. Financial accounting guidance dictates how a company records cash, values assets, and reports debt.

A balance sheet is used by management, lenders, and investors to assess the liquidity and solvency of a company. Through financial ratio analysis, financial accounting allows these parties to compare one balance sheet account with another. For example, the current ratio compares the amount of current assets with current liabilities to determine how likely a company is going to be able to meet short-term debt obligations.

Income Statement

An income statement , also known as a “profit and loss statement,” reports a company’s operating activity during a specific period of time. Usually issued on a monthly, a quarterly, or an annual basis, the income statement lists revenue , expenses , and net income of a company for a given period. Financial accounting guidance dictates how a company recognizes revenue, records expenses, and classifies types of expenses.

An income statement can be useful to management, but managerial accounting gives a company better insight into production and pricing strategies compared with financial accounting. Financial accounting rules regarding an income statement are more useful for investors seeking to gauge a company’s profitability and external parties looking to assess the risk or consistency of operations.

Cash Flow Statement

A cash flow statement reports how a company used cash during a specific period. It is broken into three sections:

• Operations – These are the costs of a company’s core business activities.
• Financing – This is money the company receives from taking loans or issuing shares, as well as money paid in interest on loans and dividends to investors.
• Investments – This is money that comes from buying and selling the company’s investments, such as securities or fixed assets.

Financial accounting guidance dictates when transactions are to be recorded, though there is often little to no flexibility in the amount of cash to be reported per transaction.

A cash flow statement is used by management to better understand how cash is being spent and received. It extracts only items that impact cash, allowing for the clearest possible picture of how money is being used, which can be somewhat cloudy if the business is using accrual accounting.

Shareholders' Equity Statement

A shareholders' equity statement reports how a company’s equity changes from one period to another, as opposed to a balance sheet, which is a snapshot of equity at a single point in time. It shows how the residual value of a company increases or decreases and why it changed. It gives details about the following components of equity:

• Share Capital – Money raised by selling stock in the company
• Net Income – Any profit after expenses and deductions
• Dividends – The part of profit that is paid to shareholders
• Retained Earnings – Whatever is left after paying dividends

Nonprofit entities and government agencies use similar financial statements; however, their financial statements are more specific to their entity types and will vary from the statements listed above.

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.

Accrual Method

The accrual method of financial accounting records transactions independently of cash usage. Revenue is recorded when it is earned (when a bill is sent), not when it actually arrives (when the bill is paid). Expenses are recorded upon receiving an invoice, not when paying it. Accrual accounting recognizes the impact of a transaction over a period of time.  

For example, imagine a company receives a $1,000 payment for a consulting job to be completed next month. Under accrual accounting, the company is not allowed to recognize the $1,000 as revenue, as it has technically not yet performed the work and earned the income. The transaction is recorded as a debit to cash and a credit to unearned revenue, a liability account. When the company earns the revenue next month, it clears the unearned revenue credit and records actual revenue, erasing the debt to cash.

Another example of the accrual method of accounting are expenses that have not yet been paid. Imagine a company received an invoice for $5,000 for July utility usage. Even though the company won’t pay the bill until August, accrual accounting calls for the company to record the transaction in July, debiting utility expense. The company records a credit to accounts payable. When the invoice is paid, the credit is cleared.

Cash Method

The cash method of financial accounting is an easier, less strict method of preparing financial statements: Transactions are recorded only when cash is involved. Revenue and expenses are only recorded when the transaction has been completed via the facilitation of money.

In the example above, the consulting firm would have recorded $1,000 of consulting revenue when it received the payment. Even though it won’t actually perform the work until the next month, the cash method calls for revenue to be recognized when cash is received. When the company does the work in the following month, no journal entry is recorded, because the transaction will have been recorded in full the prior month.

In the other example, the utility expense would have been recorded in August (the period when the invoice was paid). Even though the charges relate to services incurred in July, the cash method of financial accounting requires expenses to be recorded when they are paid, not when they occur. 

Financial Accounting

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

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 . The type of accounting method should be determined at the outset. Changes to this method can happen later, but require specific actions. The principles are the basis of all financial accounting technical guidance. These five principles relate to the accrual method of accounting.

• 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. 
• 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). 
• 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.
• 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.
• 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.

Importance of Financial Accounting

Companies engage in financial accounting for a number of important reasons.

