In order to keep track of their financial position, operational performance and tax responsibilities, companies are obliged to control and organize all relevant information about their business. Doing so is important for any of a company’s stakeholders:
- Equity holders.
- Financial institutions.
- Governmental authorities.
- Other entities.
Accounting is the system under which companies record their:
- Other relevant financial information.
Each company cannot decide to implement its own set of accounting rules. Instead, the records must follow a set of accepted standards and rules of management and organization information, so that the outputs may be easily analyzed by any of the company’s stakeholders.
The accounting procedures output the financial statements, reports that summarize a company’s operations, financial position and cash flows over a given period, which usually corresponds to a calendar or a fiscal year, quarters or monthly (the company may have specific reporting period).
There are many different concepts within accounting, depending on the use of the accounting reporting:
- Financial accounting, which refers to the processes accountants use to generate the yearly accounting statements of a company.
- Management accounting, which uses similar processes, but use data in a different way, as it is meant to generate reports that are relevant for the company’s decision-making process.
- Cost accounting, which establish reporting and analysis as the combination of the costs that are relevant for the production of the product (or service), meaning that cash is spent is production factor.
These the different takes on accounting have different uses for the different stakeholders. Since management accounting and cost accounting are more intrinsic to each company, they are more useful as controlling mechanism. Thus, for now we will only focus on the financial accounting and its reporting.
There are three main financial statements in financial accounting:
- The Income Statement: a report that provides the company’s economic performance over a given period.
- The Balance Sheet: which states a company’s financial position at a given moment in time.
- The Map of Cash Flows: which is meant to inform the cash transactions of the company within a given period of time.
As stated above, financial reporting is performed under specific regulations; each country defines how accounting procedures should be performed by companies with operation within those countries. As a result of globalization and of financial information of a company being relevant to economic agents from everywhere around the globe, local accounting procedures have been pushed for an increased standardization, meaning that a person of financial institution in England is capable of reading the financial reports of a company in Belgium (for as long as she or he can read French or Flemish or that the reports are translated into English), knowing that she or he is familiar with the rules that were followed to prepare that information.
There are two main “families” of accounting reporting standards:
- Generally Accepted Accounting Principles (GAAP), which are mostly used by public and private entities in the United States of America. Find more at: www.sec.gov/divisions/corpfin/cfabout.shtml.
- International Reporting Financial Standards (IFRS), which are mostly used by companies outside of the United States of America. The adoption of the IFRS to local regulation differs from country to country, but general principles and most of the specific aspects are kept. As these are the standards that are usually required to be used by multinational entities, local regulation usually adjusts in accordance. Find more at: www.ifrs.org.