Behind every good businessman, there is a great accountant.
Accountants are indispensable to the business. Whether you prepare financial statements for the company or maintain invoice records, or just compile financial data, or even conduct a financial audit, no company or organization can function without the contribution of the accountancy domain. While the accounting sector is vast, there are a few types that are critical to the functioning and financial wellness of a firm.
Here is a sneak peek into accounting and its key terms.
What is Financial Accounting?
Financial accounting is the process of tracking and accurately documenting financial records in a company. This process allows you to account for an organization's revenues, receivables, and expenses. They are finally consolidated and drafted in the financial statement, to be presented to the management for decision-making regarding company strategies.
Definition Of Financial Accounting
International Financial Reporting Standards (IFRS)
Financial accounting, according to the International Financial Reporting Standards (IFRS), is the process of identifying, measuring, recording, and communicating financial information about an organization to its stakeholders. The stakeholders include shareholders, creditors, investors, and other interested parties who rely on the information to make informed decisions about the organization.
International Accounting Standards (IAS)
Financial accounting, according to the International Accounting Standards (IAS), is the process of identifying, measuring, recording, and communicating financial information about an organization to its stakeholders. The stakeholders include shareholders, creditors, investors, and other interested parties who rely on the information to make informed decisions about the organization.
Why is Financial Accounting Important?
This process is extremely important to allow businesses to meet legal compliances and helps companies adhere to fiscal and statutory requirements as mandated by domestic laws. For business owners, this is the key to informed and effective decision-making. A financial accountant will provide in-depth analysis through income, cash, and expenditure statements, which in turn, will facilitate efficient resource allocation.
Financial accounting is also important to understand the profit and loss situation in a company.
Golden Principles Of Financial Accounting
The following are some golden principles of financial accounting that guide the preparation of financial statements:
- Accrual principle: According to this principle, revenues and expenses should be recorded in the accounting period in which they are earned or incurred, regardless of when the cash is received or paid. This principle helps to match revenues and expenses accurately, giving a more accurate picture of a company's financial performance.
- Going concern principle: This principle assumes that a business will continue to operate in the foreseeable future, and its assets and liabilities will be used in the normal course of business. This principle enables the financial statements to reflect the long-term perspective of the business.
- Consistency principle: This principle requires that once an accounting method is adopted, it should be consistently applied in all subsequent periods, unless there is a valid reason to change it. This ensures that financial statements are comparable over time.
- Materiality principle: This principle requires that financial statements should disclose all material information that could influence the decisions of users of the financial statements. Information is considered material if it could impact a user's decision-making process.
- Cost principle: According to this principle, assets should be recorded at their historical cost, which is the amount paid or payable to acquire them. This principle ensures that the balance sheet reflects the amount invested in the assets.
- Objectivity principle: This principle requires that financial transactions should be supported by objective evidence, such as invoices, receipts, and bank statements. This ensures that the financial statements are reliable and verifiable.
- Full disclosure principle: This principle requires that all material information should be disclosed in the financial statements, including any significant events or transactions that could impact the financial statements. This principle ensures that the financial statements are complete and transparent.
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3 Golden Rules of Accounting
- Debit the receiver, credit the giverThis rule applies to transactions involving assets. When an asset is received, it is recorded as a debit entry, and when an asset is given, it is recorded as a credit entry. For example, when a company purchases equipment, the equipment account is debited, and the cash account is credited.
- Debit what comes in, credit what goes outThis rule applies to transactions involving liabilities and equity. When a liability is incurred, it is recorded as a credit entry, and when a liability is paid, it is recorded as a debit entry. Similarly, when equity is received, it is recorded as a credit entry, and when equity is distributed, it is recorded as a debit entry. For example, when a company issues shares to raise capital, the cash account is debited, and the equity account is credited.
- Debit expenses, credit incomeThis rule applies to transactions involving expenses and income. When an expense is incurred, it is recorded as a debit entry, and when income is earned, it is recorded as a credit entry. For example, when a company pays rent, the rent expense account is debited, and when the company sells goods, the sales revenue account is credited.
These rules form the basis of double-entry bookkeeping, which ensures that all transactions are recorded accurately and that the accounting equation (assets = liabilities + equity) is always in balance. By following these rules, accountants can create reliable financial statements that provide an accurate picture of a company's financial performance.
Objectives of Financial Accounting
The basic premise of which financial accounting functions is that it should help the company's finance stay in a healthy shape. With this as a starting point, a financial accountant prepares a company's financial statement summarizing the financial accounts for a specific period of time. These financial statements contain three important components, namely:
- Income statement that reflects the company's profit and loss account, and its revenue and expenses over a period of time.
- Balance sheet or the statement of the company's assets, liabilities, and stockholders' equity.
- Statement of cash flows that contains information about each and every cash inflow into and cash outflow out of the company over a period of time.
Financial accounting serves several important purposes:
- It provides critical information on financial transactions to investors and creditors.
- The accuracy and efficiency of financial reports prepared by financial accountants can potentially increase investment interest.
- The internal management team uses the financial statements to decide on budget and cost controls, as well as performance management processes.
- Using trends, ratios, and industry comparisons, investors analyze financial reports to gather important business information.
Also, learn about the double-entry bookkeeping method used by financial accountants.
What is Cost Accounting?
Cost accounting is a method that records and analyzes the cost incurred per unit, during the production of goods.
