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Explaining Financial Accounting

By Sophia, published on 01/10/2018 Blog > Academia > Accounting > What is Financial Accounting?

Every year, come tax time, we become painfully aware of the need to account: for our earnings and assets, our gains and losses and, of course, taxes on our property.

For businesses, that accounting takes place year-round: shareholders, investors and the government all have an interest in the financial health of the company.

Unlike our individual tax claim process which happens once per year, every three months – or quarterly, reports are published detailing businesses’ financial profile.

Note that, even though we might need a certified public accountant once per year, even companies that only report to stockholders every six months need financial and managerial accountants year-round because the numbers continue to tally on a daily basis.

Those reports are not generated by magic or by an algorithm. There are very real people crunching numbers every day to render the most accurate financial statements possible for reporting.

Those people are financial accountants. They are the invisible monitors of a business’ financial status.

Your Superprof now takes you behind the abacus, to lay bare the accounting process, accounting procedures and accounting system someone with an accounting degree might labour under.

Please note that accountants have long moved away from abaci and most have even abandoned calculators in favour of the spreadsheet but the visual is right on point, isn’t it?

Are you taking accounting courses? Studying accounting concepts and learning accounting theory?

Whether you are preparing for your CPA exam or only just learning about debits and credits as an undergraduate, this article is for you.

UK GAAP

Every financial accountant must be aware of rules governing reporting It is incumbent on financial accountants to know reporting and accounting rules! Source: Pixabay Credit: Geralt

The Generally Accepted Accounting Principles (practice, in the UK), informally called GAAP, is the body of accounting standards that govern how a company must prepare their accounts for reporting.

GAAPs in general set the financial accounting standards for managerial accounting as well as financial accounting practices in select countries, such as the US.

However, they are not the be-all and end-all of accounting standards in the UK (or elsewhere!).

The Accounting Standards Board (ASB) is the main standard setter for financial reporting in our country. They routinely issue and/or update financial reporting standards.

Here is a brief look at their methodology.

Whenever a new reporting standard or a revision of an existing standard is proposed, it is released to the public for comments, critique and suggestions.

It is only after all concerns and queries have been addressed and, when applicable, incorporated into the new standard that it is officially released and becomes a part of the body of rules governing financial reporting.

The ASB is a part of the Financial Reporting Council.

Contrary to what the name suggests, this is not a government entity; rather it exists to foster public security in investment. To that end, it acts as an independent regulator that promotes quality corporate governance and reporting.

Interestingly enough, this council is funded by the businesses whose financial regulation it oversees!

Still, there is government oversight in standards setting practices.

The Companies Act of 2006 sets out minimum reporting requirements. They may require some companies to file their accounts with the Registrar of Companies, another government body that will, in turn, make company reports available to the general public.

Conversely, they may encourage companies with international dealings to make their financial disclosures in accordance with the International Financial Reporting Standards.

This all sounds very convoluted but the bottom line is that the UK GAAP dictates to businesses in the UK how accounts must be prepared, and these principles work in accordance with the Companies Act of 2006.

A Breakdown of Financial Accounting

Keeping these standards and regulations in mind, financial accountants have one of two methods with which to perform their functions, or they may use a combination of both methods.

The accrual method means to record transactions as they occur, even if that requires projecting their completion.

Let’s say someone buys something on credit. The revenue from that sale is only projected; the company will not see actual compensation until the payment is made, even if that payment is made in increments, over time.

However, the transaction is treated as though it were complete for the purpose of bookkeeping because it gives a more accurate picture of the company’s financial condition at the time of that transaction.

Larger companies whose revenue is derived from long-term payments would be severely impacted if they reported on their exact finances at any given period of time.

Now we suppose a company, involved in a long-term project, only sees a trickle of income in each month.

However, their production expenses – materials, personnel and operating costs, continue on as normal.

That would reflect a dire financial statement indeed!

That is why the accounting cycle – the name given to the process of recording accounting events, is so fundamental: making entries in the general ledger and maintaining the trial balance…

By recording each transaction as complete at the time it is done, as opposed to cataloguing individual payments that might not offset operating costs, financial accountants give a clearer picture of the company’s financial standing.