• Creating a standard set of rules – By delineating a standard set of rules for preparing financial statements, financial accounting creates consistency across reporting periods and different companies.
• Decreasing risk – Financial accounting does this by increasing accountability. Lenders, regulatory bodies , tax authorities, and other external parties rely on financial information; financial accounting ensures that reports are prepared using acceptable methods that hold companies accountable for their performance.
• Providing insight to management – Though other methods such as managerial accounting may provide better insights, financial accounting can drive strategic concepts if a company analyzes its financial results and makes reactionary investment decisions. 
• Promoting trust in financial reporting – Independent governing bodies oversee the rules of financial accounting, making the basis of reporting independent of management and a highly reliable source of accurate information
• Encouraging transparency – By setting rules and requirements, financial accounting forces companies to disclose certain information on how operations are going, and what risks the company is facing, painting an accurate picture of financial performance regardless of how well or poorly the company is doing.

Careers in financial accounting can include preparing financial statements, analyzing financial statements, auditing financial statements, and supporting the technology/systems that produce financial statements.

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, such as a Piotroski Score , before issuing or increasing credit to a requested amount.
• 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 rate of the loan.

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.

Professional Designations for Financial Accounting

Members of financial accounting can carry several different professional designations.

• Certified Public Accountant (CPA) – The most common accounting designation demonstrating an ability to perform financial accounting within the United States is the CPA license .
• Chartered Accountant (CA) – Outside of the United States, holders of the CA license demonstrate the ability as well.
• Certified Management Accountant (CMA) – The CMA designation is more demonstrative of an ability to perform internal management functions than financial accounting. However, this license does test on financial analysis.
• Certified Internal Auditor (CIA) – Holding a CIA designation demonstrates creditability in maintaining the control environment within a company by overseeing processes and procedures related to financial accounting.
• Certified Information Systems Auditor (CISA) – The CISA exam tests proficiency on maintaining the systems of an entity and may directly or indirectly influence the outcome of the financial accounting process.

What Is an Example of Financial Accounting?

A public company’s income statement is an example of financial accounting. The company must follow specific guidance on what transactions to record. In addition, the format of the report is stipulated by governing bodies. The end result is a financial report that communicates the amount of revenue recognized in a given period. 

What Is the Main Purpose of Financial Accounting?

Financial accounting is intended to provide financial information on a company’s operating performance . Though management can analyze reports generated using financial accounting, they often find it more useful to use managerial accounting, an internally geared method of calculating financial results that is not allowable for external reports. Financial accounting is the widely accepted method of preparing financial results for external use.

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.

Financial accounting is the framework that sets the rules on how financial statements are prepared. The U.S. follows different accounting rules than most other countries. 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.

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From Numbers to Insight: Unveiling the True Meaning of Accounting

Discover the true accounting meaning from principles to modern advancements, get insights that demystify the numbers., understanding accounting, what is accounting.

Accounting is all about measuring, processing, and sharing financial info about businesses and corporations. Think of it as the language of business, helping companies keep track of their money and make smart decisions. The word “accounting” comes from Middle English “acountynge,” which means “reckoning” or “calculation,” dating back to around 1676.

In simple terms, accounting is the backbone of financial management. It helps organizations make informed decisions, keep an eye on their financial health, and follow the law. It includes activities like recording transactions, summarizing financial data, and presenting it in financial statements. Want more details? Check out our accounting definition page.

How Accounting Evolved

Accounting has been around since ancient times, but it really took off during the 15th century Renaissance. That’s when Luca Pacioli, an Italian math whiz, introduced double-entry bookkeeping. This was a game-changer, as it involved recording both debits and credits, laying the groundwork for modern accounting principles.

Fast forward to the early 20th century, and there was a big push for consistency and transparency in financial reporting. Groups like the American Institute of Accountants (now AICPA) and the Institute of Chartered Accountants in England and Wales were key players in setting up accounting standards. This led to the creation of Generally Accepted Accounting Principles (GAAP), which set the stage for future international standards.

In the last 25 years, accounting has changed a lot thanks to technology and global markets. Accountants now need to be tech-savvy and understand complex international rules. For more on how accounting has evolved, visit our accounting history page.

For more on the principles that guide accounting practices, check out our section on accounting principles . And if you’re curious about how accounting has changed over the years, our article on the evolution of accounting has got you covered.

Bookkeeping vs Accounting

When you dive into finance, it’s crucial to know the difference between bookkeeping and accounting. Though often mixed up, they play different roles in managing money.

Different Jobs

Bookkeeping and accounting might look alike, but they do different things.

Bookkeeping

Bookkeeping is all about keeping track of every penny. It’s like being the librarian of money, making sure every transaction is recorded correctly. This means jotting down sales, expenses, and receipts in a general ledger ( Bench ). The main goal? Keep everything neat and tidy.

