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What is financial accounting?

Checked for updates, April 2022.


Accounting provides information about a company, and communicates that information to interested parties. Hence, it is known as the language of business. Accounting has several branches or fields of specialization. One of them, and arguably the most famous, is financial accounting.

Financial accounting is the branch of accountancy that deals with the preparation and presentation of reports called financial statements. The financial statements present a company's condition, results of operations, cash flows, and other information.

Financial statements include: a balance sheet, an income statement, a statement of changes in equity, a statement of cash flows, and supplementary notes.

Financial Accounting Compared to Other Branches

Other branches of accounting also deal with processing of information. Each of them has its own purpose. Managerial accounting, for example, focuses on providing information to the management for internal decisions. Bookkeeping focuses on the recording process. Auditing aims to verify the correctness and reliability of financial reports (financial statements audit).

The main purpose of financial accounting is the preparation and presentation of general-purpose financial statements. One of the most distinctive features of financial accounting, especially when compared to managerial accounting, is compliance with accounting standards. Financial accounting prepares financial statements in accordance with generally accepted accounting principles (GAAP) and/or other established standards.

General-Purpose Financial Statements

The financial statements produced in financial accounting are for general purposes. It means that the information contained in them are useful to all users, in general, and not just to a particular group.

The users of financial statements include: the owners and investors, management, creditors and suppliers, lenders, government, customers, employees, and the general public.

Limitations of Financial Accounting

Financial accounting deals with historical data. Its job is to report what happened. It does not provide projections of future outcome, budgets, and the like. You will have to turn to other branches of accounting for them. However, the data used to make those projections come from financial accounting.

Financial accounting cannot provide all information to users. It focuses on common information that are generally useful. The users must look into other sources when making decisions, such as industry condition, economic situations, political environment, etc. These are not shown in the financial statements.

Financial accounting involves estimates. In fact, many of the items in the reports do not have actual costs or price tags. Take for example "bad debts". Bad debts represent the uncollectible portion of receivables. How are we to know how much of it will be uncollected in the future? That's right; we estimate.

It is not however a guess-how-much scenario. The estimate must be reasonable, based on some valid basis. Recommended methods developed by standard-setting bodies are in place to ensure reasonable and reliable estimates.

In a Nutshell

What is Financial Accounting? Financial accounting is the branch of accounting that is concerned with the preparation of financial statements in accordance with generally accepted accounting principles (GAAP). The financial statements prepared are for general purposes – addressing the common needs of all interested users.

Key Takeaways

Financial accounting involves the preparation of general-purpose financial statements. These financial statements are prepared in accordance with established accounting and financial reporting standards.

Financial accounting deals with reporting historical data which is useful to both internal and external users, compared to managerial accounting which is mainly useful to internal users.

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