The Environment of Financial Accounting
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The Environment of Financial Accounting

Financial accounting can be defined as the process to prepare financial reports on the enterprise to be used by both internal and external parties. Users of these financial reports include investors, creditors, managers, unions, and government agencies. Financial statements are prepared and presented for external users. These statements provide the firmÂ’s history quantified in money terms. Most of financial statements generally include: (1) the balance sheet; (2) the income statement; (3) the statement of cash flows, and (4) the statement of ownerÂ’s or stockholderÂ’s equity. In addition, note disclosures are an integral part of each financial statement.

Financial Statements and Financial Reporting

Financial accounting can be defined as the process to prepare financial reports on the enterprise to be used by both internal and external parties. Users of these financial reports include investors, creditors, managers, unions, and government agencies.

Financial statements are prepared and presented for external users. These statements provide the firm’s history quantified in money terms. Most of financial statements generally include: (1) the balance sheet; (2) the income statement; (3) the statement of cash flows, and (4) the statement of owner’s or stockholder’s equity. In addition, note disclosures are an integral part of each financial statement.

Some financial information is better provided, or can be provided only, by means of financial reporting other than formal financial statements such as news releases, management’s forecasts, prospectuses, reports filed with government agencies, descriptions of an enterprise’s social or environmental impact. Such information might be required by authoritative pronouncement, regulatory rule, or custom, or because management wishes to disclose it voluntarily.

Accounting and Capital Allocation

Due to resources are limited, people attempt to use them effectively. Markets, free enterprise determine whether a business become successful and thrive. This fact places the accounting profession to measure performance accurately and fairly on a timely basis, so that the right managers and companies are able to attract investment capital. For instance, accounting enables investors and creditors to compare the income and assets of such companies so that they can assess the relative return and risks concerning investment opportunities and resources more effectively.

The financial information of such company enables users to get information concerning capital allocation decision’s company. Investors and creditors use financial reports to make their capital allocation decisions. The process of determining how and at what cost money is allocated among competing interests.

The Challenges Facing Financial Accounting

Financial statements and related disclosures have captured and organized financial information in a useful and reliable manner. However, much still needs to be done as following : (1) Non-financial measurements : financial reports in the late 1990s failed to provide financial measures such as customer satisfaction index, backlog information, reject rates on goods purchased; (2). Forward-looking information : financial reports failed to provide forward-looking information needed by present and potential investors and creditors; (3). Soft Assets : financial reports focused on hard assets (inventory, plant assets) but failed to provide much information on a company’s soft assets (intangibles) such as Microsoft’s know-how, GAP’s brand image; (4). Timeliness: financial statements were prepared only quarterly, and audited financials were provided annually. Little to no real-time financial statement information was available.

Objectives of Financial Reporting

Financial reporting should provide information concerning: (1). information that is useful in investment and credit decisions; (2). information that is useful in assessing cash flow prospects, and (3). information about enterprise resources, claims to those resources, and changes in them.

“Assessing cash flow prospects” indicates that cash basis is preferred over the accrual basis of accounting. Information based on accrual accounting generally provides a better indication of an enterprise’s present and continuing ability to generate favorable cash flows than does information limited to the financial effects of cash receipts and payments. As you know that the objective of accrual basis accounting is to ensure that events that change an entity’s financial statements are recorded in the periods in which the events occur, rather than only in the periods in which the entity receives or pays cash.

The Need to develop Standards

The main problem in setting accounting standards is “Whose rules should we play by, and what should they be?” To meet these needs, a single set of general-purpose financial statements is prepared. These statements are expected to present fairly, clearly, and completely the financial operations of the enterprise. As a result, the accounting profession has attempted to develop a set of standards that are generally accepted and universally practiced. This common set of standards and procedures are called GAAP (Generally Accepted Accounting principles). Although these principles and practices have caused both debate and criticism, most members of the financial community recognize them as the standards that over time have proven to be most useful.

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Comments (2)

well done

well written and researched

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