Financial and Management Accounting: The Contribution to Effective Business and Management - Essay Example

?FINANCIAL AND MANAGEMENT ACCOUNTING: THE CONTRIBUTION TO EFFECTIVE BUSINESS MANAGEMENT Finance and Accounting Introduction Is there a difference between management accounting and financial accounting and does it benefit a business to incorporate both strategies in business? To understand this concept, it is of relevance to distinguish management accounting from financial accounting. Management accounting is an internal endeavor where the management accountant addresses the internal environment of the business organization. Management accounting is chiefly involved in planning and controlling. The management accountant envisages the future of an organization and evaluates the performance of the organization with the set standards hence achieving his controlling function (Warren, Reeve and Duchae, 2008, p. 729). Financial accounting is an external financial initiative. A financial accountant prepares financial accounts for the scrutiny of members in house to the organization and to other external members. The financial accountant is responsible to the stakeholders of the business: shareholders, employees, creditors, debtors, customers, and the community it serves. With this genesis, this research essay will be aimed at outlining the differences between financial and management accounting, delineating their benefits and limitations and consequently explaining their contribution to effective business management (Stickney, et al., 2009, p. 100). Differences between Financial Accounting and Management Accounting To begin with, the difference between financial accounting and management accounting will be delineated in regard to the requirement for an organization to have either or both. Financial accounting is mandatory for any company seeking to be registered under the company’s Act. This is since each company needs to present the financial prospect of the organization in the next five years after commencing business. Consequently, financial accounting is required by the tax authorities and the exchange and commission authorities hence it is mandatory for any organization to have financial accounting. However, management accounting is for the benefit of the internal organization and is therefore not a mandatory requirement. An organization depending on the usefulness of the information generated by the management accounting decides if it requires a management accountant or not (Warren, Reeve and Duchae, 2008, p. 729). Both management and financial accounting engage in planning activities while preparing to plan for their record generation. However, there is a difference in their emphasis during the planning process. A manager is mainly future oriented and hence managerial accounting focuses more on the future prospects of a business. It uses the vision of a business organization to plan activities, which is stipulated in the mission statement of the organization that most managerial accountants aid in the development. In contrast, financial accounting lays emphasis on past financial performances of a business and uses them as a basis of planning for the future financial prospects of a business organization (Ferrara, 2007, p.171). Management and financial accounting differ in the segment of the organization that they report to. Financial accounting is majorly a holistic approach and the report it complies shows the financial position of the company. It is via the financial accountants report that investors know the financial position of a company. In contrast, management accounting is subdivided into managerial positions in the organization. This entails that there can be a management accountant for the advertising department, sales department, procurement department and transport department. Hence compared to management accounting, financial accounting is external as it is reviewed by other parties not in the organization (Stickney, et al. 2009, p. 100). Financial accounting is governed by the Generally Accepted Accounting Principles (GAAP). GAAP governs all financial accountants as it sets down the rules that need to be adhered to when preparing financial statements. GAAP serves as a measure to the quality of financial reports and ensures that there is limited fraud and misrepresentation of the financial statements. This ensures that the financial statements do not misrepresent the financial position of the company as the financial statements serve as a basis of gathering financial assistance from financial institutions (Stickney, et al. 2010, p. 100). However, management accounting is not bound to comply with the GAAP since being an internal endeavor, most of the requirements to do not meet the timely decisions that the management accountant is expected to make. Example: GAAP requires that land be presented in its historical value, however, when the management accountant wants to sell a piece of land on behalf of the organization, he would want to know the market value of the land hence calculate his margin. However, a financial accountant is bound to present the land in its historical value (Stickney, et al. 2009, p. 100). Benefits of Management Accounting and Financial Accounting Since both are accounting systems though carrying out their accounting for diverse reasons and in diverse ways, the benefits of accounting as a discipline will be elaborated. To begin accounting aids in the generation of financial reports is used by the organization. A business uses the financial reports to compare its previous performance with its current