The meaning of Financial Accounting can be defined as a procedure of documenting, encapsulating, and reporting the multiple transactions resulting from trading operations over a timeframe. These transactions are compiled in the preparation of financial statements, comprising the income statement, balance sheet, and cash flow statement that record the enterprise’s operating accomplishment over a particular period.
Financial accounting is a specific accounting branch that maintains a company’s financial activities. With the help of regulated guidelines, all the transactions are entered, reviewed, and shown in a financial statement or financial report.
Financial statements prepared by financial accounting takes into account the following aspects of business viz. Expenses, Revenue, Asset, Equity, and Liability. Financial accounting has an important role in increasing profitability and efficiency as it helps in managing all financial resources of the business. It is statutorily required to practice financial accounting in their operations by every business organization.
Few advantages of financial accounting are:
- Maintain Business Record – Financial accounting records each and every transaction of business organization. It systematically maintains a proper book of accounts of all monetary transactions. Unlike human memory which has a limited capacity to remember things, financial accounting can record large amounts of transactions.
- Prevention And Detection Of Fraud – Avoidance, and detection of frauds or errors is an important role played by financial accounting. It records all financial data fairly which is used by management for analysis purposes. This data acts as proof and reduces the chances of any fraud or errors.
- Present True Financial Position – Financial accounting reveals and interprets the true financial position of organizations. It records each financial aspect and supplies it from time to time to the internal management team. Managers get the real ideas of all financial resources of the organization regularly through data supplied by financial accounting. It helps them in making proper decisions for managing the overall financial position.
- Helps In Preparing Financial Statements – Preparation of financial statements is a must for knowing the true profit or loss and real worth of the organization. Financial accounting supplies all relevant accounting data for the preparation of financial statements like profit and loss account and balance sheet.
- Comparison Of Result – Financial accounting helps in comparing the performance of business organizations. It systematically records and stores financial data for many accounting years. This way comparison of present data with previous year’s data can be easily done.
- Acts As Legal Evidence – Financial accounting serves as legal evidence of all data and helps in settling of all business disputes. It prepares and maintains systematic books of accounts of all financial transactions which can be used for avoiding any confusion or misunderstanding.
- Assists The Management – Managers depend on financial accounting for various data for taking managerial decisions. It provides the full information’s regarding all cash flows in an organization. They can easily anticipate any surplus or deficit of funds in an organization and take decisions accordingly.
Disadvantages of Financial Accounting –
Financial accounting is the only branch of accounting and it is not perfect. There are large numbers of limitations which open a new way to use other tools of accounting. To know what are the main limitations of financial accounting. It is very necessary for accountants. Accountants are often blind to these limitations.
- Financial accounting is of historical nature – Net effect of transactions are recorded in financial accounting which has happened in the past. These accounts is just postmortem of all events of business in the past. These records does not help for future planning and other managerial decisions. Financial accounting shows the profitability of the business but it is a failure to tell that is it good or bad. Financial accounting is also a failure to know the reasons of the low profitability position.
- Financial accounting deals with overall profitability – Accounts of business are made by a way which shows only overall profitability. It does not show net profit per product, or per department or according to job. Thus to find it difficult to all activities which do not give profit. So, it creates inefficiency in business activities.
- Absence of full disclosure of facts – In financial accounting, we record only those activities and transactions which we can show or describe in money. There are many other facts of business which are non-financial and non-monetary like efficient management, the demand of products of the firm, good relations in industry, good working environments which cannot be known by financial accounting.
- Financial reports are interim report of business – Financial statements made by financial accounting is the interim report of the firm’s all business work but financial position and profitability which are shown in it is not fully true. Due to adopting cost concept, all transactions are recorded on it real cost but by changing in the time; it is the need of time to adjust the cost of assets and liabilities according to inflation of the market. Because financial accounting does not record according to inflation so its result does not show the true position of the business.
- Incomplete knowledge of costs – From a cost point of view, financial accounting is incomplete. In financial accounting, the accountant does not calculate each and every product’s total cost. So, financial accounting does not help to determine the price of the product of the business.
- No provision of cost control – Financial accounting does not help business organization for controlling the cost. Because there is no provision of controlling cost in it. In financial accounting, we write cost, if we paid any expenses. Thus there is no provision of improvement in financial accounting. Except for this, there is no other way to inspect all expenses.
- Financial statements are affected from personal judgment – Many events of financial statements are affected from personal judgment of the accountant. Method of calculating depreciation, rate of provision of doubtful debts, and stock valuation method are decided by an accountant. Thus, financial statements do not show true and fair view of business.
The financial statements are incorporated for external usage because it is given to people who are not the employee of the company. The primary recipients of this statement are owners/stockholders and few moneylenders. In the case of a corporation’s stock that is traded publicly, the financial statements are circulated publicly such as customers, employees, labor organizations, competitors, and investment analysts.