Financial Accounting Concepts Framework
Financial accounting is an important part of the accounting process and provides information for external users. It is a process of recording and classifying economic events, summarizing and communicating financial information to people outside of the organization, and complying with legal regulations. The concept of financial accounting is based on some generally accepted accounting principles (GAAP).
GAAP is a set of standards and concepts typically established by regulatory bodies in order to standardize the financial reporting process. The guidelines set by GAAP are meant to make financial statements more reliable, accurate and comparable for users who may not be familiar with the specific accounting practices of the issuing company. By following GAAP rules, reporting companies provide accuracy and consistency in their financial statement presentation.
GAAP consists of a number of concepts and rules that are foundation to the financial reporting process. Generally accepted accounting principles are divided into different categories and include:
•Revenue recognition
Revenue is the amount a company earns before expenses are taken out, it is the money generated from selling goods or services. Revenue recognition follows the concept that revenue should be recognized when it is earned, not when the cash is collected. This means that all sales should be recognized in the accounting period when they come to fruition.
•Cost of goods sold
Cost of goods sold is the amount a company pays to acquire inventory for resale. It includes direct materials, direct labor and a portion of overhead that is associated with the production process. Cost of goods sold also needs to be properly recognized in the accounting period in which the sale of inventory is made.
•Expenses
Expenses are defined as the costs a business incurs to obtain revenue. Expenses should be recognized when incurred and should be allocated against revenue in the same accounting period in which the revenue is recognized.
•Accruals and Deferrals
Accruals and deferrals are accounting practices which are used to ensure that all revenue and expense items are recognized in the correct accounting period. Accruals are expenses or revenues incurred but not yet paid or received and deferrals are expenses and revenues that have been paid or received but have not yet been recognized in the relevant accounting period.
•Assets
Assets are items of value owned by a business. Assets should be valued at the historical cost basis, which is the amount paid to acquire the asset and account for any depreciation over the asset’s useful life.
•Liabilities
Liabilities are debts that a company owes to another entity. Liabilities should be recognized when incurred and should be reported on the balance sheet at their present value.
•Equity
Equity is the difference between the assets and liabilities of a business. It represents the ownership interests of the shareholders or owners. Equity should be valued at its residual worth at any given time.
•Cash Flow
Cash flow is defined as the amount of money that a business receives and pays out over a certain period of time, usually a month or a year. Cash flow should be reported on a periodic basis in accordance with generally accepted accounting principles.
•Disclosures
Disclosures refer to the information that must be included in financial statements in order to provide an accurate and complete description of a company’s financial position and activity. Disclosures are important for readers of financial statements and should be specific in order to provide a clear understanding of the transactions and events that have taken place.
By following these concepts, businesses will be able to produce reliable financial statements in accordance with GAAP and provide its stakeholders with accurate and up-to-date financial information. This will allow for better decision making based on the data provided and will drive efficient operations of the business.