performance and hence make the appropriate changes. Also the report helps in showing the business its financial position and adequately knowing its competitors in the industry (Needles, Powers & Crosson, 2008, p. 110). Prior to accounting, businesses were regarded as the individuals who owned them and hence there was no point of reporting the activities of the business separate from the owners. However, in the recent times, the business has been regarded as a separate entity from the owners and hence the need to report its assets and operations differently. This has led to more accountability among the managers to the stockholders of the business and also to social responsibility of the business. It is therefore through accounting that the operations and acquisitions of a business are known to the general public (Needles, Powers & Crosson, 2008, p. 110). Decision making is another benefit that a business generates from accounting. This is since it serves as a starting point for the business and the business is able to priorities its requirements with the available resources. Decision making is essential since it designates the path that a business will take for a specific trading period. Wise and timely decisions will stem from adequately compiled financial statements generated through accounting (Needles, Powers & Crosson, 2008, p. 110). Accounting is also essential for financial reasons to a business. In cases where a business wants to procure a venture, the business may need additional capital and the financial statements generated through accounting play a paramount role. The business needs financial statements for the bank to assess if the business is able to repay back the loan. Consequently, form the financial statement, the bank can assess if the business has collateral that can be used to serve as the basis for financial assistance (Needles, Powers & Crosson, 2008, p. 110). Limitations of Management Accounting and Financial Accounting Limitations of Management Accounting Management accounting is concerned with making futuristic decisions for the management of the organization. However, management accounting relies on data either from financial accounting of cost accounting. This implies that misappropriation in the source of information will translate to wrong management accounting decisions. An example is the use of ratio analysis in management accounting yet ratios take into consideration past financial performance of a business (Viavo, 2008, p. 64). Consequently, the usefulness of management accounting is also limited. Management accounting is more useful to the management heads of the respective departments who understands the management accounting principles. This limits the scope of use of management accounting and hence may not be a viable venture for a business that does not have a wide capital base. This limits middle and small sized business from using management accounting since it benefits only a small portion of the business and not all the business stakeholders. Also since the managers are the involved parties, there may be prejudice in decision making since judgment serves as the basis of decision making in management accounting (Brewer, 2008, p. 34) Limitations of Financial Accounting The first limitation of financial accounting is that it is of historic nature. It reports events as they happened in the past and it is not futuristic in any aspect. It reviews how the business has performed in the past and consequently the financial position that the performance has placed the business. This limitation hinders financial accounting from engaging in future planning of the business as they are chiefly concerned in assessing and reporting how the business has been performing (Ingram & Albright, 2006, p. 281). Financial accounting contributes to inefficiency in business reporting. This is attributed to the fact that financial accounting reports the overall profitability of the business. This can subsequently be misinterpreted as the overall sub- divisions of the organization are performing optimally. However, it is possible to have departments that are reporting failure and if not investigated and corrected in time, could translate to continued business inefficiency and thus massive losses (Ingram and Albright, 2006, p. 281). Subsequently, financial accounting reports those activities that can competently be described and presented in monetary terms. However, a business is not made by monetary aspects only and there are non monetary aspects that influence the performance of a business. This includes aspects like the working environment, public relations, and employee relations and also efficient management functioning. These are aspects that are not disclosed by the financial accounting department and are essential as they outline the internal environment of the business (Clinton, 2007, p. 24). Also, financial accounting does not report the true position of the business. With reference to the GAAP described above, it is the requirement to describe the assets of a business as per their historic value. This means that financial accounting does not take into consideration the inflation or the market value of the assets while preparing the report. This means that the information relayed may be misleading especially to individuals who are not aware of this GAAP requirement for financial reporting (Libby, Libby and Short, 2008, p. 250). Consequently, financial accounting is subject to the accountant’s judgment. This increases the possibility of bias in the preparation of financial accounts. While preparing financial