Financial Accounting For Dummies
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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. 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.

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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.

Standing on their own, the financial statements contain valuable information about a company. However, a user has to see all three financial statements interacting together to form an opinion approaching reliability about the company. Here’s a quick explanation of each financial statement:

  • 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. You’ll find all revenue, expenses, gains, and losses for a company 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 company’s financial position. It lists the company’s assets, liabilities, and equity. Assets are resources a company owns such as cash or inventory. Liabilities are claims against the company’s assets, such as unpaid bills. And equity is the difference between the two, showing 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.

Financial Accounting Key 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 of their own—usually these decisions revolve around whether the user wants to invest in or loan a company money.
  • 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 type of accounting transactions.
  • Generally accepted accounting principles (GAAP): The rules financial accountants must 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 statement can compare one company to another.

Just about everything you learn and do in a financial accounting class harkens back to the way accounting principles tell accountants how to do their job. For example, these principles determine how to expense assets, record revenue, and value inventory. The Financial Accounting Standards Board (FASB) is the private sector body that established GAAP for all non-governmental entities.

  • American Institute of Certified Public Accountants (AICPA): The national professional organization for all certified public accountants.
  • Certified Public Accountant (CPA): The professional license required to work as 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 the company accounting transactions. The accounts are numbered in order, usually starting with 1,000 (assets) continuing through to 9,000 (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 four methods of depreciation based on time: straight-line, declining balance, sum-of-the-years’ digits; and units-of-production. The last is based on actual physical usage of the fixed asset.
  • Methods of Accounting: The rules a company follows to report transactions:
    • Cash method: Revenue is recorded when it is received, and expenses are recorded when they are paid. The effects of accounts receivable and accounts payable are eliminated.
    • Accrual method: The opposite of cash, revenue is recorded when it is earned and realizable. Expenses are recorded when they are incurred. Accounts receivable and accounts payable are definitely a part of this equation!
  • 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 its 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.
  • Impairment Loss: An impairment loss takes place when a company makes the judgment call that the carrying value of an asset on the company balance sheet is less than fair value, which is what an unpressured person would pay for the asset in an open marketplace. If the impairment loss is not recoverable, under U.S. GAAP, the company must adjust the books to reflect this lessening in value.

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 corporate 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 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 required to work as 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).

About This Article

This article is from the book:

About the book author:

Maire Loughran is a self-employed certified public accountant who has prepared compilation, review, and audit reports for 15 years. She is also a university professor of undergraduate- and graduate-level accounting classes.

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