Definition of Financial accounting
Financial accounting
The production of financial statements, primarily for those interested parties who are external to the business.
financial accounting
a discipline in which historical, monetary
transactions are analyzed and recorded for use in the
preparation of the financial statements (balance sheet, income
statement, statement of owners’/stockholders’ equity,
and statement of cash flows); it focuses primarily on the
needs of external users (stockholders, creditors, and regulatory
agencies)
Related Terms:
This is a currency translation standard previously in
use by U.S. accounting firms. See: Statement of accounting Standards No. 52.
This is the currency translation standard currently
used by U.S. firms. It mandates the use of the current rate method. See: Statement of financial accounting
Standards No. 8.
financial accounting Standards Board. Sets accounting standards for U.S. firms.
The rate suggested in financial accounting Standard Board (FASB) 87 for discounting the
obligations of a pension plan. The rate at which the pension benefits could be effectively settled off the
pension plan wished to terminate its pension obligation.
Set of books kept by a firm's management for the IRS that follows IRS rules. The stockholder's
books follow financial accounting Standards Board rules.
This important term
refers to the body of authoritative rules for measuring profit and preparing
financial statements that are included in financial reports by a business
to its outside shareowners and lenders. The development of these
guidelines has been evolving for more than 70 years. Congress passed a
law in 1934 that bestowed primary jurisdiction over financial reporting
by publicly owned businesses to the Securities and Exchange Commission
(SEC). But the SEC has largely left the development of GAAP to the
private sector. Presently, the financial accounting Standards Board is
the primary (but not the only) authoritative body that makes pronouncements
on GAAP. One caution: GAAP are like a movable feast. New rules
are issued fairly frequently, old rules are amended from time to time,
and some rules established years ago are discarded on occasion. Professional
accountants have a heck of time keeping up with GAAP, that’s for
sure. Also, new GAAP rules sometimes have the effect of closing the barn
door after the horse has left. accounting abuses occur, and only then,
after the damage has been done, are new rules issued to prevent such
abuses in the future.
A special committee of the financial accounting Standards Board established to reach consensus of how to account for new and unusual financial transactions that have the potential for creating differing financial reporting practices.
A separate committee within the financial accounting Standards Board composed of 13 members representing CPA firms and preparers of financial statements
whose purpose is to reach a consensus on how to account for new and unusual financial transactions
that have the potential for creating differing financial reporting practices.
A common set of standards and procedures
for the preparation of general-purpose financial statements that either have been established
by an authoritative accounting rule-making body, such as the financial accounting
Standards Board (FASB), or over time have become accepted practice because of their universal
application.
The change in the value of a firm's foreign currency denominated accounts due to a
change in exchange rates.
Earnings of a firm as reported on its income statement.
Total liabilities exceed total assets. A firm with a negative net worth is insolvent on
the books.
The ease and quickness with which assets can be converted to cash.
The average project earnings after taxes and depreciation divided by the average
book value of the investment during its life.
Sources of funds internally provided from operations that alter a company's
cash flow position: depreciation, deferred taxes, other sources, and capital expenditures.
Corporate financial management
The application of financial principals within a corporation to create and
maintain value through decision making and proper resource management.
Corporate financial planning
financial planning conducted by a firm that encompasses preparation of both
long- and short-term financial plans.
Country financial risk
The ability of the national economy to generate enough foreign exchange to meet
payments of interest and principal on its foreign debt.
Dupont system of financial control
Highlights the fact that return on assets (ROA) can be expressed in terms
of the profit margin and asset turnover.
Financial analysts
Also called securities analysts and investment analysts, professionals who analyze
financial statements, interview corporate executives, and attend trade shows, in order to write reports
recommending either purchasing, selling, or holding various stocks.
Financial assets
Claims on real assets.
Financial control
The management of a firm's costs and expenses in order to control them in relation to
budgeted amounts.
Financial distress
Events preceding and including bankruptcy, such as violation of loan contracts.
Financial distress costs
Legal and administrative costs of liquidation or reorganization. Also includes
implied costs associated with impaired ability to do business (indirect costs).
Financial engineering
Combining or dividing existing instruments to create new financial products.
