What Are the Objectives of Financial Accounting?

Financial Accounting: An Overview

Financial accounting is the process by which an organization’s revenue, receivables and expenses are collected, measured, recorded and finally reported in financial statements.

The objectives of financial accounting are to:

• Accurately reflect business and financial activity
• Help companies meet legal, fiscal and statutory requirements
• Present financial accounts to business owners
• Allow for in-depth financial analysis
• Facilitate efficient resource allocation
• Allow third parties, such as auditors, investors, and financial analysts, to assess the activities and value of a company

Broadly, financial accounting is an important tool that companies can use to avoid financial risks and achieve success.

Structuring Financial Accounting

Companies have two basic ways that they can structure their business’s accounting policy.

Publicly traded companies must use the accrual accounting method which is standardized by generally accepted accounting principles (GAAP).

The accrual method reports revenues as they are accrued as opposed to when they are received. Expenses are reported as they are incurred rather than when they are paid.

Many private companies use GAAP to guide their accounting but they are not required to do so. Private companies also have the option to use the cash accounting method.

Key Takeaways

• The objectives of financial accounting include recording business and financial activities for analysis by management and third parties, such as investors and investment analysts.
• Companies that review their financial statements throughout the year can see their progress and make informed decisions about current and future operations.
• Shareholders and creditors have financial stakes in companies and great interest in their financial statements.
• Responsible financial accounting promotes trust in companies.
• It helps a company meet its tax and compliance obligations, as well.

Understanding Financial Accounting

In a practical sense, the main objective of financial accounting is to accurately prepare a business’ financial accounts for a specific accounting period.

Once the company’s financial activities are recorded, they can be reported by its financial statements. Primary financial statements include the income statement, the balance sheet and the statement of cash flows.

A company’s financial statements serve several purposes:

1. They are used internally by management to manage both the current operations and future activities of the firm.
2. They provide important information to shareholders and creditors, each of which has a financial stake in a company.
3. In addition, investors and analysts use a company’s financial statements to analyze, through the use of financial ratios and other analytic tools, how successful the company has been at earning revenue, building profits, and increasing its value.

The Benefits of Financial Accounting

The work involved in financial accounting has enormous benefits for a company, its stakeholders, and potential investors. Here are some of them:

1. It provides the foundation for accurate financial statements that are available to the public. Supposedly, anyone seeking a transparent view of a company’s financial health can turn to its financial statements.
2. It can build trust for management, investors, creditors, and others in how a company operates and its value.
3. That transparency and trust can open up access to credit opportunities and attract more investors.
4. Data offered by financial accounting can help companies make their operations more effective, increase revenues, cut costs, and build profits.
5. Reliable financial accounting enables companies to meet their tax and compliance obligations.
6. By studying their financial statements, companies can detect and reduce instances of fraud, and other financial risks.
7. Consistent financial accounting can help to ensure a company’s ongoing financial stability and longevity.

Important

Formal financial accounting standards became a focus after the 1929 stock market crash and during the Great Depression when the Securities Act of 1933 and the Securities Exchange Act of 1934 mandated that public companies had to be audited to ensure the accuracy of their financial statements.

Financial Reporting Standards

In the United States, financial reporting standards are set forth by the Financial Accounting Standards Board (FASB) and required under GAAP for publicly traded companies.

The FASB is contracted by the Securities and Exchange Commission (SEC) to control the approved methods and applications of financial accounting.

Following these reporting standards makes it easier for individuals to understand the financial statements of various companies, as they are presented in the same manner and therefore easier to follow.

Financial accounting is normally performed by those individuals who have studied the methods, concepts, history, and laws related to its practice. In the U.S., these individuals are referred to as certified public accountants (CPA).

The SEC requires that public companies annually report their financial statements and that this reporting is done by an impartial third party, which is where CPAs come in to play.

This ensures that the financial statements have been properly created under all required policies.

The American Institute of Certified Public Accountants (AICPA)

The American Institute of Certified Public Accountants (AICPA) is an industry-leading organization in the area of financial accounting. It has over 597,000 members worldwide.

The AICPA is a leading source of research and alerts on topics of interest in the accounting profession. The AICPA is also responsible for developing and grading the Uniform CPA Exam.

In 1973, the AICPA released a study entitled “The Objectives of Financial Statements.” The study was pivotal for the accounting industry, with objectives adopted by the FASB.

The study was also released the same year that the FASB was created, which replaced the work of the AICPA in developing accounting standards for the accounting industry.

Today financial accounting standards and objectives can be found through the FASB’s website.

Who Uses a Company’s Financial Accounting?

The management of the company itself uses its financial accounting. So do lenders, vendors, investors, regulatory agencies, and auditors.

What Financial Statements Report a Company’s Financial Accounting?

Financial statements can differ from company to company. But four main statements are the balance sheet, the income statement, the statement of cash flows, and the statement of retained earnings (also called the statement of shareholder’s equity).

How Do I Know That Financial Accounting Is Correct?

A company’s financial accounting is governed by recognized standards and principles of accounting, such GAAP. Usually, it’s prepared by one or more CPAs who uphold proper accounting standards. And financial statements that report the financial accounting of public companies are audited for truth and accuracy. However, financial accounting can be manipulated to deceive auditors and the public.

The Bottom Line

Financial accounting is meant to help companies track and monitor their revenues, income, and expenses so that they can run their businesses more effectively for their own benefit and that of other stakeholders.

Accurate, transparent financial accounting allows for better decision-making by company management, potential and existing investors, vendors, creditors, auditors, and regulators.