In commercial enterprises accounting is involved in recording business transactions and then reporting the results in the form of financial statements.
To make the financial statements more understandable, there are some common rules known as generally accepted accounting principles (GAAP). In the USA the lead organization for researching and issuing the accounting rules is the Financial Accounting Standards Board (FASB).
All of the accounting rules are based on some underlying or basic accounting principles such as cost, matching, economic entity, going concern, revenue recognition, full disclosure, materiality, conservatism, and others. Accountants also strive for the financial reporting to be relevant and reliable.
The accounting system is known as double entry, because every transaction will involve at least two accounts in a company's general ledger. The accounting system requires that at least one account be debited (amount entered on the left side) and one account be credited (amount entered on the right side).
The accrual basis of accounting provides a better picture of a company's financial results than the cash basis of accounting. Under the accrual basis of accounting, revenues and assets are reported when they are earned; expenses and liabilities are reported when they are incurred.
The output of the accounting system includes five financial statements:
- Balance sheet or statement of financial position
- Income statement, statement of earnings, statement of operations, or profit and loss (P&L)
- Statement of comprehensive income
- Statement of cash flows or cash flow statement
- Statement of stockholders' equity
The balance sheet reports a corporation's assets, liabilities, and stockholders' equity as of the final moment of the accounting period. The other financial statements report the amounts that occurred during a specified accounting period.
The notes to the financial statements are required to disclose important information not communicated by the amounts on the face of the financial statements.