Financial future
A contract entered into now that provides for the delivery of a specified asset in exchange
for the selling price at some specified future date.
Financial intermediaries
Institutions that provide the market function of matching borrowers and lenders or
traders.
Financial lease
Long-term, non-cancelable lease.
Financial leverage
Use of debt to increase the expected return on equity. financial leverage is measured by
the ratio of debt to debt plus equity.
Financial leverage clientele
A group of investors who have a preference for investing in firms that adhere to
a particular financial leverage policy.
Financial leverage ratios
Related: capitalization ratios.
Financial market
An organized institutional structure or mechanism for creating and exchanging financial assets.
Financial objectives
Objectives of a financial nature that the firm will strive to accomplish during the period
covered by its financial plan.
Financial plan
A financial blueprint for the financial future of a firm.
Financial planning
The process of evaluating the investing and financing options available to a firm. It
includes attempting to make optimal decisions, projecting the consequences of these decisions for the firm in
the form of a financial plan, and then comparing future performance against that plan.
Financial press
That portion of the media devoted to reporting financial news.
Financial ratio
The result of dividing one financial statement item by another. Ratios help analysts interpret
financial statements by focussing on specific relationships.
Financial risk
The risk that the cash flow of an issuer will not be adequate to meet its financial obligations.
Also referred to as the additional risk that a firm's stockholder bears when the firm utilizes debt and equity.
Generally Accepted Accounting Principals (GAAP)
A technical accounting term that encompasses the
conventions, rules, and procedures necessary to define accepted accounting practice at a particular time.
London International Financial Futures Exchange (LIFFE)
A London exchange where Eurodollar futures
as well as futures-style options are traded.
Long-term financial plan
financial plan covering two or more years of future operations.
London International Financial Futures Exchange (LIFFE)
London exchange where Eurodollar futures as well as futures-style options are traded.
Non-financial services
Include such things as freight, insurance, passenger services, and travel.
Notes to the financial statements
A detailed set of notes immediately following the financial statements in
an annual report that explain and expand on the information in the financial statements.
Perfectly competitive financial markets
Markets in which no trader has the power to change the price of
goods or services. Perfect capital markets are characterized by the following conditions: 1) trading is costless,
and access to the financial markets is free, 2) information about borrowing and lending opportunities is freely
available, 3) there are many traders, and no single trader can have a significant impact on market prices.
Pro forma financial statements
financial statements as adjusted to reflect a projected or planned transaction.
Purchase accounting
Method of accounting for a merger in which the acquirer is treated as having purchased
the assets and assumed liabilities of the acquiree, which are all written up or down to their respective fair
market values, the difference between the purchase price and the net assets acquired being attributed to goodwill.
Regulatory accounting procedures
accounting principals required by the FHLB that allow S&Ls to elect
annually to defer gains and losses on the sale of assets and amortize these deferrals over the average life of the
asset sold.
Short-term financial plan
A financial plan that covers the coming fiscal year.
Society for Worldwide Interbank Financial Telecommunications (SWIFT)
A dedicated computer network to support funds transfer messages internationally between over 900 member banks worldwide.
Accounting
A collection of systems and processes used to record, report and interpret business transactions.
Accounting equation
The representation of the double-entry system of accounting such that assets are equal to liabilities plus capital.
Accounting period
The period of time for which financial statements are produced – see also financial year.
Accounting rate of return (ARR)
A method of investment appraisal that measures
the profit generated as a percentage of the
investment – see return on investment.
Accounting system
A set of accounts that summarize the transactions of a business that have been recorded on source documents.
Accruals accounting
A method of accounting in which profit is calculated as the difference between income when it is earned and expenses when they are incurred.
Cash accounting
A method of accounting in which profit is calculated as the difference between income
when it is received and expenses when they are paid.
Financial reports or statements
The Profit and Loss account, Balance Sheet and Cash Flow statement of a business.
Financial year
The accounting period adopted by a business for the production of its financial statements.
Finished goods Inventory that is ready for sale, either having been purchased as such or the result of a conversion from raw materials through a manufacturing process.
