Introduction – Purpose of Accounting The definition of accounting is a useful approach through which the salient aspects of accounting are outlined. Accounting can be defined as the process through which business transactions are recorded, classified, reported and interpreted to interested users in order to help them in their economic decisions. Therefore, the purpose of accounting is mainly two fold, to record business transactions in such a way that they are reported to people/entities to help them in the decision-making process.
In order to amplify more clearly the above premise it is important that the way financial information is reported and the economic needs of these users is outlined. This will be conducted in the proceeding sections. Four Basic Financial Statements Apart the double-entry bookkeeping, through which all business transactions are recorded in accounts and classified in ledgers, the main final report provided to interested users is in the financial statements.
The financial statements are a financial document that encompasses four main statements. These are the following: The Income Statement, The Balance Sheet, The Statement of Cash Flows and The Statement of Changes in Equity. Despite portraying different information needs the aforesaid statements are interrelated together in order to portray one final image of the organization. They also use information from each statement, which results in a sequence through which they are prepared.
The Income Statement is the first statement prepared, which portrays the profitability of the organization during a particular time frame. This will serve to assess the financial performance of the firm and how well was management able to generate profits from the day-to-day operations. The final figure in the income statement (net income) will be used in all the other three statements. The statement of changes in equity, comprises the salient changes in the stockholders’ equity section.
An important element of the stockholders’ equity is the retained earnings, which is made up of the past profits and the net income of that particular period. The Balance Sheet is a statement that outlines the assets (non-current and current), liabilities (non-current and current) and stockholders’ equity of the organization at a particular point in time. It is like a photo of such balances at a particular date. In order to prepare the balance sheet the income statement and statement of changes in equity have to be prepared before.
The final statement, the statement of cash flows highlights the main movements in the cash and cash equivalents. This outlines the cash management of the firm. The statement of cash flows is normally prepared via the direct method, which starts with the accounting profit. Therefore, interrelationship again exists between the income statement and the statement of cash flows. Even though all the above elements are considered in isolation when the company is analyzed, they still all lead to one final conclusion.
This entails that of assessing the financial health of the organization. Therefore, interrelationship is again seen in the utilization of the aforementioned statements present in the financial statements. This financial health aspect is also very important for external users to help them in their economic decisions, which is in line with the definition above. Such aspect will be considered in further detail in order to outline its utility by considering financial information needs of internal and external users.