Purpose of Financial Accounting
1. Providing information to investors and creditors: Financial accounting provides investors and creditors with information about a company’s financial position, performance, and cash flows. This information is used to assess the company’s risk and potential return and to make informed investment and lending decisions.
2. Ensuring transparency and accountability: Financial accounting helps to ensure that companies are transparent about their financial affairs and accountable to their stakeholders. This helps to protect investors and creditors from fraud and mismanagement.
3. Facilitating economic decision-making: Financial accounting provides information that is used by businesses, governments, and other organizations to make informed economic decisions. For example, businesses use financial accounting information to make decisions about pricing, production, and investment.
4. Promoting financial stability: Financial accounting helps to promote financial stability by providing information that can be used to identify and mitigate financial risks. This can help to prevent financial crises and protect the economy.
5. Measuring financial performance: Financial accounting provides a standardized framework for measuring a company’s financial performance. This allows companies to compare their performance to other companies and to track their performance over time.
GAAP and IFRS
GAAP is a set of accounting standards and principles that govern how companies prepare their financial statements. It provides a consistent framework for measuring, recording and reporting financial transactions and events. The primary purposes of GAAP are:
- To provide a common language for business: GAAP establishes a uniform set of accounting rules and definitions, allowing companies to present their financial information in a way that is understandable to users around the world.
- To enhance the comparability of financial statements: By requiring companies to apply the same accounting standards, GAAP enables users to compare the financial statements of different companies on a fair and consistent basis.
- To improve the transparency and reliability of financial reporting: GAAP promotes transparency by requiring companies to disclose relevant financial information in a clear and concise manner. It also enhances reliability by ensuring that financial statements are prepared on a sound and consistent basis.
- To protect investors and creditors: GAAP provides a framework for measuring and reporting a company’s financial position, performance, and cash flows. This information is critical for investors and creditors to assess the company’s risk and potential return, and to make informed investment and lending decisions.
Purpose of Cost Accounting
Unlike cost data used for financial reporting to shareholders, cost data used for managerial purposes (that is, within the company) does not have to conform to GAAP or IFRS. Management is permitted to define cost information in its own way. Indeed, accounting data utilised for external reporting is frequently completely unsuitable for managerial decision-making.
For example, managerial decisions concern the future, and hence estimates of future costs are more helpful for decision-making than externally reported historical and current expenses. Unless otherwise stated, we assume that the cost information is being created for internal use by managers and is therefore exempt from GAAP or IFRS compliance.
This does not mean there is no “right” or “wrong” way to account for costs. It does mean that the best, or correct, accounting for costs is the method that provides relevant information to the decision-maker so that he or she can make the best decision.