Financial Accounting Basics

Study Notes

Financial Accounting

Financial accounting is the process of recording, classifying, summarizing, analyzing, interpreting, and reporting financial information about a business's operations, financial position, and cash flows. It serves two primary purposes:

To produce reports for external users, which can be shareholders, lenders, potential investors, government agencies, and other interested parties. These reports must comply with generally accepted accounting principles (GAAP) to ensure standardization and consistency across companies.
To maintain internal records for management. Internal financial statements help managers monitor performance, plan future actions, and make informed decisions based on accurate data.

Key elements of financial accounting include:

General journal: A record book where transactions are initially recorded. Each transaction appears as debit entries against assets, liabilities, equity accounts, revenue, or expenses; offsetting credit entries are made in the general journal opposite each debit entry. The double-entry system ensures that for every pair of debit and credit entries, the total debits equal the total credits.
Trial balance: This report checks whether the sum of all the account balances in the trial balance agrees with the sum of the totals shown in the adjusted trial balance. If it does, the adjusted trial balance will balance when compared to the trial balance; if not, the balance sheet and income statement will have errors.
Adjusted trial balance: After making any necessary adjustments to the general ledger, a new trial balance is prepared by adding up all the account balances from the general ledger.
Balance sheet: The balance sheet provides information about a company's financial position at a specific point in time. It lists assets, liabilities, and equity. Assets are arranged in order of liquidity, while liabilities and equity are also listed in order of increasing risk.
Income statement: Also known as the profit and loss statement, this shows revenues, gains, losses, deductions, expenses, taxes, and net profits over a period.
Statement of retained earnings: This shows changes in retained earnings during the year, including dividends paid and stock repurchases.
Cash flow statement: This statement details the sources and uses of cash during a specified time period. Net income or loss computed under GAAP is used to create a taxable income or loss.

Financial accounting is crucial for any business to function effectively. It helps in making informed decisions, determining the financial health of a company, forecasting, and making strategic plans.

Description

Learn about the key elements of financial accounting, including the general journal, trial balance, balance sheet, income statement, and more. Understand the importance of financial accounting in producing reports for external users and aiding management decision-making.