What is financial accounting?
Financial accounting is a specific branch of bookkeeping involving a process of recording, summarizing and reporting the myriad of transactions resulting from business operations over a period of time. These operations are summarized in the preparation of financial statements, including the balance sheet, income statement and cash flow statement, which record the operating performance of the company over a specified period.
Job opportunities for a financial accountant can be found in the public and private sectors. The duties of a financial accountant may differ from those of a general accountant, who works for himself rather than directly for a business or organization.
How financial accounting works
Financial accounting uses a series of established accounting principles. The choice of accounting principles to use during financial accounting depends on the regulatory and reporting requirements facing the business. For US public companies, companies are required to perform financial accounting in accordance with generally accepted accounting principles (GAAP).The establishment of these accounting principles aims to provide consistent information to investors, creditors, regulators and tax authorities.
Key points to remember
- Financial accounting follows either accrual accounting or the cash basis of accounting.
- Nonprofits, corporations and small businesses use financial accountants.
- Financial reporting is done through the use of financial statements in five distinct areas.
Financial statements used in financial accounting present the five main classifications of financial data: income, expenditure, assets, liabilities and equity. Income and expenses are recognized and reported in the income statement. They can include everything from R&D to payroll.
Financial accounting leads to the determination of the net result at the bottom of the income statement. Assets, liabilities and equity accounts are carried on the balance sheet. The balance sheet uses financial accounting to report ownership of the future economic benefits of the business.
Exercise method vs cash method
Financial accounting can be done using the accrual method of accounting, the cash method of accounting, or a combination of both. Accrual accounting involves the recording of transactions when the transactions have taken place and the income is recognizable.
Cash accounting involves recording transactions only when exchanging cash. Income is only recorded upon receipt of payment, and expenditure is only recorded upon payment of the obligation.
Financial accounting vs. Management accounting
The key difference between financial and management accounting is that financial accounting aims to provide information to parties outside the organization, while management accounting information aims to help managers within the organization to take decisions.
The preparation of financial statements using accounting principles is most relevant for regulators and financial institutions. Because there are many accounting rules that do not translate well into the management of business operations, different accounting rules and procedures are used by internal management for internal business analysis.
The most common accounting designation demonstrating an ability to perform financial accounting in the United States is the Certified Public Accountant (CPA) license. Outside of the United States, holders of the Chartered Accountant (CA) license also demonstrate their ability. The Certified Management Accountant (CMA) designation demonstrates more of an ability to perform internal management functions than financial accounting.