In simple terms, accounting is the process by which information is processed to provide information to a decision maker about the financial condition and resources of a company. The information processed through accounting includes balance sheets (a statement of comprehensive account), income statement (a statement of income including cash flow and balance sheet items), statement of cash flows (which reports the flow of funds in and out of a company), and note. A company may have one or more issued notes. A note is a promissory note for credit or debt.
All financial statements will report an item called ‘financial ratio’, which is calculated as the annual income or net income divided by the market cap or equity of the company. This ratio is also known as the P/L ratio or net book value. The greater the net book value of a company’s equity, the higher the P/L or financial ratios. All of these financial ratios are important in the assessment of a company’s health.
Accounting is used alongside financial reporting in the creation of balanced or net income statements. All of the important financial ratios are calculated using the balance sheet. When the financial statement and the income statement of cash flows are used together, they form a statement of equity. The balance sheet can also be used alongside financial statements to determine the value of stock options. The historical cost of capital for a company is also reported on a balance sheet.
All of the activities that a company does are reported on the balance sheets. Activities that do not impact the balance sheet directly, but which have an effect on the financial statements are accounted for by operating expenses, and a profit or loss statement is then prepared. All significant events that have a direct effect on the company’s performance are documented on the balance sheets as well. These events can include the acceptance of a capital lease, the signing of a master operating contract, the issuance of one or more securities in the open market, an assignment of management accounts to an outside investment entity, the sale of one or more equity shares, the recording of a debt extinguishment, the transfer of one or more assets between owners or within one transaction, or an initial public offering (IPO).
An important aspect of accounting is the measurement of its results in terms of the costs of assets or liabilities. The accounting report is called a cost basis. Under the master costing method, costs of assets or liabilities are measured at the date of preparation of the income statement or balance sheet. Under the fair value method, costs of assets or liabilities are measured at the date of transaction for the issuance or repurchase transaction.
A company must prepare its financial statements and records in accordance with generally accepted accounting principles (GAAP). An accounting statement contains the information necessary for the preparation of the company’s financial reports and should be prepared in the standard format. It consists of four parts. The first part is the income statement, which includes the income statement, balance sheet, and statement of cash flows. The second part is the statement of business control, which includes the statement of control assets as well as liabilities.