accounts, the accountant decides on the depreciation method to use, whether to write off debts, and also decides on the stock valuation method. This entails that if auditing is not carried out for ascertaining the credibility and validity of the methods used, financial accounting creates a loophole for misrepresentation and possible fraud (Clinton, 2007, p. 24). Moreover financial accounting robs off the business its privacy. An example is where a business needs to be listed in the securities and commission exchange and has to publish its financial statements. Through this publication, competitors are able to know the business secrets and hence narrow the competitive edge of the business. This entails that the business has to continuously come up with ideas to maintain its competitive edge failure to which other business take advantage and propel forwards (Libby, Libby, & Short, 2008, p. 250). Role of Financial Accounting and Management Accounting In Effective Business Management Role of management accounting in effective business management Recent technology has led to the addition of Activity Based Costing (ABC) as a costing strategy adopted by management accounting. This has been documented as the answer to the changing needs in the in the business world and has led to the birth of other initiative in management accounting. Activity based costing has played an effective role in business since it has led to the inventions of activities like shareholder value analysis and activity based management. Management accounting adoption of ABC serves as a paradigm shift from the traditional based volume costing method which aimed at highlighting the costing principles in the aim of achieving efficiency in business. However, the adoption of ABC has made managing business more effective since it aims at enabling the decision holders understand the causality of costs in the business. This hence serves as a viable alternative as pertains to the management of cost since the management does not just focus on production cost only but addresses the root cause of the cost hence manage cost effectively. Therefore, the adoption, of ABC in management accounting has made the management and decision making as pertains to cost effective more timely, effective and efficient (Talha, Raja, & Seetharaman, 2010, p. 86) Moreover, management accounting plays an important role in making business effective through the use of Total Quality Management. This initiative by the management accountants aim at educating, training, and consequently, empowering the employees to do multiple tasks in the business. It is based on the hypothesis that prosperity in business is all about improvement and hence managing accounting aims at improving the well being of all stakeholders in the business. TQM has been described as a behavioral concept since it aims at motivating the employees through improving their business capabilities hence making them more efficient in the performance of business activities. TQM as an initiative of management accounting aims at training, preventing rather than correcting, continuous improvement, focusing on the customer, supporting the staff, and involving the employees in the performance of business activities. TQM being a continuous process is a strategy used by management accountants to maintain the business at a competitive edge in comparison to other businesses, making the business more effective (Talha, Raja, & Seetharaman, 2010, p. 88) Subsequently, Activity Based Management has also been documented as a recent initiative employed by management accounting hence making business more effective. This is serving as a replacement of the traditional accounting system that businesses have employed. ABM makes a business more effective as a result of its ability to link precisely indirect and other overhead costs to the customer and product segments. Previously, traditional accounting systems linked indirect costs with bases example; machine hours, manufacturing hours and direct and indirect labor hours. However, the ABM tracks the cost to the activity leading to the generation of the cost and this cost can be documented to result from either the customer or the product. ABM therefore calls for collaboration among the managers and employees and is only effective if there is team effort in classifying the costs. This makes management effective since activities to be performed are identified, activity used to determine cost drivers, overheads re grouped, data collected and the cost assigned to either customer or product. ABM an initiative of management accounting translates to better management of costs by grouping their source hence reducing redundancy of costs (Talha, Raja, & Seetharaman, 2010, p. 90). Budgeting is another role of management accounting that makes business management more effective. Planning as earlier foretold is an important initiative by management accountants since they are aimed in assisting the managers in decision making. Upon planning, the managers need to make a budget that outlines the time, and costs incurred in implementing the decisions made. Budgeting acts as a check for the business since it aids in evaluating if what the business stipulated has been achieved. It entails the futuristic aspect of the business since it plans and uses the budget to check the effectiveness of the business. Budgeting makes the business more effective since it serves as a measurement tool of the business and aids in the allocation of scarce resources in order of priority (Vaivo, 2008, P. 64). Role of Financial Accounting in Effective Business