Accounting is like the detective work of finance. It’s about summarizing, interpreting, and sharing the financial story that the bookkeeper has written down. Accountants dig into the data, analyze it, and then explain what it all means, including things like loans and payments ( Bench ). The aim is to understand the financial health and share that info with the right people.

Want to know more about accounting? Check out our article on accounting definition .

Skills and Credentials

The skills and qualifications for bookkeeping and accounting are quite different.

Bookkeeping Skills

Bookkeeping doesn’t need fancy skills, but being detail-oriented and accurate is key. Basic math and knowing how to use bookkeeping software help too.

Accounting Skills

Accounting is more complex and needs specific skills and credentials. Accountants usually need more education and might go for certifications like CPA (Certified Public Accountant).

Curious about what it takes to be an accountant? Explore our resources on accounting degree and accounting course .

Knowing the difference between bookkeeping and accounting is a big deal for anyone into finance. Whether you’re thinking about a career in accounting or just want to handle your money better, understanding these roles can help you make smarter choices.

Accounting Basics

Getting a grip on the basics of accounting is a must for anyone diving into the field. These core ideas keep everything consistent, reliable, and accurate when it comes to financial reporting. Let’s break down the main principles: accrual, matching, historic cost, conservatism, and substance over form.

Accrual Principle

The accrual principle is all about timing. It says transactions should be recorded when they happen, not when the money changes hands. This gives a true picture of a business’s financial health by matching revenues and expenses to the right periods. For example, if you ship goods in December but get paid in January, you record the sale in December. This rule is backed by both IFRS and GAAP and is a must for businesses making over $5 million a year.

Matching Principle

The matching principle says you should record expenses in the same period as the revenues they help generate. This makes sure your income statements show the real costs of earning those revenues. For instance, if you buy equipment in January and use it over two years, spread the cost over those 24 months. This gives a realistic view of profitability and efficiency.

Historic Cost Principle

The historic cost principle is straightforward: record assets at their original purchase price. This gives a clear, objective basis for accounting since the original cost is verifiable. Using historic cost helps avoid the guesswork of current market values and keeps financial reporting consistent, making it easier to compare statements over time.

Conservatism Principle

The conservatism principle is all about playing it safe. It says to recognize expenses and liabilities as soon as possible, even if there’s some uncertainty, but only record revenues and assets when they’re sure things ( Shiksha ). This keeps financial statements from being too optimistic and gives a cautious view of a company’s financial health. It’s the basis for the rule that inventory should be reported at the lower of its cost or market value.

Substance over Form Principle

The substance over form principle says financial statements should reflect the real economic substance of transactions, not just their legal form. This means capturing the true economic reality. For example, if you lease equipment in a way that’s basically a purchase, record it as an asset ( The Centre for Legal Leadership ). This helps present a true and fair view of the company’s financial position.

For more on these and other accounting basics, check out our article on accounting principles . Understanding these principles will give you a solid foundation in accounting and help you make sense of financial info. Curious about how these principles apply in different types of accounting, like managerial accounting or financial accounting ? We’ve got articles on those too.

Types of Accounting

Getting a grip on the different types of accounting is like having a cheat sheet for understanding financial data and making smart choices. Each type has its own job, from keeping you on the right side of the law to helping you cut costs and make better decisions.

Managerial Accounting

Managerial accounting is all about giving the inside scoop to folks running the show—managers and execs. Think of it as the backstage pass to the company’s financials. It involves detailed reports on stuff like budgets, performance, and costs. This info helps in planning and keeping things on track to hit financial targets.

Imagine a manager using these reports to figure out which department is making bank or if it’s worth splurging on new gear. These reports are packed with analyses, forecasts, and financial models. Curious for more? Check out our piece on accounting concepts .

Financial Accounting

Financial accounting is the go-to for whipping up financial statements like the balance sheet, income statement, and cash flow statement. These docs give a snapshot of the company’s financial health and are a must-read for investors, creditors, and regulators. Financial accounting sticks to rules like GAAP or IFRS to keep things consistent and transparent.

These statements help outsiders size up the company’s performance and make smart investment moves. Want the nitty-gritty? Head over to our accounting principles page.

Tax Accounting

Tax accounting is all about dealing with taxes—preparing returns and making sure you’re playing by the rules. It focuses on figuring out taxable income and how much you owe Uncle Sam. Tax accountants need to stay on top of ever-changing tax laws to keep the company compliant and snag any tax breaks.

Tax accounting is key to dodging penalties and maximizing tax savings. For more deets, check out our article on accounting standards .