Management accounting
The production of financial and non-financial information used in planning for the future; making decisions about products, services, prices and what costs to incur; and ensuring that plans are implemented and achieved.
Strategic management accounting
The provision and analysis of management accounting data about a business and its competitors, which is of use in the development and monitoring of strategy (Simmonds).
Accounting equation
The formula Assets = Liabilities + Equity.
accounting
A broad, all-inclusive term that refers to the methods and procedures
of financial record keeping by a business (or any entity); it also
refers to the main functions and purposes of record keeping, which are
to assist in the operations of the entity, to provide necessary information
to managers for making decisions and exercising control, to measure
profit, to comply with income and other tax laws, and to prepare financial
reports.
accounting equation
An equation that reflects the two-sided nature of a
business entity, assets on the one side and the sources of assets on the
other side (assets = liabilities + owners’ equity). The assets of a business
entity are subject to two types of claims that arise from its two basic
sources of capital—liabilities and owners’ equity. The accounting equation
is the foundation for double-entry bookkeeping, which uses a
scheme for recording changes in these basic types of accounts as either
debits or credits such that the total of accounts with debit balances
equals the total of accounts with credit balances. The accounting equation
also serves as the framework for the statement of financial condition,
or balance sheet, which is one of the three fundamental financial
statements reported by a business.
accrual-basis accounting
Well, frankly, accrual is not a good descriptive
term. Perhaps the best way to begin is to mention that accrual-basis
accounting is much more than cash-basis accounting. Recording only the
cash receipts and cash disbursement of a business would be grossly
inadequate. A business has many assets other than cash, as well as
many liabilities, that must be recorded. Measuring profit for a period as
the difference between cash inflows from sales and cash outflows for
expenses would be wrong, and in fact is not allowed for most businesses
by the income tax law. For management, income tax, and financial
reporting purposes, a business needs a comprehensive record-keeping
system—one that recognizes, records, and reports all the assets and liabilities
of a business. This all-inclusive scope of financial record keeping
is referred to as accrual-basis accounting. Accrual-basis accounting
records sales revenue when sales are made (though cash is received
before or after the sales) and records expenses when costs are incurred
(though cash is paid before or after expenses are recorded). Established
financial reporting standards require that profit for a period
must be recorded using accrual-basis accounting methods. Also, these
authoritative standards require that in reporting its financial condition a
business must use accrual-basis accounting.
double-entry accounting
See accrual-basis accounting.
statement of financial condition
See balance sheet.
financial leverage
The equity (ownership) capital of a business can serve
as the basis for securing debt capital (borrowing money). In this way, a
business increases the total capital available to invest in its assets and
can make more sales and more profit. The strategy is to earn operating
profit, or earnings before interest and income tax (EBIT), on the capital
supplied from debt that is more than the interest paid on the debt capital.
A financial leverage gain equals the EBIT earned on debt capital
minus the interest on the debt. A financial leverage gain augments earnings
on equity capital. A business must earn a rate of return on its assets
(ROA) that is greater than the interest rate on its debt to make a financial
leverage gain. If the spread between its ROA and interest rate is unfavorable,
a business suffers a financial leverage loss.
financial reports and statements
financial means having to do with
money and economic wealth. Statement means a formal presentation.
financial reports are printed and a copy is sent to each owner and each
major lender of the business. Most public corporations make their financial
reports available on a web site, so all or part of the financial report
can be downloaded by anyone. Businesses prepare three primary financial
statements: the statement of financial condition, or balance sheet;
the statement of cash flows; and the income statement. These three key
financial statements constitute the core of the periodic financial reports
that are distributed outside a business to its shareowners and lenders.
financial reports also include footnotes to the financial statements and
much other information. financial statements are prepared according to
generally accepted accounting principles (GAAP), which are the authoritative
rules that govern the measurement of net income and the reporting
of profit-making activities, financial condition, and cash flows.
