The financial accounting process consists of
- categorizing past transactions and events,
- measuring selected attributes of those transactions and events, and
- recording and summarizing those measurements.
The first step places transactions and events into categories that reflect their type or nature. Some of the categories used in financial accounting include (1) purchases of inventory (merchandise acquired for resale), (2) sales of inventory, and (3) wage payments to workers.
The next step assigns values to the transactions and events. The attribute measured is the fair value of the transaction on the exchange date. This is usually indicated by the amount of cash that changes hands. If equipment is purchased for a $1,000 cash payment, for example, the equipment is valued at $1,000. The initial valuation is not subsequently changed. This original measurement is called historical cost.
The final step in the process is to record and meaningfully summarize these measurements. Summarizing is necessary because, otherwise, decision makers would be overwhelmed with an extremely large array of information. Imagine, for example, that an analyst is interested in Ford Motor Company’s sales for 1998. Providing a list of every sales transaction and its amount would yield unduly detailed information. Instead, the financial accounting process summarizes the dollar value of all sales during a given time period and this single sales revenue number is included in the financial statements.