Cost Accounting

Cost accounting is like the detective of the accounting world, tracking down the costs of making goods or services. It helps businesses spot ways to save money and boost efficiency. Cost accountants keep tabs on direct materials, direct labor, and overhead to figure out the total production cost.

Knowing the cost structure helps businesses set the right prices and stay profitable. For more insights, swing by our accounting cycle page.

Each type of accounting is a piece of the puzzle in managing a business’s finances. Whether you’re into managerial accounting , financial accounting, tax accounting, or cost accounting, getting the hang of these types will give you a real appreciation for what accounting’s all about.

Why Accounting Matters

Keeping tabs on your money.

Accounting is like the heartbeat of your business, keeping track of every penny and making sure you’re not bleeding cash. With accurate financial records, you can see where your money’s going and make smart decisions ( Cardiff University International Study Centre ). This helps you spot trends, catch problems early, and plan for what’s next.

One of the main tools for this is the balance sheet. It’s like a snapshot of your company’s financial health, showing what you own, what you owe, and what’s left over. By looking at these numbers, you can see how stable your business is. For more on how to read and create balance sheets, check out our article on the accounting balance sheet .

Stopping Sneaky Business

Accounting is your best friend when it comes to catching and stopping fraud. Keeping detailed and accurate records makes everything transparent and accountable. Regular audits and internal checks can catch any funny business before it gets out of hand.

Setting up good internal controls, like making sure different people handle cash and record-keeping, can really cut down on fraud. For example, having one person handle the money and another person keep the books can prevent shady activities. Learn more about the accounting principles that help keep fraud at bay in our dedicated article.

Planning Your Spending

Budget planning is another biggie that accounting helps with. By looking at past financial records, you can figure out where to spend, where to save, and how to make more money ( Cardiff University International Study Centre ). A good budget helps you use your resources wisely, set financial goals, and keep track of how you’re doing.

A solid budget includes expected income, expenses, and cash flow for a certain period. This helps you plan for future investments, manage your cash, and avoid spending too much. For more tips on making a killer budget, visit our section on accounting objectives .

By understanding how accounting helps with financial health, fraud prevention, and budget planning, you can keep your business on solid ground. To dive deeper into what accounting really means, check out our article on accounting definition .

Accounting in the Modern Era

Tech on the rise.

Computers have flipped the accounting game upside down. Gone are the days of tedious number crunching and manual record-keeping. With the rise of accounting software, tasks that once took hours now take minutes, and the accuracy is through the roof. Cloud computing and data analytics have taken things up a notch, letting accountants do real-time financial analysis and make snap decisions.

But wait, there’s more! Artificial intelligence, blockchain, and machine learning are the new kids on the block, ready to shake things up even more. Automation and AI are like having a superpower—routine tasks get done in a flash, and AI helps with big-picture decisions ( Wilke CPAs & Advisors ). And let’s not forget cybersecurity. Firms are beefing up their defenses with IT pros, regular security audits, and the latest security trends to keep client data safe from cyber baddies.

Curious about accounting software? Check out our article on accounting software .

Accounting Goes Global

Accounting isn’t just a local gig anymore. With businesses crossing borders, accountants need to know international tax laws, regulations, and reporting requirements. The push towards global standards like the International Financial Reporting Standards (IFRS) has made this shift smoother.

Want to dive deeper into accounting standards? Visit our page on accounting standards .

CPAs: The New Age Heroes

Technology and globalisation have turned CPAs into superheroes. No longer just number crunchers, CPAs are now key players in strategic planning and decision-making. With the help of tech tools, they offer insights that drive business growth. Real-time data and analytics mean they can give spot-on financial advice when it’s needed most.

To stay on top of their game, CPAs need to keep up with tech advancements and global regulations. Continuous learning and certifications in areas like data analytics and cybersecurity are becoming must-haves.

For more on the evolving role of CPAs, check out our article on accounting jobs .

Understanding these trends helps you see what accounting really means today. Whether you’re just starting out or you’re a seasoned pro, staying updated is key to success. For more basics, explore our article on accounting definition .

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What is Accounting? Definition, Objectives, Advantages, Limitation, Process

• Post last modified: 22 February 2022
• Reading time: 35 mins read
• Post category: Finance

What is Accounting?

Accounting is the art of recording, classifying, summarising and analyzing business transactions and interpreting the results thereof. In accounting, only those transactions and events are recorded which can be measured in terms of money.

The basic objective of accounting is to provide the desired information to the owner as well as to all other interested parties i.e. investors, creditors, employees, financial institutions, government etc.