Internal financial statements, although based on the same profit
accounting methods, report more information to managers for decision
making and control. Sometimes, financial statements are called simply
financials.
internal accounting controls
Refers to forms used and procedures
established by a business—beyond what would be required for the
record-keeping function of accounting—that are designed to prevent
errors and fraud. Two examples of internal controls are (1) requiring a
second signature by someone higher in the organization to approve a
transaction in excess of a certain dollar amount and (2) giving customers
printed receipts as proof of sale. Other examples of internal
control procedures are restricting entry and exit routes of employees,
requiring all employees to take their vacations and assigning another
person to do their jobs while they are away, surveillance cameras, surprise
counts of cash and inventory, and rotation of duties. Internal controls
should be cost-effective; the cost of a control should be less than
the potential loss that is prevented. The guiding principle for designing
internal accounting controls is to deter and detect errors and dishonesty.
The best internal controls in the world cannot prevent most fraud
by high-level managers who take advantage of their positions of trust
and authority.
accounting rate of return (ARR)
the rate of earnings obtained on the average capital investment over the life of a capital project; computed as average annual profits divided by average investment; not based on cash flow
cost accounting
a discipline that focuses on techniques or
methods for determining the cost of a project, process, or
thing through direct measurement, arbitrary assignment, or
systematic and rational allocation
Cost Accounting Standards Board (CASB)
a body established by Congress in 1970 to promulgate cost accounting
standards for defense contractors and federal agencies; disbanded
in 1980 and reestablished in 1988; it previously issued
pronouncements still carry the weight of law for those
organizations within its jurisdiction
financial budget
a plan that aggregates monetary details
from the operating budgets; includes the cash and capital
budgets of a company as well as the pro forma financial
statements
financial incentive
a monetary reward provided for performance
above targeted objectives
management accounting
a discipline that includes almost
all manipulations of financial information for use by managers
in performing their organizational functions and in
assuring the proper use and handling of an entity’s resources;
it includes the discipline of cost accounting
Management Accounting Guidelines (MAGs)
pronouncements of the Society of Management Accountants of
Canada that advocate appropriate practices for specific
management accounting situations
responsibility accounting system
an accounting information system for successively higher-level managers about the performance of segments or subunits under the control
of each specific manager
Statement on Management Accounting (SMA)
a pronouncement developed and issued by the Management
accounting Practices Committee of the Institute of Management
Accountants; application of these statements is
through voluntary, not legal, compliance
Accounting change
An alteration in the accounting methodology or estimates used in
the reporting of financial statements, usually requiring discussion in a footnote
attached to the financial statements.
Accounting entity
A business for which a separate set of accounting records is being
maintained.
Accrual accounting
The recording of revenue when earned and expenses when
incurred, irrespective of the dates on which the associated cash flows occur.
Constant dollar accounting
A method for restating financial statements by reducing or
increasing reported revenues and expenses by changes in the consumer price index,
thereby achieving greater comparability between accounting periods.
Generally accepted accounting principles
The rules that accountants follow when processing accounting transactions and creating financial reports. The rules are primarily
derived from regulations promulgated by the various branches of the AICPA Council.
chief financial officer (CFO)
Officer who oversees the treasurer and controller and sets overall financial strategy.
costs of financial distress
Costs arising from bankruptcy or distorted business decisions before bankruptcy.
financial assets
Claims to the income generated by real assets. Also called securities.
financial intermediary
Firm that raises money from many small investors and provides financing to businesses or other
organizations by investing in their securities.
financial leverage
Debt financing amplifies the effects of changes in operating income on the returns to stockholders.
financial markets
Markets in which financial assets are traded.
financial risk
Risk to shareholders resulting from the use of debt.
financial slack
Ready access to cash or debt financing.
generally accepted accounting principles (GAAP)
Procedures for preparing financial statements.
Financial Intermediary
Any institution, such as a bank, that takes deposits from savers and loans them to borrowers.
Financial Intermediation
The process whereby financial intermediaries channel funds from lender/savers to borrower/spenders.
Accounting Errors
Unintentional mistakes in financial statements. Accounted for by restating
the prior-year financial statements that are in error.
Accounting and Auditing Enforcement Release (AAER)
Administrative proceedings or litigation releases that entail an accounting or auditing-related violation of the securities laws.
Accounting Irregularities
Intentional misstatements or omissions of amounts or disclosures in
financial statements done to deceive financial statement users. The term is used interchangeably with fraudulent financial reporting.
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