Financial Accounting | Component of financial Statement | Basic Concepts
Financial accounting is referred to as the accounting concerned with the summary, investigation, and reporting of financial transactions related to a business. This includes the preparation of financial statements available for public use. Stockholders, suppliers, banks, employees, government agencies, business owners, and other stockholders are examples of people interested in receiving such information for decision-making purposes. Financial accountancy is governed by both local and international accounting standards.
Generally Accepted Accounting Principles (GAAP) is the standard framework of guidelines for financial accounting used in any given jurisdiction. It includes the standards, conventions, and rules that accountants follow in recording and summarizing, and in the preparation of financial statements.
Component of Financial Statement
There are three components of financial statements :
Statement of cash flows
The statement of cash flows examines the inputs and outputs in concrete cash within a stated period. The general template of a cash flow statement is as follows: Cash Inflow – Cash Outflow + Opening Balance = Closing Balance
For example: at the beginning of September, Ellen started out with $5 in her bank account. During that same month, Ellen borrowed $20 from Tom. At the end of the month, Ellen bought a pair of shoes for $7. Ellen’s cash flow statement for the month of September looks like this:
- Cash inflow: $20
- Cash outflow:$7
- Opening balance: $5
- Closing balance: $20 – $7 + $5 = $18
Statement of Financial performance
The statement of profit or income statement constitutes the changes in the value of a company’s accounts over a set period (most commonly one fiscal year) and may compare the changes to changes in the same accounts over the previous period. All changes are condensed on the “bottom line” as net income, often reported as “net loss” when income is less than zero.
- Selling, general, administrative expenses (SGA)
- Cost of goods sold
- Depreciation/ amortization
- Earnings before interest and taxes (EBIT)
- Interest and tax expenses
Statement of Financial Position
The balance sheet is the financial statement showing a firm’s assets, liabilities, and equity (capital) at a set point in time, usually, the end of the fiscal year reported on the accompanying income statement. The total assets always equal the total cooperate liabilities and equity. This statement best demonstrates the basic accounting equation Financial Accounting is based on the company’s assets, liabilities, and total expenses.
Assets = Liabilities +Equity
The statement can be used to help show the financial position of a company because liability accounts are extraneous claims on the firm’s assets while equity accounts are internal claims on the firm’s assets.
Accounting standards often set out a general format that companies are expected to follow when presenting their balance sheets. International Financial Reporting Standards (IFRS) normally require that companies report current assets and liabilities separately from non-current amounts. A GAAP-compliant balance sheet must list assets and liabilities based on decreasing liquidity, from most liquid to least liquid. As a result, current assets/liabilities are listed first followed by non-current assets/liabilities. However, an IFRS-compliant balance sheet must list assets/liabilities based on increasing liquidity, from least liquid to most liquid. As a result, non-current assets/liabilities are listed first followed by current assets/liabilities
Current assets are the most liquid assets of a firm, which are expected to be realized within a 12-month period. Current assets include:
- Investee companies – expected to be held less than one financial period
- Cash – physical money
- Accounts receivable – revenues earned but not yet collected
- Prepaid expenses – expenses paid for in advance for use during that year
The stable measuring assumption
The unit of measure in accounting shall be the base money unit of the most relevant currency. This principle also presumes the unit of measure is stable; that is, changes in its general purchasing power are not considered sufficiently important to require adjustments to the basic financial statements.
Historical Cost Accounting, i.e. financial capital maintenance in nominal monetary units, is based on the stable measuring unit assumption under which accountants simply assume that money, the monetary unit of measure, is perfectly stable in real value for the purpose of measuring monetary items not inflation-indexed daily in terms of the Daily CPI and constant real value non-monetary items not updated daily in terms of the Daily CPI during low and high inflation and deflation.
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