In short, we can say that accounting is the language of business by which all the financial and other information are communicated to various interested parties.

Table of Content

• 1 What is Accounting?
• 2 Introduction to Accounting
• 3 Definition of Accounting
• 4 Characteristics of Accounting
• 5.1 Financial Accounting
• 5.2 Management Accounting
• 5.3 Cost Accounting
• 5.4 Tax Accounting
• 5.5 Social Accounting
• 5.6 Human Resource Accounting
• 5.7 National Accounting
• 5.8 Green Accounting
• 5.9 Creative Accounting
• 5.10 Forensic Accounting
• 6.1 Stewardship functions
• 6.2 Managerial functions
• 6.3 Statutory compliance function
• 7.1 Reliability
• 7.2 Understand ability
• 7.3 Comparability
• 8.1 Single Entry
• 8.2 Double Entry System
• 9 Concept of Accounting Process
• 10.1 Maintaining systematic records
• 10.2 Communicating the financial results
• 10.3 Meeting legal needs
• 10.4 Stewardship
• 10.5 Fixing responsibility
• 11.1 Owners/Shareholders
• 11.2 Managers
• 11.3 Prospective Investors
• 11.4 Creditors, Bankers and other Lending Institutions
• 11.5 Government
• 11.6 Employees
• 11.7 Customers
• 12.1 Helpful in the Determination of Financial Results
• 12.2 Comparison of Results
• 12.3 Assistance to Management
• 12.4 Helpful in Assessing the Tax Liability
• 12.5 Helpful in the Case of Insolvency
• 12.6 Provides Information to Interested Parties
• 12.7 Raising of Funds Become Easy
• 13.1 Recording of Monetary Items Only
• 13.2 Effect of Inflation
• 13.3 Accounting Information May be Biased
• 13.4 Conflict Between Accounting Principles
• 14.1 Identification of Transaction
• 14.2 Recording the Transaction
• 14.3 Classifying
• 14.4 Summarising
• 14.5 Presentation of Financial Information

Introduction to Accounting

Accounting is a business language which explains the various kinds of transactions during a given period of time. Accounting is used by business entities for keeping records of their money or financial transactions.

A businessman who invested money in his business would like to know whether his business is making a profit or incurring a loss, the position of his assets and liabilities and whether his capital in the business has increased or decreased during a particular period. The main object of a business house is to earn profit. Accounting is the medium of recording business activities and it is considered a language of business.

To find out the results of a business, the information relating to the cost of the products and revenues from the products is collected. Then the costs and revenues are compared to find out the profit or loss of the business. If volume of sales of the products is high and the number of transactions of the business is very high, it is impossible to keep all these transactions in the mind of a businessman.

Thus a need of recording of all these business transactions rose. The recording of business transactions or activities is done through a process of accounting.

Definition of Accounting

The Accounting definition is given by the American Institute of Certified Public Accountants (‘AICPA’) clearly brings out the meaning of accounting. According to it, accounting is “ the art of recording, classifying and summarizing in a significant manner and in terms of money, transactions and events which are, in part at least, of a financial character and interpreting the results thereof ” .

As per Robert N. Anthony , “ Accounting system is a means of collecting, summarizing, analyzing and reporting, in monetary terms, information about the business”.

As per Smith and Ashburne , “ Accounting is the science of recording and classifying business transactions and events, primarily of a financial character and the art of making significant summaries, analysis and interpretations of these transactions and events and communicating the results to persons who must take decisions or form judgment.”

As per R.N. Anthony “Nearly every business enterprise has accounting system, it is a means of collecting, summarising and reporting in monetary terms, information about business.”

Characteristics of Accounting

Following are the characteristics of accounting :

• Accounting is an art which it helps us in attaining our aim of ascertaining the financial results, that is, operating profit and financial position. Analysis and interpretation of financial data require special knowledge, experience and judgement.
• In accounting the financial transactions are recorded in the Journal. With the help of Journal, the recorded data are classified into ledger under appropriate heads. Then with the help of ledger the trial balance and financial statements are prepared.
• It records only those transactions and events which are of financial character: If a transaction has no financial character then it will not be measured in terms of money and not recorded.
• It records transactions in terms of money. All transactions are recorded in terms of common measure i.e. money.
• On account of recording of business transactions in a systematic manner, it is also called a science. First the business transactions are recorded in the primary books i.e. Journal, for classification the ledger is prepared. With the help of ledger the Trial Balance, Profit and Loss account and Balance Sheet is prepared. Profit and Loss account is prepared after a period to find the result of the business and Balance Sheet to know the financial position of the business

Divisions of Accounting

Accountants tend to specialize in various types of accounting work and this has resulted in the development of different branches of accounting. Some of the divisions of accounting are given as:

Financial Accounting

Management Accounting

Cost Accounting

Tax accounting, social accounting, human resource accounting, national accounting, green accounting, creative accounting, forensic accounting.