This method of revenue recognition is much more convoluted than cash accounting but deemed necessary because of today’s business practices.

When cash trades hands, cash accountants record the transaction Cash accounting denotes recording transactions only when cash changes hands Source: Pixabay Credit Stux

The second method, cash accounting, entails recording transactions only when cash changes hands.

Let’s say you buy £5000 worth of furniture from an independent furniture store, with the promise to pay in full by the end of next month.

That transaction will not show up in their books until you have made your payment, even though the store’s inventory was diminished by that amount the month before.

In the purest sense, this leads to some inaccuracy in accounting information because there is a gap between the inventory value and the financial value of the company until you pay for your purchase.

Cash accounting does not provide an accurate picture of liabilities that have been incurred and not yet paid for.

Furthermore, this accounting method impacts businesses at tax time because tax laws dictate that a company can only deduct business expenses that have occurred within the tax year, which may cause harm to a small business owner’s financial profile.

Back to our furniture buyers, for a moment.

They buy new furniture in March, with the payment due by April 30th, and that is the very date they make their payment. The furniture store will not be able to receive credit for this transaction on the previous year’s tax cycle.

Most smaller businesses adopt this method of accounting because it is a simpler method of accounting, and more straightforward.

Larger companies are required by GAAP to use the accrual accounting method.

Where the Financial Accountant Comes In

The role of the financial accountant is to record every financial transaction, using the generally accepted accounting principles, and prepare reports to that effect.

S/he would collect data, analyse it and investigate variances. S/he also summarises that data and reports on positive or negative trends.

Compliance with all applicable laws and regulations is mandatory! Therefore, financial accountants must stay abreast of every law and regulation change and implement those changes within his/her company.

Working with managerial accountants, financial accountants provide financial advice by analysing operational issues; they develop recommendations and procedures to protect the company’s financial health.

Ahead of shareholder and/or executive meetings, financial accountants conduct financial statement analysis, prepare special reports, help to prepare budgets and make financial forecasts.

Should there be a financial inquiry, such as an audit – or worse: a forensic accountant is called in to examine a company’s accounting system! financial accountants gather and summarise data. They may be called on to interpret said data.

With regard to taxation: financial accountants calculate quarterly estimated tax payments and prepare annual tax returns.

Perhaps their most visible function is the preparation of quarterly and annual statements for government entities, company executives and shareholders.

You couldn't fit everything a financial accountant knows into a briefcase! The sum total of knowledge, skills and abilities embodied in the financial accountant would not fit in a briefcase! Source: Pixabay Credit StockSnap

Required Knowledge and Skills

Far more than just basic accounting and being enraptured with numbers, there are a number of skills a financial accountant must embody.

Knowledge of cost accounting, management accounting and principles of accounting in general, as they apply to the employing institution: those are accounting basics.

Research skills allow for efficient investigating of financial matters and staying abreast of financial and accounting regulations.

Statistical analysis permits such accountants to recognise business trends and advise for/against them, to make forecasts based on historical data and recognise outliers – a single event that impacted the business.

The 2008 global financial downturn is an outlier; weak financial growth since then is a trend.

Every financial accountant must have a sense of the business s/he accounts for.

Obviously, a locally owned and operated business is not going to have the same financial profile or accounting needs as an international trading company.

Even though they are not in on the actual decision making, because a part of the financial accountant’s duties involves making recommendations for the better health of the company, s/he must know a bit about the business and how to make it grow.

Furthermore, in the case of mergers or takeovers, financial accountants should be on the front lines with their accounting information systems, ready to expound not only on the company’s assets but also on its liabilities.

Summary: What is financial accounting?

  • It is the process of recording, summarising and reporting transactions resulting from business operations within a specific period of time

  • Such reporting can be done on a quarterly, biannual or annual basis and be done publicly, only to shareholders or only to tax authorities or other government entities.

  • reporting may be done via a balance sheet, an income statement or a cash flow statement

  • regardless of what type of reporting, the statements should reflect the company’s operating performance at the time of reporting.

You could say that financial accountants have their fingers on the pulse of the business: from making recommendations to profitability, and reporting it.

More so than an office suite in The Shard or a Lamborghini in the car park, financial accountants are the verity of any business.

They are just not as visible or recognisable.

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