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Accounting

The Nature Of Financial Accounting

Financial accounting is concerned with the recording, classification, summarising, analysis, interpretation and communication of business transaction information through accounts and financial statements. Financial accounting is governed by the International Financial Reporting Council through sets of rules including the International Financial Reporting Standards (IFRS) and International Accounting Standards (IAS). The standard of information required and who requires it depends on the structure of the business as well as it’s size. The bulk of financial accounting information is meant to be used by external leaseholders that include but are not limited to owners, creditors, government authorities, communities and institutional investors. To best understand the nature of financial accounting we can look at its various functions and the impact on the various user groups identified. This articles outlines the nature of financial accounting.

Recording transactions

The first practice that informs on the nature of financial accounting is that of recording transactions that a business undertakes. This is referred to as primary information which we shall later see is used to report and communicate information on both the performance and the position of the company through the Income Statement, Cash Flow Statements and the Balance Sheet respectively. All accounting information is based on the primary transactions entered in the journals, the primary books of accounting. By recording data on cash inflows and outflows as well as the transfer of assets or liable the foundation is laid for the processing of this information for the reporting function.

 

Recording financial information

Of course, the records are not limited to transaction data. There is more information that contributes to the roles of financial accounting than transactions. A simple example that we can grasp is the depreciation information of non-current assets. Depreciation is not a transaction but is information important to assessing a businesses performance and position. The nature of financial accounting requires the recording of more than financial or quantitative data. Some cases necessitate recording data that cannot be quantified but has an impact on the users of financial statements and financial accounting information.

 

Classification of data

Not all data is created equal and it also necessary for financial accounting data to be classified. Identifying the difference between assets, liabilities, revenues, capital expenditure and disbursement are some of the important work involved in financial accounting. The nature of financial accounting information users makes it very important that data be classified correctly. Business involves very complex transactions which are not always clear to the average user. An example of this is leasing, which depending on the arrangement between the lessor and lessee can be classified as either a finance lease or and Operating lease and the two are treated differently for accounting purposes.

Summarise financial information

So far we have spoken about the use of Journals to record transaction data. The next step in the process is to post journal entries to Ledgers. Ledgers are double-sided accounts recording inflows and outflows on opposite ends. By so doing ledgers provide summaries of transaction information for an individual account, a class of accounts or the entire business. After this, the next step in the process is a trial balance before going to create the full financial statements we previously referred to. These statements also summarise the transaction information of business giving either performance over a period or a snapshot in time for the state of a business. For the majority of users these are the only records they view of businesses and therefore the summary function is very important to the nature of financial accounting.

Analyse financial information

In public companies that are required to present full financial statements, the user pool is very wide. These users, while looking at different elements of financial statements also require analysis of the information. Due to the wide variance in sophistication and resources, it is considered best practice for these companies to provide both commentary and analysis on the information provided in the financial statements. This information is usually found in notes to the financial statements. Which information is displayed wherein the financial statements depends on the rules in International Accounting Standard (IAS) 1 which gives a guideline as to how information is treated in terms of inclusion in the statements. Users also use the information for investment purposes and comparative information such as accounting ratios is also included in financial accounting statements as notes to the financial statements.

 

Reporting of financial information

Reporting financial information is another important part of the nature of financial accounting. Using public companies as an example there is an agency relationship that exists between owners of the business and the management of the company. As stewards of resources belonging to other people management are required to report on company performance and the prospects for the future of the company. While owners or shareholders are the primary users of this information they are not the only users concerned with it. Local tax authorities require businesses of all sizes and legal structures to report on their performance for taxes including Income tax, Value added tax, Capital gains tax and Pay As You Earn on employees income. The higher standard required of public companies to publish their financial statements makes the information widely available to creditors and other external stakeholders.

Interpretation of financial information

Financial statements alone are not easily understood by the ordinary user. As such, there is a requirement for financial statements to be interpreted and explained for some of the users who have neither the access nor the resources to easily interpret financial statements. To understand how important this is to the nature of financial accounting we must take cognisance of the complexity that is involved in financial reporting. Complicated arrangements such as a sale and leaseback where company A sells an asset to company B then leases back the asset from company B. Ordinarily this transaction could be treated as a simple lease of the asset. However, under certain circumstances, the transaction may be treated as ownership of the asset by company A. So interpretation of financial information is an important role of financial accounting.

Communicating financial information

Financial accounting information must also be communicated to the various stakeholders and users of the information. The nature of financial accounting information is such that it must be communicated to be useful. Financial accounting standards and national laws require companies and businesses to report their financial information to different users through various means. Businesses are required to submit their accounts to tax authorities at specified times for various tax laws.

 

The nature of financial accounting can be seen as that of providing reliable, accurate and timely information on a businesses performance and position to the various users of the information.

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