Accounting designed or meant for outsiders is known as financial accounting. It is concerned with the recording of business transactions and the periodic preparation of income statement, balance sheets and cash flow statement from such records.

It is concerned with the interpretation of accounting information to guide the management for future planning, decision-making, control, etc. Management accounting, therefore, serves the information needs of the insiders, e.g., owners, managers and employees.

It has been developed to ascertain the costs incurred for carrying out various business activities and to help the management to exercise strict cost control.

This branch of accounting has grown in response to the difficult tax laws such as relating to income tax, sales tax, excise duties, customs duties, etc. An accountant is required to be fully aware of various tax legislations.

This branch of accounting is also known as social reporting or social responsibility accounting. It discloses the social benefits created and the costs incurred by the enterprise. Social benefits include such facilities as medical, housing, education, canteen, provident fund and so on while the social costs may include such matters as extra hours worked by employees without payment, environment pollution, unreasonable terminations, etc.

It is concerned with the human resources of an enterprise. Accounting methods are applied to evaluate the human resources in money terms so that the society might judge the total work of the business enterprises including, its non-human assets.

It is, therefore, accounting for the people of the organisation. Unfortunately, no objectively verifiable method has been developed for universal application.

The accounting for the resources of the nation as a whole. It is generally not concerned with the accounting of individual business entities and is not based on generally accepted accounting principles. It has been developed by economists and statisticians.

The concept of green accounting is related to the calculation of national income in which standard measures of income and output are Gross National Product (GNP) Gross Domestic Product (GDP) Gross National Income (GNP) etc.

In simple words, Green Accounting is a kind of accounting that tries to take into consideration the environmental costs in the calculation of the operating income of an enterprise. Green Accounting discloses or emphasizes more clearly about the quality of economic growth in terms of sustainable development.

It is the primary duty of the persons in accounting professions, the accountants, to report a true and fair view of the financial statements, namely: the profit and loss account and the balance sheet.

Creative accounting is nothing but the manipulation of the operating results and financial position of the company, of course, within the confines (limits) of the accounting standards.

Financial scams and frauds in accounting practices have drawn attention of the users of the accounting information supplied by business enterprises. Even the well-governed multinational companies like Enron and other World companies have not escaped from the fraudulent accounting practices.

Auditors who are also qualified accountants have the increased responsibility of detecting the frauds and scams in the corporate world

Functions of Accounting

As mentioned earlier, accounting information is used by different stakeholders, especially the management, to decide the future course of action for the organisation.

There are three main functions of accounting, which are explained as follows:

Stewardship functions

Managerial functions, statutory compliance function.

These functions of accounting include the following:

• Recording, classifying and summarising the financial transactions of an organisation
• Analysing the financial data
• Representing the financial position of the organisation by displaying various results such as net profit, credit, debit, loan, etc.
• Communicating the financial information to the interested stakeholders.
• Formulating a financial policy
• Conducting planning
• Preparing budget and controlling costs
• Preventing financial errors and frauds

These functions include the following:

• Submitting financial statements such as profit and loss account, balance sheet, etc. to regulatory bodies as a legal and regulatory requirement
• Providing the bases for filing returns for both direct and in- direct taxes

Qualitative Characteristics of Accounting Information

Relevance: Financial information obtained through financial statements should be according to the objectives of the organization. The objective-oriented information helps the investors, managers and creditors to take decisions about the business. The information should be given according to the priorities and needs of each and every interested party.

Reliability

Understand ability, comparability.

Financial Information should be based on facts which can easily be verified. Financial information can be verifiable if it is based on original source documents. Source documents include cash memo, purchase invoices, sales invoices, property transfer papers and written agreements, etc.

Financial information should be presented in a simple and easy way so that the users i.e. investors, debenture holders, employees and government officials can understand it easily. It should be simple enough even for a person who is not aware about the rules and terms used in accounting. Some explanatory notes should be given so as to make the information more understandable.

The financial statements must show corresponding information for the preceding year(s) so that the users may be able to compare the financial performance, position and cash flows of different years. The measurement and display of the net financial effects of similar type of transactions must be treated in a consistent form.

Methods of Accounting

Single entry.

