When it comes to understanding how Financial Accounting works in SAP, it helps to take a step back from the ERP software and digest (at least) the basic accounting concepts first. The basic concepts should help you link basic accounting to financial accounting in SAP.
This in turn will give you a backbone of understanding the purpose of SAP Finance functionalities, behaviors, configurations, and more.
If you read my previous post on 10 BIG Tips for SAP FICO Consultants – Career Journey (First Few Months), I mentioned that I took up an online accounting course to further aid my understanding on the topic. I personally decided to pursue the online course on top of the SAP resources provided by the company I was working in because I felt that I needed more accounting knowledge.
At the time I thought “Hey, it could serve as a refresher (maybe) or even a huge chunk of valuable information”. At the end of the day, this approach helped me associate the basics to the overall functionality and use of SAP in terms of finance.
If you think this approach will help you then I highly encourage you to try it. It may not work for everyone, but I am sharing this insight in case you feel it is worth a try – even if it is through free courses, YouTube videos, free learning materials, etc.
This post will not serve as that basic accounting course rolled up into one blog post. Instead, it will focus on some of the important parts such as an introduction to accounting and the financial statements.
This is me trying to avoid information overload. I plan to write more on basic accounting through a series of posts so you can expect more of this topic in the future.
- What is Accounting?
- What are the Financial Reporting Requirements?
- Who Makes the Rules?
- Who is Responsible for Financial Reporting?
- What are the Required Financial Statements?
- Additional Information
What is Accounting?
As seen on Investopedia’s definition on “What is Accounting?”, accounting is the process of recording financial transactions pertaining to a business.
My personal take is that you can also think of accounting as a huge notebook (with guidelines or rules) filled with the financial transactions of a business. This notebook must keep track and should contain the financial transactions of the business.
…Okay, so why do we have to record or keep track of the financial transactions of a business?
A business exists because at the end of the day it provides some service or product to its customers in exchange for money. The goal of the business is to ultimately earn profit from the services they provide and/or products they sell.
In order for a business to understand its performance in context of that goal, it needs to have realistic data to analyze. As such, a business needs to keep track of the business transactions that happen.
What are the Financial Reporting Requirements?
It is not as simple as keeping track of the business transactions in a notebook according to your preference.
Recall our association to accounting with a huge notebook containing the financial transactions of the business. Before you can write something in the notebook, consider that there are certain guidelines and rules for note taking.
Everything that is written in that huge notebook needs to consider the guidelines and rules. Aside from recording business transactions in that huge notebook to know the business performance, a business needs to provide the information to those who require the information.
After all, a business must be kept in check.
Putting up a business requires you to follow certain country policies, procedures, etc.
The business would have to pay taxes, meet certain standards, and comply with the requirements of running the business.
Let us say we are talking about a company called “Company ABC”.
This company, needs to provide periodic financial statements to those who require the information such as the Securities and Exchange Commission (SEC).
Periodic in this case includes annual reporting, quarterly reporting, and current reporting – anything important enough to move stock price.
Who Makes the Rules?
Earlier I mentioned that you can also think of accounting as a huge notebook (with guidelines or rules) filled with the financial transactions of a business. Basically, there must be some sort of formality and accepted guidelines as to how accounting would work. With this, allow me to introduce the following: GAAP and IFRS.
Generally Accepted Accounting Principles (GAAP)
GAAP was established by the US Congress who delegates to the SEC who delegates to FASB that is composed of EITF and AICPA. Yes, that is a lot of acronyms and groups. Here are the acronym definitions below.
- SEC – The Securities and Exchange Commission
- FASB – Financial Accounting Standards Board
- EITF – Emerging Issues Task Force
- AICPA – American Institute of CPA’s (Certified Public Accountants)
International Financial Reporting Standards (IFRS)
IFRS was established by the IASB and are required in over 100 countries. You can read more about this in IFRS: Beyond the Standards.
- IASB – International Accounting Standards Board (London based EU)
Overall, US GAAP is required for US firms.
Who is Responsible for Financial Reporting?
In general, management is responsible for the preparation of the financial statements. The management holds primary responsibility for the published financial statements ensuring that they are not misleading, does not contain fraud and irregularities, etc.
You can read more about this in Management Responsibility.
…But wait… isn’t that like grading yourself or grading your own company?
Yes, but that is why there is such a thing as an “audit committee”. Auditors are hired by the board of directors to “express an opinion” about whether the financial statements are prepared in conformity with GAAP.
The SEC and other regulators can take action against a firm if any violators of GAAP or other rules are found. In addition, other intermediaries such as stock analysts, institutional investors, even the media, may expose firms with questionable accounting.
At some point in time you might have seen related news on the matter throughout the years.
What are the Required Financial Statements?
We have 4 Required Financial Statements. This is to introduce the financial statements for now.
- Balance Sheet
- Income Statement
- Statement of Cash Flows
- Statement of Stockholders Equity
To make things a bit simpler for us, (moving forward) let us consider that Company ABC must provide financial statements / reports every month and every year. We will discuss (in detail) each of these financial statements throughout our basic accounting post series and use Company ABC as an example.
The 3 Sets of Books (or notebooks)
We talked about having a huge notebook with all the business transactions in it (written according to the guidelines).
In every business, it helps to keep the notebook organized. As such we can categorize these books (or notebooks into 3):
- Financial Accounting – Focuses on standardized reports for external stakeholders / those who need the information.
- Tax Accounting – Focuses on computing taxes payable according to IRS rules. IRS pertaining to Internal Revenue Service. You can read more about this on Tax Accounting.
- Managerial Accounting – Focuses on custom reports for internal decision making. This is for internal use purposes only and these are not necessarily provided to the public.
How are these “books” or “categories” associated to SAP?
- Financial Accounting – SAP FI
- Tax Accounting – SAP FI
- Managerial Accounting – SAP CO
Let us quickly add some notes onto the previous image. In the image below, we can see an overview or summary of what we have discussed.
At the end of the day, businesses need these kinds of data to understand and know their financial position and performance. In addition, businesses need to be able to provide these information to those who require them.
NOTE: Future posts on the basic accounting series will be linked here. Alternatively, feel free to browse through the content hub as needed.
I hope this helps. Good luck! 😊
I would be happy to hear from you! Feel free to send me an email or leave a comment down below if you have questions / feedback.