August 8, 2011
The main purpose of accounting is to identify, record, and communicate certain economic events so an organization can determine their financial status and make sound financial decisions. The events are summarized in four basic, but important, financial statements, balance sheet, income statement, retained earnings statement, and statement of cash flow. In this paper, the subject to discuss is the purpose of accounting, how the four statements are interrelated and how they are useful.
The purpose of accounting is for organizations to determine their financial status. Without accounting, organizations will not know the next course of action to take, what their sales versus expenses are, or liabilities versus assets. The organization will not know if they can process paychecks, hire a new employee, or raise prices on goods and services. Identifying every economic event that relates to an organization, for example, sale of goods or payment of wages is the first step in accounting. Next, recording those events creates a history, then communicating the events by means of accounting reports and financial statements. A number of people and other organizations, internally and externally can view these statements for business, investing, and research purposes.
Each financial statement has its own, and shares some of the same information. Financial statements typically must comply generally accepted accounting principles (GAAP). These principles came from two groups, the Financial Accounting Standards Board (FASB) and the Securities and Exchange Commission (SEC). For example, the income statement, retained earnings statement, and statement of cash flow indicate the period to which they apply. The balance sheet gives a specific date. Each statement also has a similar heading stating the organization name and the kind of statement. The terminology in each statement also must follow the generally accepted accounting principles. These basic terms are “assets, liabilities, equity, revenues, and expenses” (Weygandt, 2008, p. 297).
Organizations create income statements first because information from the statement is used in other statements. For example, the net income from the income statement is also in the retained earnings statement. The retained earnings from the retained earnings statement is also in the balance sheet. The cash from the balance sheet is also in the statement of cash flow. Usually included with the financial statements is one set of notes instead of notes for each statement.
The four financial statements are an important means of communicating the financial status and accounting information of an organization to anyone that has interest in the organization. Those people include managers, investors, employees, creditors, and any others that have an interest in the organization.
Managers use these statements to review product profitability. They may also review the cash flow statement to see where the money goes and to see if they can be more efficient. More specific, Human Resources managers will look over the reports to see if the organization can afford to give the employees pay raises. They look at the income statement from one period to the next to look at sales and expenses and look for any big changes. On the balance sheet, they pay attention to liabilities and assets and watch for any changes that they may need to