It is an incomplete system of recording business transactions. The business organization maintains only cash book and personal accounts of debtors and creditors. So the complete recording of transactions cannot be made and trail balance cannot be prepared.

Double Entry System

The double entry system is based on scientific principles and is, therefore, used by most of business houses. The system recognizes the fact that every transaction has two aspects and records both aspects of each and every transaction.

Under this system, in every transaction an account is debited and other account is credited. The crux of accountancy lies in finding out which of the two accounts are affected by a particular transaction and out of these two accounts which account is to be debited and which account is to be credited.

Concept of Accounting Process

Accounting process is the complete sequence of accounting procedures which begin with the recording of business transactions from source documents in the Journal or in subsidiary books, as the case may be, and end with the preparation of two basic financial statements, namely Income Statement (or profit and loss account) and Balance Sheet. In the case of Limited Liability Companies, the Cash Flow Statement is also prepared.

The essential steps in the Accounting Process are:

• To enter the transactions in the source documents such as purchase invoice, sales invoice, cash receipts, bank pay-in-slips etc.
• To record or enter the transactions in the Journal or in subsidiary books, as the case may be.
• Classifying the transactions (i.e., the entries found in the Journal or Subsidiary Books) to post or transfer those entries in the appropriate accounts in the ledger.
• To enter the adjustments, if any, in the Journal.
• To balance the various accounts in the ledger to prepare the trial balance in order to check the arithmetical accuracy of the ledger accounts.
• To prepare the final accounts or final statements in the form of trading and profit and loss account (i.e., income statement) and Balance Sheet from the Trial Balance, at the end of the accounting period to ascertain profit or loss of the business for the accounting period and the financial position of the business at the end of the accounting period.

Objectives of Accounting

Following are the objectives of accounting :

Maintaining systematic records

Communicating the financial results, meeting legal needs, stewardship, fixing responsibility.

Business transactions are properly recorded, classified under appropriate accounts and summarized into financial statement.

Accounting is used to communicate financial information in respect of net profits (or loss), assets, liabilities etc., to the interested parties.

The provisions of various laws such as Companies Act, Income Tax and GST Acts require the submission of various statements, i.e., annual account, income tax returns and so on.

Accounting assists the management in the task of planning, control and coordination of business activities.

In the case of limited companies, the management is entrusted with the resources of the enterprise. The managers are expected to act true trustees of the funds and the accounting helps them to achieve the same.

Accounting helps in the computation of the profits of different departments of an enterprise which help in fixing the responsibility of departmental heads.

Users of Accounting Information

Owners/shareholders, prospective investors, creditors, bankers and other lending institutions.

The primary aim of accounting is to provide necessary information to the owners related to business.

In large business organizations and in corporations, there is a separation of ownership and management functions. The management of such business are more concerned with the accounting information because they are answerable to the owners.

The person who is contemplating an investment in a business will like to know about its profitability and financial position. They derive this information from the accounting reports of the concern.

Trade creditors, bankers and other lending institutions would like to be satisfied that they will be paid on time. The financial statements help them in judging such position. Banks and other lending agencies rely heavily upon accounting statements for determining the acceptability of a loan application.

The Government is interested in the financial statements of business enterprise on account of taxation, labour and corporate laws.

Employees are interested in financial statements on accounts because their wage increase and payment of bonus depend on the size of the profit earned.

Customers may also have either short-term or long-term interest in the reporting entity or long-term interest in the reporting entity and they may be satisfied with the profitability, liquidity and solvency position.

Advantages of Accounting

Following are the advantages of accounting :

Helpful in the Determination of Financial Results

Comparison of results, assistance to management, helpful in assessing the tax liability, helpful in the case of insolvency, provides information to interested parties, raising of funds become easy.

Accounting is very useful in the determination of the profit and loss of a business and showing the financial position of the business.

Accounting information when properly recorded can be used to compare the results of one year with those of earlier years so that the significant changes can be analyzed.

The accounting information helps the management to plan its future activities by preparing budgets in respect of sales, production, expenses, cash, etc. Accounting helps in the coordination of various activities in different departments by providing financial details of each department.

The managerial control is achieved by analyzing in money terms the departures from the planned activities and by taking corrective measures to improve the situation in future.

Generally, a businessman has to pay corporate tax, VAT and excise duty, etc. Therefore, it is necessary that proper accounts should be maintained to compute the tax liability of the business.

Sometimes the businessman becomes insolvent. If he has properly maintained the accounts, he will not face the problems in explaining few things in court.

Interested parties like owners, creditors, management, employees, customers, government, etc. are interested in accounting information.

