The Importance of Financial Accounting

The Importance of Financial Accounting Introduction According to Weygandt, Kieso and Kimmel (2012), financial accounting is identifying, recording and communicating the economic events of an organization to, mainly, external users. Through financial accounting, some financial reports will be generated. Four financial statements are frequently used to report and analyze the financial status of companies and they are Income statement, Retained Earning Statement, Statement of Financial Position and Statement of Cash Flow. These financial statements can always give useful information to users. The objectives and roles of financial accountingThe Financial Accounting Standards Board, known as FASB, (1978, 1980, as cited in Nicholas & Shyam, 1980, p.

1) stated the major objective of financial accounting is “to provide useful information for decision-making”. It gives the foundation to users to plan, control and make decision with great assistance, for instance, internal users like managers need the information about profit or loss, return, cash on hands, budget and the like. Also, external users have little authority to access the information so they rely on financial statements to know about the economic resources, financial position, earning power and the like.Others objectives includes recording business transactions so that the daily operations can be marked to reduce error, calculating net income or net loss to reveal the performance of companies and effect of the decisions made, and illustrating financial position to know whether the company is more advanced when comparing to other organizations. To achieve the above objectives, financial accounting has a number of roles.

Firstly, it acts as a quantitative financial information provider that communicates with the stakeholders and assists the users to make better decisions. It also acts as data handler.It identifies, classifies and summarizes the data into financial reports and statements to display the operating status of companies. Third, it is also a regulator that helps control the companies’ activities and resources. Definition of relevant information In order to accomplish these purposes, the information recorded should be accurate, organized and reliable.

FASB (1977, as cited in Nicholas & Shyam, 1980) suggests the elements of the information needed include the main categories of accounts which are assets, liabilities, owners’ equity, revenues, expenses, incomes and losses. The financial reports should show relevant information.As FASB (2008, p. 17) indicates, “information is relevant if it is capable of making a difference in the decisions made by users in their capacity as capital providers.

” Information of economic event can make a difference when it has predictive value, confirmatory value, or both. The meaning of being capable of making a difference is not depending on if the information has in fact made a difference previously or will make a difference in the future. Information may be resulting in a different decision even if some users choose not to take advantage of it or are already aware of it.For example, my house worth $9 million today and it is predicted to worth $20 million after five years. These are relevant information that will affect my decision of when I should sell the house.

Users of financial reporting Financial accounting provides information to external users. Generally, external users usually mean individuals that are physically outside the company. To be more accurate, they are individuals that have financial interest now or in the coming future in the reporting company, but are not concern with daily operations (Williams, Haka, Bettner & Carcello, 2006).They include creditors, potential investors, suppliers, customers, government, labor union, general public and the like. They usually use the financial information for decisions of cooperating with that company.

On the other hand, it also gives evidence to internal users in a smaller extent about the condition of the company. Internal users are employees and management. They usually use the information for decisions of future strategies and directions for the company. Every user may require information to make decisions. However, the diversity of users is quite broad.It is hard to provide different financial information to all of them.

Therefore, we need financial reporting— a set of documents that summarizes all financial information. The reasons why finance market needs financial reporting Financial reporting refers to the periodic publication of financial statements (Horizon Community Bank, 2012). As humans cannot remember all things in a long term period, especially quantitative information, they should record the economic events in the financial reports. Every financial statement has different functions to the company.

For Statement of Financial Position, it shows a snapshot of a company’s assets, liabilities and equity. It points out whether the company can take on more debt and it can meet its obligations. The income statement reports the company performance in terms of revenues and expenses for a specific period of time. It reveals whether the sales have improved compared to last accounting period.

The Retained Earning Statement indicates the reasons of rise or drop of retained earnings, and whether the net income has dropped or has given out excessive dividends.The Statement of Cash Flow demonstrates the cash receipts and payments of operating, investing and financing activities, and whether there is sufficient cash. These methodical records possibly eliminate the frauds and the thefts. If there is no financial report, no correct figures can be analyzed to get the answers of the questions. All the decisions will be made by intuition without any basis.

That will lead to serious problems like heavy debts and bankruptcy. Role of financial accounting to assist in efficient resources allocation As a result, financial accounting is directly related to efficient resources allocation.It is the precondition of efficient resources allocation. A study carried out by Stocken, Phillip, Verrecchia & Robert (2004) recommends that if manager can only choose imprecise financial information, it may reduce the efficiency in allocating resources. It also acts as inspirational role to assist in allocating the resources.

Since users of financial information have to analyze the data so as to get the idea of adding or reducing the resources. The premise is carrying out financial accounting. Conclusion Financial accounting is important in all organizations which involve in economic activities, no matter large or small companies.It can always help internal or external users to make decisions. Although making decision may also require non-financial information such as behavioral and socio-economic information, financial accounting provides numerical data which is the simplest and most direct information for people to make decision.

(1,051 words) References Financial Accounting Standards Board, S. (29 May 2008). Conceptual Framework for Financial Reporting: The Objective of Financial Reporting and Qualitative Characteristics and Constraints of Decision-Useful Financial Reporting Information.Retrieved October 24, 2012 from http://www.

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Financial Accounting Information. Retrieved October 26, 2012 from http://highered. mcgraw-hill. com/sites/0072996501/student_view0/ebook/chapter1