Where to Go from Here
Each chapter stands on its own, so no matter where you start, you won’t feel like you’re coming in on a movie halfway through. Your motivation for purchasing this book will likely dictate which chapters you want to read first and which you’ll read only if you have some spare time in the future.
If you’re a financial accounting student, flip to the chapter explaining a topic you’re a little fuzzy on after reading your textbook. Business owners can get a good overview of the financial accounting process by starting with Chapters 1 and 3; these two chapters explain the nuts and bolts of financial accounting and its concepts. Otherwise, check out the table of contents or index for a topic that interests you, or jump in anywhere in the book that covers the financial accounting information you’re wondering about.
Part 1
Getting a Financial Accounting Initiation
IN THIS PART …
Discover why financial accounting is so important to many different individuals and businesses.
Get a brief overview of the three financial statements: the balance sheet, income statement, and statement of cash flows.
Learn information relevant to small business owners.
Meet the various financial accounting standard-setting and regulatory organizations, such as the Financial Accounting Standards Board (FASB) and the U.S. Securities and Exchange Commission (SEC).
Chapter 1
Seeing the Big Picture of Financial Accounting
IN THIS CHAPTER
I assume that you have a very good reason for purchasing this book; most people don’t buy a title like Financial Accounting For Dummies on a whim in the bookstore. Most likely, you’re taking your first financial accounting class and want to be sure you pass it, but perhaps you’re a business owner wanting to get a better handle on financial statement preparation. Whatever your motivation, this chapter is your jumping board into the pool of financial accounting.
I explain what financial accounting is and why it’s so important to many different individuals and businesses. I spell out the various users of financial accounting data and explain why they need that data. Finally, I briefly introduce four all-important characteristics of financial accounting: relevance, reliability, comparability, and consistency. Whether you’re a financial accounting student or a business owner, you need to understand these crucial financial accounting terms from the very beginning.
Knowing the Purposes of Financial Accounting
Broadly speaking, accounting is the process of organizing facts and figures and relaying the result of that organization to any interested customers of the information. This process doesn’t just relate to numbers spit out by a computer software program; it pertains to any type of reconciliation.
Here’s an example from my own life of accounting that doesn’t involve numbers or money: A teenager slinks in after curfew, and his parent asks for a complete accounting of why he is late. When the teenager tells the facts, you have information (his car broke down in an area with no cell coverage), the individual producing the information (the mischievous teen), and the interested customer, also known as the user of the information (the worried parent).
The subject of this book, financial accounting, is a subset of accounting. Financial accounting involves the process of preparing financial statements for a business. (Not sure what financial statements are? No worries — you can find an overview of them in the next section.) Here are the key pieces of the financial accounting process:
Information: Any accounting transactions taking place within the business during the accounting period. This includes generating revenue from the sales of company goods or services, paying business-related expenses, buying company assets, and incurring debt to run the company.
Business entity: The company incurring the accounting transactions.
Users: The persons or businesses that need to see the accounting transactions organized into financial statements to make educated decisions of their own. (More about these users in the “Getting to Know Financial Accounting Users” section of this chapter.)
Preparing financial statements
If you’re taking a financial accounting class, your entire course is centered on the proper preparation of financial statements: the income statement, balance sheet, and statement of cash flows. Financial accountants can’t just stick accounting transaction data on the statements wherever they feel like. Many, many rules exist that dictate how financial accountants must organize the information on the statements; these rules are called generally accepted accounting principles (GAAP), and I discuss them in Chapter 4. The rules pertain to both how the financial accountant shows the accounting transactions and on which financial statements the information relating to the transactions appears.
Curious about the purpose of each financial statement? (I know the mystery is eating at you!) Here’s the scoop on each:
Income statement: This financial statement shows the results of business operations consisting of revenue, expenses, gains, and losses. The end product is net income or net loss. I talk about the income statement in Chapter 2, and then I cover it from soup to nuts in Chapter 10. For now (because I know the excitement is too much for you!), here are the basic facts on the four different income statement components:Revenue: Gross receipts earned by the company selling its goods or services.Expenses: The costs to the company to earn the revenue.Gains: Income from non-operating-related transactions, such as selling a company asset.Losses: The flip side of gains, such as losing money when selling the company car. A lot of non-accountants call the income statement a statement of profit or loss or simply a P&L. These terms are fine to use because they address the spirit of the statement.
Balance sheet: This statement has three sections: assets, liabilities, and equity. Standing on their own, these sections contain valuable information about a company. However, a user has to see all three interacting together on the balance sheet to form an opinion approaching reliability about the company.Part 3 of this book is all about the balance sheet, but for now here are the basics about each balance sheet component:Assets: Resources owned by a company,