What is Financial Accounting? It's Features, Objectives, Uses

Let us see, as to, what is financial accounting and its features, objectives, functions, advantages and limitations. Let us also look into how it works? And also see the other aspects of it

Financial Accounting is the art of recording and reporting financial transactions in the books of accounts using financial statements. The main objective is to maintain a systematic record of business transactions of a business entity to evaluate the financial performance & position for a year and to communicate the results to the users of financial statements.

Financial transaction is an agreement or communication between two parties to exchange goods, services or assets for consideration. Consideration means something in return. Here, consideration could be in cash/kind

This is explained by an example below to understand it easily.

For example, Gama pvt ltd purchased 1000 sofas for $5000 from Zeta pvt ltd.

Meaning, Definition & Scope of Financial Accounting

It is the art of recording, summarizing, analyzing, and reporting business transactions of the enterprises by Financial Statements. These statements include the income statement, balance sheet, and cash flow statement

In 1966, American Accounting Association defined it as, "the process of identifying, measuring, communicating financial information to permit judgements and decisions by users of accounts."

Accountancy refers to a systematic knowledge of accounting. It tells us how to prepare the books of accounts and how to summarize the accounting information to communicate it to the users of information. The users are creditors or suppliers of raw materials and finished goods, debtors or customers, investors, employees, tax authorities to levy a tax, management to take useful decisions, government and their agencies, and the general public. The users are interested in the performance or profit or loss of a business entity.

Objectives of Financial Accounting

The main objective is to maintain a systematic record of transactions of a business entity, to evaluate the profit or loss and assets and liabilities position for any year, and to communicate these results to the users

One of the main objectives is to prepare and present the financial statements before management and stakeholders to reveal financial performance and position. Financial statements include balance sheet, income statement and cash flow statement.

This profit of loss is revealed by the preparation of profit and loss account in trading entities. Non-Trading organizations prepare Income and Expenditure account to know surplus or deficit for any year.

The assets and liabilities position of a business entity is revealed by preparing a Balance sheet.

One of the main objectives is to Prevent & Detect all the frauds, errors, and forgeries happening in the business organisation. It is the responsibility of the management to prevent & detect all the frauds & errors in the business organisation

One of the main objectives would also include decision-making by management.

Characteristic Features of Financial Accounting

The characteristic features are described in simple words in simple steps below.

The Monetary transactions are recorded and Non-monetary transactions are not considered in books of accounts. Only those transactions are recorded that can be measured in terms of money.

One of the main features is the art of recording all the business transactions in chronological order in Journal, the book of primary entry. Then, all the recorded transactions are transferred to Ledger, the book of secondary entry. This process is called Recording & Classifying the business transactions.

All the business transactions are balanced in Ledger and these balances are transferred to Trial Balance, a statement to show that all the debit and credit balances are equal. This process is called, Summarising the business transactions. Finally, we shall transfer all the balances from Trail balance to Financial Statements such as the Balance sheet and Profit & loss statement.

The financial statements show the financial performance & position of the business entity. Financial statements include balance sheet, profit and loss statement, disclosures and cash flow statement. This information would be helpful for investors, creditors, debtors, banks, government, and management to make useful decisions. This process would be called Analysing & Interpreting the Financial Information

The Balance Sheet is a statement of Assets and liabilities which gives information on the financial standings of the business entity. This Balance Sheet helps to know the value of the business entity, its assets & liabilities, capital & reserves, Net worth and capital employed.

Similarly, the Profit & Loss Statement helps to know financial performance such as profit made or loss incurred by the business entity. This profit and loss statement gives the pictures of sales made, purchases made, expenses incurred, incomes earned, profit or loss incurred during the financial period.

We have a Cash Flow Statement that gives the cash position and Cash flow made during the period. Cash flow is cash inflow and cash outflow occurred during the period. Cash flow depicts Net cash flow from Operating Activities, Net cash flow from Investing Activities, Net cash flow from Financing Activities. This statement helps to know the Beginning cash balance, Closing cash balance. This probably would help us to manage the cash and cash equivalents of the business entity.

It is the language of business. It means all the business transactions are recorded as per the applicable accounting standards, principles, and policies that will be understandable by Accounting Professionals. It is widely accepted across the globe as these standards, principles, and policies are mostly the same across all countries.