Management Financial accounting is concerned with the generation of the most important financial statements for any business: cash flow statement, profit and loss, and the balance sheet. By a glance at these financial statements, one is able to comprehend the relationship between the sales and purchases of a business, the receipts and expenses, and also a relationship between the assets and the liabilities. Financial accounting hence plays an important role in effective business management since it informs the in and out house as pertains to the business activities with respect to a particular period of time. Financial accounting is thus essential for the success of any business due to the reports and summaries it provides (Albert, Stice & Stice, 2010, p. 20). Financial accounting plays a dire role in effective business and management since it summarizes and classifies important business aspects. This limits the existence of multiple concepts that relate to the same prospect. Example, in the balance sheet, financial accounting aids in the classification of assets and liabilities. This aids in telling apart what the business owns from what it is required to pay out to other parties. This is an essential aspect for any business and upon its utilization; it translates to effective business management. Consequently, in the profit and loss financial accounting statement, the financial accountant summarizes the receipts from the expenses that the business is required to meet. This makes the distribution of the available resources easy and the business can plan for the future receipts and adopt measures to cut on its expenses. This leads to a business gaining effective business management skills (Albrech, Stice & Stice, 2010, p. 20). Conclusion It is evident that there is a difference between financial accounting and management accounting as pertains to the concepts that they both address though there are similarities that exist between them. Financial accounting differs from management accounting since financial accounting is for external purposes while management accounting is for internal purposes. Consequently, financial accounting relies on past information to come up with financial statements while management accounting is aimed at making futuristic prospects for the business. However, being systems of accounting the business benefits as pertains to account keeping, decision making, and planning, budgeting and controlling function. Even though management accounting makes business more effective through the employment of current business initiatives; activity based costing, total quality management, budgeting, and activity based management. These initiatives by management accountants are aimed at giving the business a competitive edge. Though management accounting is not a requirement, businesses that desire to have effective business management should embrace this concept. They will not only achieve a more competitive edge, but they will also know the non financial aspects of the business that financial accounting does not display. Hence, both financial accounting and management accounting contribute to effective business management. References Albrech, W., Stice, E., Stice, J., 2010, Financial Accounting, 11th Edition, Cengage Learning Brewer, P.C., 2008, "Redefining Management Accounting", Strategic Finance, vol. 89, no. 9, pp. 26-34. Clinton, B 2007, "Crisis!", Strategic Finance, Vol. 88, no. 7, pp. 24-30. Ferrara, W 2007, "Topics Worthy of Continued Discussion and Effort-Even after Forty Years of Trying", Journal of Management Accounting Research, vol. 19, no. 10492127, pp. 171-179. Ingram, R., Albright, T., 2006, Financial Accounting: information for decisions, 6th Edition, Cengage Learning Libby, R., Libby, P., Short, D., 2008, Financial Accounting, 5th Edition, McGraw- Hill Irwin Needles, B., Powers, M., Crosson, S, 2008, Financial and Management Accounting, 8th Edition Cengage learning Stickney, C., Weil, R., Schipper, K., Francis, J., 2009, Financial accounting: an introduction to concepts, methods, and uses, 13th edition, Mason OH: South- Western/ Cengage Learning Talha, M., Raja, J.B. & Seetharaman, A. 2010, "A New Look At Management Accounting", Journal of Applied Business Research, vol. 26, no. 4, pp. 83-96. Vaivio, J. 2008, "Qualitative management accounting research: rationale, pitfalls and potential", Qualitative Research in Accounting and Management, vol. 5, no. 1, pp. 64-86. Warren, C, Reeve, J., Duchae, J, 2008, Financial and Managerial Accounting, Cengage Learning Appendix A: Tabular comparison of Financial Accounting and Management Accounting Financial Accounting Management Accounting It is rigid and hence less flexible. More flexible. Has to adhere to the GAAP. Does not have to adhere to the GAAP. Relies on the past performance of the organization in preparation of financial accounts. it is futuristic and is mainly prepared for future planning by the management of the organization It is less timely since it is prepared as the financial periods of the organization. It is timely as it is used to assist the management solves the short term crisis and assists management in decision making. It only presents the major parts of a business organization especially the assets, liabilities, receipts and payments of the organization. It takes into considerations the minor parts of the organization that assist in making its whole. It only takes into consideration reporting the quantitative information of the organization. It takes into consideration both the quantitative and qualitative information of the organization. Read More