Accountants are constantly learning on the job. They have to or else businesses would collapse. Cost accountants, for example, have to constantly keep up with market trends and analyses, build their know-how about changing accounting standards, all this while keeping a tab on the flow of production to accurately gather cost information in each step.
You can prepare cost accounting statements using accounting software.
Difference Between Cost Accounting and Financial Accounting
An introduction to the world of accounting would make you feel that all types of accountants are involved in similar reporting processes and value-added roles. But there are important differences. Below are the primary dissimilarities between cost and financial accounting:
- Nature of Accounting: While financial accounting records all types of transactions related to company finance, cost accounting is only concerned with documenting production-related costs.
- Nature of Costs: Financial accounting depends on historical data for preparing its reports and statements. Cost accounting, however, involves both historical as well as forecasted data. The latter can include current orders that are yet to be paid for.
- The objective of Accounting: Cost accounting has a very specific task of recording all production costs only. Financial accounting, of course, is a much larger domain. It has to track all sorts of business transactions in order to assess the financial well-being of a company.
- Purpose of Accounting: While financial statements are meant for a larger audience, which includes external company stakeholders like investors or tax authorities, cost accounting reports are shared with an internal management committee, which uses them to make business decisions.
- Type of Reports: A financial statement includes a profit and loss account, balance sheet, and cash flow statement. A cost analysis report includes the components of variance analysis, marginal cost, and break-even analysis.
- Compliance: Financial accounting is mandated by law, and as such the reports need to be made public. There is no such need for cost accounting.
- Frequency of Reporting: Cost accounting reports are prepared on an ad hoc basis, as deemed important by management. Financial accounting reports have to be filled at the end of a fiscal year, by law.
- Type of Information: While financial accounting only records monetary information, there might be non-monetary elements in cost accounting.
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What is Management Accounting?
Management or managerial accounting is the practice of identifying, measuring, analyzing, interpreting, and communicating financial information to managers for the pursuit of an organization's goals.
Managerial accountants rely on reports furnished by cost accountants and financial accountants to arrive at trend analysis, which they use to make recommendations to management executives. These recommendations are considered for important decision-making related to:
- Budget controls.
- Performance management.
- Innovation.
- Scale and expansion.
- Shutting down a business.
- New product launch.
Note that cost accounting is a sub-set of managerial accounting that focuses specifically on production costs. Management accountants use this information to be able to reduce costs and increase efficiency in production.
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Difference Between Financial Accounting and Management Accounting
As the financial accounting definition suggests, it is a process that captures all finance-related data of an organization. Managerial accounting, on the other hand, analyses this data to provide financial advice to businesses. Below is a comparison between the two concepts to highlight their differences:
- The objective of Accounting: Financial accounting reflects the financial wellness of a firm, while management accounting uses that information to set business goals and drive decision-making.
- Reporting: Management accounting, like cost accounting, is meant for an internal purpose, and as such do not get reported outside the company. This is just the opposite in the case of financial accounting.
- Compliances: Unlike financial accounting which is bound by law and legal statutes, managerial accounting does not need to adhere to any such compliances or rules.
- Components of Reporting: Financial statements are meant to give an overview of the entire company's finance. On the other hand, management accounting concerns itself with individual departments. It ensures performance and budget controls are adhered to by different departments so that it contributes to the overall well-being of the company.
- Type of Data: Financial accounting uses previous data from past transactions. Management accounting, by definition, is a futuristic process and thus used for forecasting.
- Standard Formats: Management accounting being an internal process, does not follow any prescribed formats and can be presented as per the internal requirements. Financial statements, on the other hand, of course, have to follow certain standards for reporting.
- Accounting Principles and Standards: This is a significant difference between the two types of accounting. Financial accountants have to abide by the Generally Accepted Accounting Principles (GAAP), but management accountants have no such obligations.
You can learn more about the basic accounting concepts to build more clarity.
Career Opportunites In Financial Accounting in India
India is one of the fastest-growing economies in the world, and the demand for financial accounting professionals is on the rise. There are many career opportunities in financial accounting in India, including:
- Chartered Accountant (CA): The CA qualification is highly respected in India and is recognized globally. A CA can work in various fields, such as accounting, auditing, taxation, and consultancy.
- Certified Public Accountant (CPA): The CPA qualification is recognized globally and is highly valued in the finance and accounting industry. CPAs can work in various fields, such as public accounting, corporate accounting, and government accounting.
- Cost Accountant: Cost accountants work in the field of cost accounting, which involves analyzing costs and determining the cost of producing goods or services. Cost accountants can work in various industries, such as manufacturing, construction, and healthcare.
- Financial Analyst: Financial analysts analyze financial data and provide insights to help companies make informed business decisions. Financial analysts can work in various fields, such as investment banking, equity research, and corporate finance.
- Tax Consultant: Tax consultants help individuals and businesses comply with tax laws and regulations. Tax consultants can work in various fields, such as public accounting, corporate accounting, and government accounting.
- Accounting Manager: Accounting managers oversee the accounting and finance functions of a company. They are responsible for financial reporting, budgeting, and financial analysis.
- Auditor: Auditors examine financial statements and records to ensure they are accurate and comply with accounting standards and regulations. Auditors can work in various fields, such as public accounting, internal auditing, and government auditing.
These are just a few of the many career opportunities in financial accounting in India. With the growing economy and increasing demand for financial accounting professionals, the opportunities are endless. A strong education in accounting, combined with professional certifications, can help individuals pursue a successful career in financial accounting in India.
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