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What is Financial Accounting?

Financial accounting deals with the reporting of information to people outside of an organization.




Financial accounting involves the preparation of statements such as the profit and loss (also known as the income statement), the balance sheet, the statement of cash flows, and the statement of stockholders equity. If you take a look at the quarterly and annual reports filed by publicly traded companies these are the reports that you will find. In addition to those reports there will be a lot of additional footnotes and other wordy documents included in the business filings. Some of these footnotes can contain information that is more telling of a company's financial position than the actual numbers on the reports. Companies are required to include footnotes on things such as pending lawsuits, long term debt that will be renewing, and other important information.


Is This Information Trustworthy?

The information filed by publicly traded companies is audited on an annual basis. An audit report will accompany the filings and will include if the company has received an unqualified audit opinion or if there are things that are not fairly represented. An audit does not indicate that there is no fraud within the company. It's impossible for an audit to cover ever single transaction. Rather the audit aims to limit the risk of a material mistatement to an acceptable level.


What's a Material Mistatement?

A material mistatement is information that is not represented accurately and is likely to change the actions of the user of the financial information, such as an investor. In other words if Google fails to record a $1,000 purchase of some office supplies it's not likely to cause investors to not purchase stock. On the other hand not notifying their investors of pending litigation that could cause Google to be ordered to pay $5 million in damages would be a material mistatement. It's all relative to the size of the company.


Financial accounting is different from managerial accounting which focuses on the information used within the company.