The financial statements of a company are end-products of a process for recording transactions of the company related to operations, financing, and investment. The structures of financial statements themselves reflect the system of recording and organizing transactions. To be an informed user of financial statements, the analyst must be knowledgeable about the principles of this system. This reading will supply that essential knowledge, taking the perspective of the user rather than the preparer. Learning the process from this perspective will enable an analyst to grasp the critical concepts without being overwhelmed by the detailed technical skills required by the accountants who prepare financial statements that are a major component of financial reports.

This reading is organized as follows: Section 2 describes the three groups into which business activities are classified for financial reporting purposes. Any transaction affects one or more of these groups. Section 3 describes how the elements of financial statements relate to accounts, the basic content unit of classifying transactions. The section is also an introduction to the linkages among the financial statements. Section 4 provides a step-by-step illustration of the accounting process. Section 5 explains the consequences of timing differences between the elements of a transaction. Section 6 provides an overview of how information flows through a business’s accounting system. Section 7 introduces the use of financial reporting in security analysis. A summary of the key points and practice problems in the CFA Institute multiple-choice format conclude the reading.