Financial accounting is concerned with providing relevant financial information to various external users. However, the primary focus is on the financial information provided by profit-oriented companies to their present and potential investors and creditors.
Cash basis accounting provides a measure of periodic performance called net operating cash flow, which is the difference between cash receipts and cash disbursements from transactions related to providing goods and services to customers. Accrual accounting provides a measure of performance called net income, which is the difference between revenues and expenses. Periodic net income is considered a better indicator of future operating cash flows than is current net operating cash flows.
Generally accepted accounting principles (GAAP) comprise a dynamic set of both broad and specific guidelines that companies follow when measuring and reporting the information in their financial statements and related notes. The Securities and Exchange Commission (SEC) has both the authority and responsibility to set accounting standards. However, the SEC has always delegated the responsibility to a private sector body, at this time the Financial Accounting Standards Board (FASB).
Accounting standards can have significant differential effects on companies, investors, creditors, and other interest groups. For this reason, the setting of accounting standards often has been characterized as a political process.
The FASB’s conceptual framework is a set of cohesive objectives and fundamental concepts on which financial accounting and reporting standards will be based.
The objectives of financial reporting are concerned with providing information to help investors and creditors predict future cash flows. The primary decision-specific qualities that make accounting information useful are relevance and reliability. To be relevant, information must possess predictive value and/or feedback value and must be provided in a timely manner. The characteristics of reliable information are verifiability, representational faithfulness, and neutrality. The 10 elements of financial statements are assets, liabilities, equity, investments by owners, distributions to owners, revenues, expenses, gains, losses, and comprehensive income.
The four basic assumptions underlying GAAP are (1) the economic entity assumption, (2) the going concern assumption, (3) the periodicity assumption, and (4) the monetary unit assumption.
The four broad accounting principles that guide accounting practice are (1) the historical cost principle, (2) the realization principle, (3) the matching principle, and (4) the full-disclosure principle.
