Financial accounting information plays an important role in an economy. It is used by managers, investors, financial analysts, creditors, regulators, and even employees and customers on occasion. All these people need to understand both the current financial status of an organization, as well as the events that caused a change in that status from some prior point in time.
The purpose of an accounting system is to collect, summarize, and report information concerning the impact of various business events on an organization’s financial status and financial performance. Organizations periodically report their financial status as of a certain date, and their financial performance for some period of time preceding that date, called the accounting period. They do this on four separate financial statements: the balance sheet, the income statement, the statement of retained earnings, and the statement of cash flows.
The balance sheet is a financial status report prepared as of the last day of the accounting period. The income statement is a financial performance report for the accounting period. The statement of retained earnings explains the changes that took place in owners’ (as opposed to lenders’) claims on the organization. The statement of cash flows, or SCF, explains in an organised way the reasons for any change in
The role of an auditor: although an audit could be conducted by a single certified public accountant (CPA), most audit are done by teams. The team usually consist of the head auditor who is in charge of the audit and several other members of the firm’s partner. The auditors’ role is to determine if an organization,their client followed GAAP in the preparation of its financial statements. At the conclusion of its audit, the auditors issue an opinion letter, usually signed by the firm itself, not by the individuals who conducted the audit. The opinion letter states that the auditors conducted all reasonable tests to ascertain whether the company’s accountants followed GAAP in preparing the financial statements.4
If the auditors believe that the company followed GAAP, and that there were no material errors or omissions, they give the company a clean opinion. If, in the auditors’ judgment, the company did not follow GAAP, or if the auditors believe there were material errors or omissions, they give the company a qualified opinion. In giving a qualified opinion, the auditors indicate that the accuracy of the financial statements is subject to question in certain areas, which they specify in their opinion letter.
If we look at what a person owns as of a point in time, we are concerned with the level of resources. If we look at earnings and expenses, we are concerned with resource flows.
In accounting, levels are called assets, liabilities, and equity, and flows are called revenues and expenses. All of these will be discussed in this Note. Beginning with flows, revenues arise from the sale of a company’s goods or services to its customers, and expenses are incurred by the company in the course of earning its revenues. Example of expenses are the rent a company pays for its offices and the salaries of its employees. The difference between revenues and expenses is called income. Income can have many modifiers, such as operating income, income before tax, and net income
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