Here, the managers, bookkeepers, professionals communicate the financial information to the users of financial statements using financial statements such as balance sheets, profit and loss statements. cash flow statements. This is the communication on the financial performance and financial position of the business organization to the users of financial statements to make decisions.

Historical Nature transactions are considered that means transactions that have taken place in history. For example, machinery purchased for cash is recorded in books.

Preparing a Profit and loss account and balance sheet is a legal requirement in the case of a company form of organization. It discloses the Performance in terms of profitability of the business as a whole

The balance sheet also called a position statement is prepared to disclose the financial position of a business enterprise. It shows the assets and liabilities of a business organisation

It follows the Accounting Principles and standards to finalize the accounts. Thus, it is performed as per the applicable standards, principles, policies to ensure that financial statements prepared are free from misstatements, frauds, errors. This ensures financial statements are prepared and presented as per the applicable laws, principles of the state.

It Communicates the results to the users of information. The information contained in the financial statements is revealed to the users of financial statements to make useful decisions and judge the financial performance & financial position of the business entity. The users of financial statements would include suppliers, debtors, management, government, investors, shareholders, banks, credit rating agencies, creditors, employees. The financial statements help the users of financial information to make decisions. For example, healthy financial statements induce banks, creditors, suppliers to give loans and advances to the business entity. It also encourages the credit rating agencies to give high ratings to the entity.

One of the main features is to Prevent & Detect all the frauds, errors, and forgeries happening in the business organisation. It is the responsibility of the management to prevent & detect all the frauds & errors in the business organisation. Management can also implement internal audits to check and examine the internal control systems. This internal audit helps management to ensure that all the internal control systems are appropriate, sufficient, existence. This internal audit helps to ensure that all the internal control systems are functioning smoothly and efficiently. This also helps to reduce fraud, errors, forgeries etc.,

A statutory Audit is performed as per the laws of the state every year, whereas an internal audit is performed to check the internal control systems of the business organization. The audit is also performed as per the applicable auditing standards and regulations of the state

Auditing is an independent examination of the financial information contained in the financial statements of any organisation with a view to express an opinion on financial statements by the Auditor. The audit is generally performed to examine all the information contained in books of accounts and financial statements and to express an opinion on financial statements.

The Important Functions of Accounting

The main three important functions are:

To produce the General Purpose Financial Statements such as balance sheet income statement and cash flow statement

To produce the information which is used by the management for helpful decision making

The important function is planning and performance evaluation

What are the functions of Accounting?

What are the objectives of Accounting?

The Importance & Advantages of Accounting:

The importance is described as follows:

It helps to track Income and Expenditure of business activities

It helps to identify the Assets and liabilities as on a particular date

It helps to record the business transactions in books of accounts

It helps to prepare the Balance Sheet and Profit & loss statement

It helps to adhere to statutory compliance and legal requirements

It also helps to adhere to accounting principles and ensures the comparison of results with competitors

It helps in providing useful information to the management in the decision making

Limitations of Financial Accounting are:

Financial statements are prepared based on Historical costs. Thus balance sheet may be misleading if there is a fluctuation in historical cost and market value of assets and liabilities recorded

Financial statements may not be comparable if the business entities use different accounting policies and practices

Information contained in the financial statements could be misleading and false if management wants to disclose the healthy financial performance and position even if it making losses.

Accounting is a cumbersome and technical subject that is not easy to understand for a common man unless he possesses sound knowledge of the subject.

Cost controls are not possible as they are known at the end of the year after preparing financial statements

It doesn't record the changes in price fluctuations and does not consider the market value of assets in the balance sheet

How The Accounting Works

Accounting uses Accounting Principles. The U.S. public companies and business entities are required to perform accounting as per the generally accepted accounting principles (GAAP).

These principles provide consistent and reliable information to investors, creditors, regulators, and tax authorities. These principles help in comparison of results thereof.

What are the Accounting Principles?

Bookkeeping

Bookkeeping is concerned with record keeping and maintaining the records of transactions in books of accounts which is often clerical in nature.

The main objective of bookkeeping is to maintain the systematic record of transactions in the books of accounts. This work is performed by junior staff. The job of a bookkeeper is clerical in nature and routine work.

What is Bookkeeping?

What are the main objectives of Bookkeeping?

What are the Features of Bookkeeping?

