Introduction
The following essay examines the purpose of accounting.The essay also discusses the four basic financial statements and how they are interrelated with each other and the importance of financial statements to managers, investors, creditors, and employees. Accounting entails the process of analyzing, recording, summarizing and reporting accounting information to parties that are involved (Weygandt, 2008, P.6).
Purpose of Accounting
The following are the main purposes of accounting; Financial accounting helps keep systematic record of all the financial activities of a business entity.Usually,business transactions are prepared and recorded in financial statements such as income statement, statements of financial position ,cash flow statement and change in owners equity. The International Accounting Standards requires that business transactions should be properly recorded in order to facilitate remembering of all business transactions in future. Human beings have limited memory and therefore, they can forget business transactions if they are not kept in a systematic manner (Baneriee, 2010, P.2).
The other purpose of financial accounting is to provide information about the financial position, cash flows and performance of a business entity. The financial statements facilitated meeting this objective by providing information about the assets, liabilities ,equity, income and expenses, cash flows and other changes in equity of a business entity. This financial information as well as the information contained in an entity’s accompanying notes enables the users to evaluate the future cash flows of a business entity (Baneriee, 2010, P.2).
Financial accounting plays an important role of communicating the financial results of a business entity to the users to enable them make decisions. Accounting is usually deemed as a business language because it communicates valuable information to various interested groups. Accounting plays an important role of communicating past and present performance of a business entity and this enables the users to determine whether business operations are carried out in effective and efficient manner (Baneriee, 2010, P.2).
Accounting is also used as a tool of meeting legal requirements. Business are required to keep their accounts in an orderly manner facilitate such legal requirements such as tax assessment (Baneriee, 2010, P.2).
Basic financial statements
Financial statements entail the end products which are prepared from the adjusted trial balance. There are four basic financial statements namely; income statement, statement of financial position, cash flow statement and changes in owners equity.
The income statement also known as profit and loss account is a financial statement that is used in reporting the operating performance of a business entity over an accounting period. The income statement summarizes the earnings and expenses of an entity over an accounting period. The income statement is thus a recapitulation of all the financial transactions of a business entity during an accounting period. It allows organizational leaders and other users of account information to track the revenues and expenses. Revenues are usually recorded on the right-hand side of an income statement account and this implies that revenues increase the shareholders equity.
Expenses are recorded on the left hand-side of an income statement denoting the fact that they decrease shareholder’s equity. The profit and loss account is a temporary account and it is closed at the end of an accounting period and the balance is transferred to the shareholder’s equity and eventually, to the balance sheet. If revenues exceed expenses, then a profit is recorded and this amount is placed on the left-hand side of profit and loss account when closing an income statement. A loss which arises when expenses exceeds revenues appears on the left hand side of a profit and loss account (Weygandt, 2008, P.6-12).
The balance sheet is a financial statement that provides the company’s worth at a specific moment in time. The balance sheet shows all the assets as well as all the liabilities of a business entity. The net worth of a firm is derived from the difference between the company’s assets and the liabilities. The balance sheet can be used in determining the liquidity level of a firm by comparing the current assets amount to the current liabilities amount. It also plays an important role of determining whether the firm is able to pay dividends to shareholders (Weygandt, 2008, P.6-12).
The cash flow statement is a financial statement that enables tacking of sources and uses of funds. The totals of cash flows are crucial as they show whether a business is successful or not because cash is key with regards to efficient functioning of an entity (Weygandt, 2008, P.6-12).
Changes in owners equity arises from the increase or decreases in owner’s capital account as a result of the various transactions that occur in an accounting period. In computing owner’s equity, liabilities are deducted from assets. Equity refers to owners claim in company’s assets after deducting liabilities (Weygandt, 2008, P.6-12).
The statements are interrelated with each other in that they provide the various users with relevant financial information for decision making (Weygandt, 2008, P.6-12).
Importance of financial statements
Financial statements is useful to the following users i.e. managers, investors, creditors, and employees. Information contained in financial statements enables managers to highlight financial strength and weaknesses of a business entity. It enables them to predict the financial crises that can affect their business and thus to take corrective measures in advance. Financial statement information is valuable to investors as it enables them to know the profitability of a business entity and thus make decisions on whether to invest or not. Creditors are concerned with the financial statement information in order to determine the liquidity position of a firm and to know whether the firm will meet their short term claims. The employees require financial statement information in order to know whether is in a position to increase their wages (Weygandt, 2008, P.6-12).
Reference List
Baneriee, B. (2010). Financial accounting: Concepts, Analysis, Methods and Uses. New Delhi: PHI Learning Pvt.Ltd.
Weygandt, J (2008). Financial accounting (6th ed). Hoboken: John Wiley & Son.