Financial Accounting For Dummies
Financial accounting is the process of preparing financial statements for a business. The three key financial statements are the income statement, balance sheet, and statement of cash flows, and they serve two broad purposes: to report on the current financial position of the company, and to show how well the company performs over a period of time. Investors, creditors, and other interested parties rely on such information to find out whether a business is making or losing money, and they depend on financial accountants to help ensure that these statements are materially correct and understandable.
Accounting Details in Different Kinds of Financial Statements
The three key financial statements are the income statement, balance sheet, and statement of cash flows. All three record the same daily accounting transactions occurring in a business, but each presents the facts slightly differently.
Income statement: The income statement shows a company’s results of operations. Using this statement, you can see if a business has income or loss during the financial period. All the company’s revenue, expenses, gains, and losses appear on this financial statement.
Balance sheet: The balance sheet shows the health of a business from the day it started operations to the specific date of the balance sheet report.Therefore, it reflects the business’s financial position. The balance sheets lists the company’s assets (resources such as cash and inventory), liabilities (claims against the assets), and equity (the difference between assets and liabilities, which reflects the owners’ total investment in the business).
Statement of cash flows: This financial statement reveals how a company is bringing in and spending its cash. Investors and potential creditors use this information to gauge whether a business has sufficient cash flow to pay dividends to its investors or repay loans made by its creditors.
Key Financial Accounting Terms and Definitions
In a financial accounting class, and on the job as an accountant, you need to know some jargon. Following is a glossary of words and phrases crucial to the accounting profession.
Users of financial accounting information: The people or businesses that need to see the accounting transactions organized into financial statements to make educated decisions (such as whether to invest in or loan money to a company).
Characteristics of financial information: Financial accounting information has to be
Relevant: The information directly relates to the facts you’re trying to evaluate or understand.
Reliable: You can depend on the information to steer you in the right direction.
Comparable: The quality of the information is such that users can identity differences and similarities between companies they are evaluating.
Consistent: The company uses the same accounting treatment for the same types of accounting transactions.
Generally accepted accounting principles (GAAP): The rules financial accountants have to follow when handling accounting transactions and preparing financial statements. Financial accountants can’t just throw numbers on the income statement, balance sheet, or statement of cash flows; a level playing field must exist between businesses so that the individuals reading the financial statements can compare one company to another.
Just about everything you learn and do in a financial accounting class harkens back to the way GAAP tell accountants how to do their job. For example, GAAP determine how to expense assets, record revenue, and value inventory. The Financial Accounting Standards Board (FASB) is the private-sector body that establishes GAAP for all non-governmental entities.
American Institute of Certified Public Accountants (AICPA): The national professional organization for all certified public accountants (CPAs).
Certified Public Accountant (CPA): The professional license for accountants. To become a CPA, you must first complete a certain number of accounting and business-related courses in college. You then must take and pass the Uniform Certified Public Accountant exam, which is written and scored by the AICPA.
Chart of accounts: A list of all accounts set up to handle a company’s accounting transactions. The accounts are numbered in order, usually starting with 1000 (assets) and continuing through to 9000 (miscellaneous gains and losses).
General ledger: The record of all financial transactions taking place within a business during a particular accounting cycle, ordered by chart of account number.
Depreciation: The method used to systematically move the cost of an asset from the balance sheet to the income statement over the course of the asset’s useful life. Financial accounting uses three methods of depreciation based on time: the straight-line, declining balance, and sum-of-the-years’-digits methods. A fourth method, units-of-production, is based on actual physical usage of the fixed asset.
Stockholders’ equity: The claim that shareholders of the corporation have to the company’s net assets. Stockholders’ equity has three common components:
Paid-in capital: Money the shareholders in the corporation invest in the business
Treasury stock: A company’s own stock, which it buys back from other investors
Retained earnings: The company’s total net income or loss from the first day it’s in business to the date on the balance sheet
Contingency: A liability that exists because of a circumstance (such as a lawsuit) that may cause a business loss in the future depending on other events that have yet to happen (such as the outcome of a trial) and indeed may never happen.
Business combination: The process of combining two or more businesses — also known as mergers and acquisitions (M&A). Business combinations come in two different forms:
Asset acquisition: One company acquires the net assets of another company.
Stock acquisition: The acquiring company purchases an investment in another company (which is now a subsidiary).
Working toward a Financial Accounting Career
As a financial accountant, you may choose to work in public accounting (doing jobs for multiple business clients) or private accounting (performing accounting work only for your employer). You can also choose to specialize in governmental accounting, not-for-profit accounting, forensic accounting (which relates to legal proceedings or testimony), or other specific fields.
No matter what your professional goals are, certain coursework and certifications — as well as a handful of crucial skills and traits — can help ensure your success.
Undergraduate courses: For a bachelor’s degree in accounting, you probably need about 120 credit hours total. In addition to general education requirements, you take core business classes such as Financial Accounting, Managerial Accounting, Business Law, Principles of Management, Economics, Finance, and Marketing. You also take more specific accounting courses, such as Intermediate Accounting, Federal Income Tax, Accounting Information Systems, and Auditing.
Graduate courses: To earn a Masters in Business Administration (MBA) degree, you probably need to take 30 credit hours of graduate-level courses. If you plan to sit for the Certified Public Accountant (CPA) exam, be sure to map your MBA courses to meet the requirements to sit for the exam. Check out Steps to Become a CPA at the American Institute of CPAs for guidance.
CPA exam: The CPA is the professional license for accountants. To become a CPA, you must first complete a certain number of accounting and business-related courses in college. You then must take and pass the Uniform Certified Public Accountant exam, which is written and scored by the American Institute of Certified Public Accountants (AICPA).
Other licenses: In addition to pursuing your CPA license, you may decide to add more initials after your name by pursuing a designation such as Forensic CPA, Certified Fraud Examiner (CFE), or Certified Management Accountant (CMA).
Essential skills: Successful financial accountants bring great communication skills (both oral and written) to the job, as well as decent computer skills.
Personality traits: The best financial accountants have a desire to work independently, even when they’re part of a team; a love for research, detail, and logic; and the willingness to listen and learn about a variety of industries.