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What is Financial Accounting? - Definition & Purpose

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  • 0:03 The Purpose of…
  • 1:08 Double-Entry Bookkeeping
  • 1:48 GAAP, FASB & SEC
  • 3:44 Financial Statements
  • 4:20 Lesson Summary
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Lesson Transcript
Instructor: Tammy Galloway

Tammy teaches business courses at the post-secondary and secondary level and has a master's of business administration in finance.

In this lesson, we'll define financial accounting. You'll also learn about generally accepted accounting principles and the reporting requirements for publicly traded versus privately held companies.

The Purpose of Financial Accounting

Juan is so excited he's entering high school. He's going to take a dual credit accounting class, meaning he will receive credit toward high school graduation and college hours.

Juan meets with his counselor to finalize the schedule, and she asks him if wants to take financial or managerial accounting. 'What's the difference?' he asks. The counselor tells him to speak with Mr. Wade, the accounting teacher, then come back and select the class.

Juan finds Mr. Wade in the teacher's lounge and explains his conversation with the counselor. Mr. Wade says he would be happy to explain the differences. He tells Juan managerial accounting provides executives and managers with financial data to make internal business decisions. Managerial accounting reports can be created in any format based on the end user's request, whereas financial accounting provides information about the company's financial health to help the external users to make decisions. Financial accounting creates verified and reliable information based on a set of guided principles. Mr. Wade asks Juan to follow him to the classroom so he can provide further explanation.

Double-Entry Bookkeeping

The first standardization accountants follow in financial accounting is to use double-entry bookkeeping. Double-entry bookkeeping is a system whereby each transaction creates two (double) entries. For example, if a business pays $1,000 in cash for rent, the accountant adds $1,000 to a rent account and subtracts $1,000 from the cash account.

Accountants enter those entries on what we call T accounts. There is a T account for rent and one for cash. On the left side of the T account are debit entries and on the right side of the T account are credit entries. Some accounts increase with a debit, while some decrease with a credit and vice versa.

GAAP, FASB, & SEC

Mr. Wade points to a poster on his classroom wall that shows the acronym GAAP. He asks Juan if he knows what the acronym represents. GAAP refers to Generally Accepted Accounting Principles, which are standards publicly traded companies must follow to report financial data.

The Financial Accounting Standards Board (FASB) established GAAP and makes continual revisions. FASB is a non-profit organization comprised of seven main board members. They, along with their staff, establish standards in reporting to increase confidence in the financials of companies for lenders, investors, and other external users.

Companies are categorized as privately or publicly owned. Privately held companies seek financing through loans, donations, and private investments when they want to expand and grow. They do not necessarily follow a set of standards in reporting. However, companies who seek financing from the public are required to follow GAAP to provide a level of confidence in the reported information.

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