What are the functions of Bookkeeping?

The Two Methods of Bookkeeping:

There are two methods of bookkeeping. They are the Double Entry System and the Single Entry System.

Under the Double Entry System, transactions are recorded as Debit and Credit. Each transaction has a dual aspect which is debit and credit. This is a scientific and reliable system mostly followed across the world.

Under the Single entry system, only one aspect of the transactions is recorded. Mostly, personal accounts and cash balance registers are maintained. This is an unscientific, unreliable system that is not used or rarely used.

What is Double Entry System?

What is Single Entry System?

Accrual basis and Cash basis

Accounting is performed using the cash basis or accrual basis method or both methods. Cash basis means transactions are recorded only when cash is received or paid. The accrual basis means transactions are recorded when expenses are incurred or income accrued during the year irrespective of the cash element involved in it.

Other Aspects

The other aspects to be considered are Journal, Ledgers, Trial Balance, Balance sheet, Profit and loss statement, and Cash flow statement

Journal

It is the book of primary entries to record journal entries in chronological order regarding day-to-day business transactions.

A Journal is called a book of prime entry or a book of original entry because all the business transactions are first recorded in the journal. The process of recording a transaction in the journal is called Journalising. An entry made in the journal is a journal entry. Each journal entry is recorded in chronological order or date-wise. Each journal entry has Narration which is a brief explanation of transactions recorded.

What is Journal?

Ledgers

Ledgers are books of secondary entry where the journal entries are posted from journal to ledger in ledger accounts. The next step after recording a transaction in a journal is to transfer these transactions to ledger accounts in the ledger. ledger is a principal book that contains all the accounts. ledger may be kept in the form of bound books, loose-leaf sheets, punched card sheets, floppy diskettes. ledger provides all the information of all accounts in one book like items of expenses, incomes, assets, liabilities. It helps in preparing trial balance, profit and loss account, balance sheet.

What is Ledger?

Trial balance

The Trial balance is a statement that is prepared after the ledger where debit and credit balances are equal. Trial balance is prepared to ensure the arithmetical accuracy of ledger accounts. It is a statement, not an account that has a total of debit balances and credit balances. The total of debit balances is equal to the total of credit balances in the trial balance. trial balance helps in preparation of profit and loss a/c, balance sheet.

What is Trial Balance in Accounting?

Profit and loss account or Income statement

A profit & loss account or Income statement is prepared to know the profit or loss of the business entity. This account is a nominal account that has all direct & indirect expenses and incomes like sales, purchases, salary paid, rent paid, etc.,. This account reveals profit made or loss sustained in a year. Profit & loss a/c is prepared at the end of the year to know the performance of an entity.

What is Profit and loss statement?

Balance sheet or Position statement

The Position statement or Balance sheet shows the assets and liabilities of the company. This is a statement of assets and liabilities. The asset is a resource that yields economic benefits and liability is the debt of the business entity. Assets include fixed assets and current assets like building, furniture, cash, debtors, stock. liabilities are the debts like short term & long term borrowings and creditors.

What is Balance Sheet?

Cash flow statement

This is the statement prepared to know the cash inflow and cash outflow of the business entity. Cash flow may be cash flow from operating activities and cash flow from investing activities and cash flow from financing activities. A Cash flow statement helps to manage the cash effectively and efficiently. It helps to ascertain cash inflows or cash receipts and cash payments or cash outflows to manage cash effectively. This statement helps in cash flow analysis

What is Cash Flow Statement?

Conclusion

Thus, now we can conclude, as to, what is the Financial Accounting? It's Meaning, Definition, Features, Objectives, Uses and how it plays a vital role in any business entity to know the profitability, performance, assets & liabilities position in any year. We also learned the other topics like Double Entry System and Single Entry System, Journal, Ledger, Trial Balance, Profit and loss statement, Balance Sheet, Cash flow statement.

What are the objectives of the Journal?

What are the 9 different types of Journal Entries?

What are the 10 types of Journal?

What are the two main methods of bookkeeping?

What are the different fields and branches of Accounting?

Who are the users of financial statements?

What are Subsidiary Books? Its features, types, objecctives

What are Ledgers?

What are the functions of bookkeeping?

What are the features of bookkeeping?

What are the objectives of bookkeeping?

What is Trial Balance?