It helps in raising funds from investors or financial institutions by promising investors a fixed claim (interest payments) on the cash flows generated by the assets, with a limited or no role in the day-to-day running of the business.

Limitation of Accounting

Following are the limitation of accounting :

Recording of Monetary Items Only

Effect of inflation, accounting information may be biased, conflict between accounting principles.

In accounting, only those transactions, which have monetary value, are recorded. And those transactions which do not have financial value whether those are important in business are not recorded in the accounting.

In accounting, the transactions are recorded at the historical cost. Accordingly, the assets of the business are shown at cost in the balance sheet. Thus the balance sheet prepared on the basis of historical cost ignores the price-level changes (inflation). In this way, the balance sheet of the business does not present the true and fair picture of the business.

Accounting information is not without personal influence or bias of the accountant. In measuring income, accountant has a choice between different methods of inventory valuation, deprecation methods, treatment of capital and revenue items etc. Hence, due to the lack of objectivity income arrived at may not be correct in certain cases.

In accounting, one accounting principle conflicts another. For instance, inventory should be valued on the basis of ‘least of the cost and market price’ as per the principle of conservatism.

Accounting Process

Accounting process involves the following steps or stages:

Identification of Transaction

Recording the transaction, classifying, summarising, presentation of financial information.

In accounting, only business transactions are recorded. A transaction is an event which can be expressed in terms of money and which brings a change in the financial position of a business enterprise. An event is an incident or a happening which may or may not being any change in the financial position of a business enterprise.

Therefore, all transactions are events but all events are not transactions. A transaction is a complete action, to an expected or possible future action. In every transaction, there is a movement of value from one source to another.

For example, when goods are purchased for cash, there is a movement of goods from the seller to the buyer and a movement of cash from buyer to the seller. Transactions may be external (between a business entity and a second party, e.g., goods sold on credit to Hari or internal (do not involve a second party, e.g., depreciation charged on the machinery).

Journal is the first book of original entry in which all transactions are recorded event-wise and date-wise and presents a historical record of all monetary transactions. It may further be divided into sub-journals as well which are also known subsidiary books.

Accounting is the art of classifying business transactions. Classification means statement setting out for a period where all the similar transactions relating to a person, a thing, expense, or any other subject are groped together under appropriate heads of accounts.

Summarising is the art of making the activities of the business enterprise as classified in the ledger for the use of management or other user groups i.e. Sundry debtors, Sundry creditors etc. Summarisation helps in the preparation of Profit and Loss Accounts and Balance sheet for a particular fiscal year.

Analysis and Interpretation The financial information or data as recorded in the books of an account must further be analyzed and interpreted so to draw useful conclusions. Thus, analysis of accounting information will help the management to assess in the performance of the business operations and forming future plans also.

The end users of accounting statements must be benefited from analysis and interpretation of data as some of them are the ‘stock holders’ and other one the ‘stakeholders’. Comparison of past and present statements and reports, use of ratio analysis and trend analysis are the different tools of analysis and interpretation.

From the above discussion, one can conclude that accounting is a art which starts and includes steps right from recording of business transactions of monetary character to the communicating or reporting the results thereof to the various interested parties.

( Click on Topic to Read )

• 4 Accounting Conventions
• What Is Accounting Standards?
• What is Accounting Equation?
• What is Source Documents?
• What i s Accounting Cycle?
• Classification Of Accounts
• 3 Branches of Accounting
• What is Double Entry System of Accounting?
• What i s Journal In Accounting?
• What is Ledger In Accounting?
• What is Posting In Accounting?
• What is Trial Balance?
• What is Accounting Errors?
• What is Depreciation In Accounting?
• What is Financial Statements?
• What is Departmental Accounts?
• What is Branch Accounting?
• Accounting for Dependent Branches
• Independent Branch Accounting
• Accounting for Foreign Branches

Corporate Finance

• What is Corporate Finance?
• Long Term Financing
• What is Inventory Management?
• External Sources Of Finance
• Short Term Financing
• Time Value Of Money
• Capital Assets Pricing Model (CAPM)
• What is Capital Rationing?
• What is Capital Budgeting?
• What is Cost o f Capital?
• What is Dividend?
• Dividend Theories
• What is Dividend Policy?
• What is Cash Management?
• Types of Derivatives Contract
• What is Inventory Control?
• What is Consumer Financing?
• What is Management Accounting?
• What is Financial Statement Analysis?
• Types of Accounting
• What is a Management Accountant?
• Inventory Control Techniques
• Determination Of Working Capital
• What is Cash Flow Statement?
• Determination of Working Capital

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