Accounting & Finance

Abstract

A largely accepted language is required for a business or organization to effectively communicate its results and position to stakeholders, which is why accounting has come to be known as the "language of business". Accounting is really the means for providing financial information to others. Financial analyst then take the data the accountants have compiled in the form of reports, and make educated guesses at what their company should do next. David ballast (1996) stated, "The fact remains that accounting and finance are the primary tools for reducing business problems and opportunities to a common denominator, setting goals, measuring results, and making decisions." (p. 1)

Accounting & Finance

Distinguishing between Accounting & Finance

Both accounting and finance deal with money and assets; however, they are categorically different concepts. This portion of the essay will discuss the dissimilarities between accounting and finance. Examples of different concepts will be given for both practices.

Accounting as a discipline is more of a law, whereas finance is more of a theoretical practice. Accounting has clearly defined guidelines, rules and regulations. As defined by Wikipedia (2005), "accounting is the measurement, disclosure or provision of assurance about information that helps managers and other decision makers make resource allocation decisions".

Two key disciplines in accounting are financial accounting and auditing. Financial accounting involves processes by which financial information about a business is recorded, classified, summarized, interpreted, and communicated (Wikipedia, 2005). Auditing is a related to financial accounting, but it is a separate discipline. "Auditing is the process whereby an independent auditor examines an organization's financial statements in order to express an opinion that conveys reasonable but not absolute assurance as to the fairness and adherence to generally accepted accounting principles." (Wikipedia, 2005)

As previously stated, finance as a discipline or a science does not have clearly defined guidelines and/or regulations, but is more of a theoretical practice. Finance is defined as the "management of money, banking, investments, and credit" (The American Heritage Dictionary, 2004). It manages the ways in which individuals, businesses, and organizations raise, allocate, and use monetary resources over time, taking into account the risks entailed in their projects (Wikipedia 2, 2005).

Brealy, Myers, and Marcus (2004) suggest, "Financial decisions are rarely cut and dried, and the financial markets in which companies operate are changing rapidly" (p. VII). However, Donald MacKenzie (2004) suggests, "over the last fifty years, the academic study of finance has been transformed from a largely descriptive, non-mathematical enterprise to a highly analytical one in which sophisticated mathematics is deployed" (p. 4).

Balance Sheets & Income Statements

In order to make informed business decisions one must be able to understand the financial statements of a business. Two of the financial statements that one needs to know and understand are the balance sheet and the income statement. This section of the paper will analyze these two financial statements and their relationship to each other.

According to Marshal (2004), "The balance sheet is a listing of the organization's assets, liabilities, and owners' equity at a point in time. In this sense, the balance sheet is like a snapshot of the organization's financial position, frozen at a specific point in time. The balance sheet is sometimes called the statement of financial position because it summarizes the entity's resources (assets), obligations (liabilities), and owners' claims (owners' equity)."

A company usually creates the balance sheet at the end of a company's fiscal year or at the end of each quarter. The equation that the balance sheet is derived from is: Assets = Liabilities + Owners' equity. Assets are probable economic benefits of a company because of past transactions. Liabilities are sacrifices of economic benefits due to past decisions or transactions. Owners' equity is what belongs to the owner after the liabilities is subtracted from the assets (Marshal, 2004). As the name indicates both sides of the equation must always be equal.

While the balance sheet is a snapshot at the end and beginning of a given period, the income statement shows the activities that got the balance sheet from the beginning to the end of any given period. The "principal purpose of the income statement...is to answer the question: 'Did the entity operate at a profit for the period of time under consideration?'" (Marshal, 2004).

The balance sheet and the income statement are interrelated in that every transaction made on the income statement shows up on the balance sheet as either an increase or decrease to either the assets or the liabilities. The link between the balance sheet and the income statement is the statement of changes in owners' equity.

Accounting Theories, Assumptions, & Principles

Over the years, several accounting concepts or principles have been developed. These principles are not laws but the financial world generally follows and accepts them. Looking at the different financial statements, one can see these accounting theories, assumptions, and principles are generally adhered to. This section will discuss four of these principles as they pertain to the big picture of accounting, the various transactions that are made, bookkeeping, and financial statements.

1. The Big Picture

The financial equation mentioned above (assets = liabilities + equity) "is the mechanical key to the entire financial accounting process", and the basis to many of these principles (Marshal, 2004). Each individual business has its own financial statements, is its own accounting entity, and is defined by the business' accountant. When doing the accounting one of the assumptions is that the company is going to continue and that next week or next year the company will still exist. This assumption is known as the going concern concept.

2. Transactions

Two of the principles or concepts that are related to transactions are the cost principle and objectivity. The cost principle simply states that the transaction