By: Les Heitger
Accounting is sometimes called the “language of business,” implying that in organizations there would be little effective communication of financial information without it. Because all organizations (both for-profit and not-for-profit) operate with limited resources, it is essential for them to understand the financial consequences of what they do. Of course, not everyone thinks accounting information is an essential or a positive part of the successful operations of organizations.
I do not suggest that all accounting reporting systems are completely effective, nor will I tell you they are error free. However, the vast majority of accounting reports, both for external stakeholders and for internal users, play an essential role in the effective and efficient operations of ALL organizations that attempt to use wisely the scarce resources at their disposal.
Accounting systems are designed to provide relevant, timely, and accurate financial information. The two major functional areas of accounting are financial accounting, which provides information primarily for external users (stakeholders), and managerial accounting, which provides information primarily for internal users (managers in an organization).
This article focuses on the significant role of financial accounting in a vibrant economy. Many people are familiar with financial aAccounting reports. The two main reports used are the income statement and the balance sheet. First, the income statement measures the amount of revenue earned during a period and the amount of expenses incurred during the period. The resulting number is referred to as net income, income or profit. Income statements cover a period of time — typically a year — but can be prepared for any period of time (e.g., monthly or quarterly). Second, the balance sheet reports the balance in all asset, liability and owners’ equity accounts at a specific point in time such as the end of an accounting period. For example, a company may prepare its income statement for the year 2016, with the balance sheet capturing those numbers as of Dec. 31, 2016.
Traditional financial statements are used extensively by investors, lenders, regulators and anyone else who wants to know something about a company and its financial health. Because financial statements are prepared using a standard set of rules/guidelines — Generally Accepted Accounting Principles (GAAP), or other international standards of financial reporting — users have a common basis for comparing the financial information across different businesses. Because users of these financial statements want assurance that the statements were prepared properly, many companies choose (or in some cases are required) to have their financial statements audited by an independent external auditor. Using Generally Accepted Auditing Standards (GAAS), auditors evaluate the financial statements of a firm and express an opinion about whether the statements fairly present the company’s financial condition. This seemingly simple process is absolutely essential for capital markets to exist and function effectively. Investors would not risk putting their capital in companies unless they felt they had a good way to determine how well their investments were performing. Financial reporting based on GAAP and independent audits conducted using GAAS gives investors and financial markets the assurance they need to function efficiently and effectively; and, economies tend to prosper in such environment.
A future article will discuss managerial accounting, the second major function of accounting systems, which focuses on providing internal managers with the essential information they need to effectively manage each segment of their business.
Professor Les Heitger, Ph.D., CPA, is the BKD Distinguished Professor of Forensic Accounting in the School of Accountancy at Missouri State University, He is the national president of the Forensic Accounting Section of the American Accounting Association, he is co-author of “Forensic and Investigative Accounting” and he teaches primarily graduate forensic accounting courses. He can be reached firstname.lastname@example.org
This article appeared in the July 23, 2016 edition of the News-Leader and can be accessed online here.