Accounting Is The Language Of Finance Accounting Essay

Category: Accounting

If "accounting is the language of finance" (Lasher 2008, p.9), then financial accounting is the "communication of financial information useful for making investment, credit, and other business decision."(Wild et al. 2009, p. 681). No matter in large-scale business or small-scale business, financial accounting plays a prominent role in decision making process because decision making process, for instance, investment and loaning money, requires realistic and objective financial information which come from accounting. Accounting, fundamentally, gathers processes, examines past and current financial data for the purpose of evaluating performance and estimating future risks and potential and then directs them to interested parties. In the following, we are going to discuss:

What are the major objectives of financial accounting?

What is relevant information?

Who are the users of the financial reporting?

Whether and why the financial market needs financial reporting?

How is the role of financial accounting to assist in efficient resources allocation?

What are the major objectives of financial accounting?

According to Statement of Financial Accounting Concepts (SFAC) No.1(Delta Publishing Company 2006) , there are three main objectives of financial reporting.

First of all, since financial reporting provides whole number of different instruments and analyses procedures for understanding business, that can help present and potential investors and creditors and other users to make rational decisions such as investment, credit and other similar decisions, so that they can have a legitimate understanding of economic and business activities.

Secondly, financial reporting should assist present and potential investors and creditors and other users to evaluate the timing, amounts, and uncertainty of expected cash receipts from interest or dividends and the profit from the sales, ransom, or maturity of securities or loans. Moreover, investors and creditors' cash flows and enterprise' cash flows have a very close relationship, financial reporting can assist investors and creditors to evaluate the timing, amounts and uncertainty of expected net cash inflows to the related enterprise.

Thirdly, users of financial reporting can get the information of economic resources of an enterprise, the claims to those resources (responsibilty of the enterprise to shift resources to other entities and owners' equity), and the effects of transactions, events, and circumstances that influence its resources and claims to those resources.

What is relevant information?

Firstly, relevant information is the predicted future costs and revenues that are distinct among the alternatives. That means, information has to be an expected future revenue or cost, and it must have an element of difference among the alternatives. (Horngren et al. 2011) For instance, suppose you always purchase apples from either of two nearby fruit stores. Yesterday you realized that one store was selling apples at $2.00 each and the other store was selling apples at $1.90 each. Your apple juice store requires apples to produce juice today and in you decision making process of choosing which store to buy apples, you assume that the prices haven't changed. In this case, the relevant cost is $2.00 and $1.90, the expected future costs that will differ between the alternatives. For the irrelevant information, for instance, you plan to purchase a bag of tomatoes and suppose you expect the price of a bag of tomatoes to be the same at either station, the expected future cost is irrelevant to your decision pertaining to which station to stop at because it will be the same under either alternative. Moreover, we have to note that relevant information is not a summary of the past, i.e. historical or past information because the decision cannot alter what has already happened.

Who are the users of the financial reporting?

The users of financial statement analysis are creditors, investors, managers, security analysts, banking lending officers, taxing authorizes, regulatory agencies, labour unions, customers, and many other parties who base on the financial data to make decision for a company.

Financial statement analysis mainly focuses on the data coming from external reports as well as supplementary information coming from management. From the analysis, various users relay on financial statement analysis to identify significant changes in trends, amounts, and relationship. For instance, when a manager of a manufacturing company discovers that the product returns are high in the internal financial and inventory report. Then the manager should investigate into the reasons of product returns and improve the control of product quality. Moreover, investors need realistic and objective information to determine the potential earning ability of a company because the earning ability of the company will influence the market price of company's stock and the amount of dividends the company will pay. Then they will determine whether they should sell, buy or hold onto a specific company's stock. In addition, creditors have to base on the financial statement analysis to determine the potential debt-paying ability of the company.

Whether and why the financial market needs financial reporting?

Financial market needs financial reporting because the information of financial reporting can help examine the entire business quality (security plus efficiency) and make decision for future and the four most prominent financial statements are balance sheet, income statement, cash flow statement and statement of changes in owner's equity.

Firstly, balance sheet shows financial position of a company and serves as a basis for accessing the security of business. There are three aspects including assets, liabilities and owner's equity in balance sheet and assets are always equal to liabilities and owner's equity.

Secondly, income statement shows the performance of a company at a particular time period such as profit or loss by subtracting revenues and expenses. If revenues exceed expenses, it is profit, vice versa. Besides, it serves as a basis for accessing the efficiency of business which is an ability of achieving specific goals.

Thirdly, cash flow statement shows cash receipts and cash expenditure and their difference, i.e. cash flow

.

Finally, statement of changes in owner's equity shows all transaction which refers to profit or loss for a particular time period.

How is the role of financial accounting to assist in efficient resources allocation?

Resource allocation always determines the successful of business. A successful resource distribution could help companies to maximize their profits with the minimum costs. To allocate resources in a efficient way, a set of standard or criteria is required and financial reporting. These standard or criteria could be obtained by the financial reports. Companies may use the financial statement to convert the information into useable data for different purpose, such as business quality measurement. Through the converting process, they can recognize the strength of itself and so that they can make use of those advantages. And by recognizing company's weakness, they may reallocate their resources and take correction actions. For instance, in 2011, HSBC (HK) announced that they would axe 3000 jobs by the end of 2013 and the primary focus would be in legal, HR and back office position. Such decision making is based on the cost efficiency rate (CER)which found on the financial report due to the CER in Hong Kong was below average. Up to this point, we can see the financial accounting is acting as a role of standard or criteria to helps companies allocate their resource efficiently.

Words: 1188