Financial Accounting

Financial accounting is the branch of accounting concerned with recording an organization's transactions and summarizing them in a standard set of reports for people outside the business. Those reports, the financial statements, show what the organization owns and owes, how much profit or loss it made, how its cash moved and how the owners' stake changed during a period. Investors, lenders, suppliers, regulators and tax authorities all rely on them.

Financial accounting is usually contrasted with managerial accounting, which produces detailed internal reports to help managers plan and control the business, and with tax accounting, which follows tax law rather than accounting standards. Because outsiders depend on financial accounting reports without being able to ask for more detail, the work must follow common rules: generally accepted accounting principles (GAAP) in the United States, or International Financial Reporting Standards (IFRS) in most other countries.

All financial accounting rests on the accounting equation:

Here $\text{Assets}$ are resources the business controls, $\text{Liabilities}$ are obligations to others and $\text{Equity}$ is the owners' residual claim. Every transaction affects at least two accounts so the equation stays in balance, which is the basis of double-entry accounting. If a company borrows $50,000 from a bank, assets (cash) rise by $50,000 and liabilities (loans payable) rise by $50,000. If it then spends $20,000 of that cash on equipment, one asset falls and another rises by the same amount, and equity is unchanged.

Financial accounting also relies on accrual accounting, which records revenue when earned and expenses when incurred, regardless of when cash changes hands. Other long-standing concepts include the going concern assumption, historical cost, consistency, materiality and full disclosure.

The steps of the accounting cycle turn everyday events into published reports:

• Transactions are captured from source documents such as invoices, receipts and contracts and recorded as journal entries.
• Entries are posted to the general ledger, which holds a running balance for every account.
• At period end, a trial balance is prepared, adjusting entries are made for accruals, deferrals and estimates, and the accounts are reconciled.
• The adjusted balances are used to prepare the balance sheet, income statement, statement of cash flows and statement of changes in equity, together with explanatory notes.
• Temporary accounts are closed, and the books are ready for the next period.

In the United States, the FASB writes GAAP for private companies and nonprofits, while the Securities and Exchange Commission has legal authority over the reporting of listed companies and has largely delegated standard-setting to the FASB. The IASB issues IFRS, which more than 140 jurisdictions require or permit. Public companies must have their annual statements examined by an independent auditor, and many private companies do so voluntarily to satisfy banks or investors. Financial accountants are often certified public accountants or hold equivalent qualifications abroad.

Financial accounting looks at the business as a whole, mainly reports past results, follows mandatory standards and is produced on a fixed timetable, typically quarterly and annually. Managerial accounting, including cost accounting, can break results down by product, department or customer, uses budgets and forecasts, and need not follow GAAP. The two draw on the same underlying records, so errors in one tend to show up in the other.

Financial accounting reports are historical and rely on estimates and judgments, such as useful lives, bad debt allowances and fair values. Many valuable resources, including internally built brands, customer loyalty and staff expertise, are not recorded as assets. Different acceptable methods, such as FIFO or LIFO for inventory, can make similar companies look different. Readers therefore study the notes, compare companies carefully and combine the statements with other information.