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Financial accounting standards are a set of standards, guidelines, and concepts that are critical to a shared understanding of business performance throughout a marketplace. While these standards are invoked by governmental regulatory agencies, their real importance is in facilitating the ability of owners, investors, and consumers to make good financial decisions based on commonly shared definitions and calculations. These standards were developed over time by professional accountants.
The environments in which financial accounting standards are applied affect their usefulness. Industries often vary tremendously in cost structure and profit potential. While the standards are applied to an individual company and not to an industry, over time certain patterns will emerge in a given industry because of consistent application of the standards. This accumulated result then increases the importance of the financial accounting standards beyond each individual business.
The basic financial accounting standards used within the United States have addressed six major areas, called concepts. These include financial reporting by businesses (Concept No. 1) and non-business organizations (No. 4), proper use of financial statements (Nos. 5 and 6), quality in accounting data (No. 2), and use of cash flow information (No. 7). Concept No. 3 has been incorporated into other concepts.
The objective of these six concepts is to establish good accounting principles and to enable an accountant to recognize when an accounting event has been reported in a quality fashion. Quality considerations include an evaluation of data accuracy, timeliness, method and persons of collection, and verification. Additional concerns include the appropriateness of the data and its correct representation. The evaluation of accounting data often requires interpretation of the standards by the accountant. The financial accounting standards try to convey the spirit of the standards through guidance and discussion.
A set of financial statements for a business is a key concept within financial accounting standards. Typically, such statements are comprised of three elements. A profit and loss statement covers a specified period, often a year, and lists the revenues and expenses of the business during that year. The difference is either the profit or loss for the business for the period.
A balance sheet is a list of accounts at a particular point in time. The differences in the equity portion of the balance sheet from one year to a prior year should match the profit or loss from the intervening profit and loss statement. A cash flow statement explains the sources and uses of cash.