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

?Financial and Management Accounting: The Contribution to Effective Business and Management Table of Contents Table of Contents Introduction 2 Financial Accounting 3 Management Accounting 4 Differences between Two Approaches 5 Benefits of Two Approaches 6 Limitations 8 Conclusion 9 Reference 10 Appendices 12 Introduction For efficiently running a business the management of a company should make it sure that the money available to them is utilized at the best manner. The main objective of the company management is optimally using the resources available to them. Here comes a conflict between the management and the shareholders of the company about the objective of the business. But it has been widely maintained that the long term objective of the business should be shareholders’ wealth maximization and the short term objective should be profit maximization of the company. For achieving the goal the accountants make it sure that the accounts are recorded properly and they have to prepare financial statements periodically based on these. The stakeholders of the company i.e. the shareholders, the customers, banks, government, the management of the company are interested in the financial statements. Their future decisions about the company depend on the financial statements which describes the financial condition of the company at a certain date. The shareholder of the company takes decisions about whether or not to invest in the company further; the customers get interested if the company is performing well. The role of the management accountants also depend on those financial statements. They have to plan for the future based on the statements. This paper is an attempt to analyze the role of management and financial accounting and the benefits, limitations of the approaches with the help of some current practices. Financial Accounting This field of accountancy is concerned with the preparation of the financial statements which are used by the stakeholders of the company for different purposes. The financial accountants summarize the day to day accounting records and prepare the financial statements for a period. It should be making sure by the accountants that the information disclosed by them are precised, transparent so that it reflects the actual financial condition of the company. The management has to make sure that they are abiding the rules of the financial boards such as Financial Accounting Standards Board (FASB) and the statements are prepared according to the principles like Generally Accepted Accounting Principles (GAAP). The report made by the company management should be relevant for the users of those statements. The companies should make it sure that the published statements are properly audited by the external and internal auditor. The auditors’ job is to check that the reported statements are transparent and according to the financial reporting standards. The stakeholders of the company can take the decision based on the audited statement as the reliability is more than the unaudited statement. Financial accounting also makes strong the corporate governance of a company. In the late 90s the compensation of the U.S. executives has been reduced generally due to the direct role of accounting. The board can decide about the compensation and bonus of the employees on the basis of the financial statements (Bushman and Smith, 2001, p.242). Efficient corporate governance in a company assures the successful continuity of a business. For reporting the financial statements the accountants should identify the stakeholders’ area of interest. A research done in China suggests that domestic investors of China are interested more on gaining in short term basis than the financial data; where the international investors are more interested on the book values for evaluating the stocks than the earnings information available to them (Wu, Koo and Kao, 2005, pp.15-18). This example suggests that the financial accountants of the company should emphasized more on the data in which the investors are interested. Management Accounting Planning and controlling are two important dimensions of continuing a business operation. A robust planning is needed to be prepared by the company management to use the resources efficiently available to them. Based on the financial statements prepared by the financial accountants, the management accountants take decisions that would be suitable for the company for gaining more profit and increase the shareholders’ wealth. From the cost sheet of the last period the management identify the cost incurred responsibility centre wise. According to that the management can take decision which measure should be taken for reducing the cost or controlling that. If the cost of production come down then the management would certainly generate more profit. The performance of the responsible persons of different cost centres can also be analyzed by using the cost sheet. The budget for the next accounting period is prepared by the management accountants on the basis of the cost sheet and other financial statements. From the financial statements available to them the management understand the financial position of the company on a certain date. Also there are the detailed segment reports about the customers, products and departments. From this the management can forecast the sales of the next financial year and do the needed budget allocation for the operations. The prepared budget is being reviewed periodically by the management and the required change is made. In 1993 the Italian government decentralized the responsibilities to individual universities. This autonomy opened up new opportunities to the universities but the management found it difficult to take the decisions which were previously taken by the government itself. From the research done on four universities on Italy it was concluded by the researcher that the management accountants should have the long term orientation i.e. they should make sure that the business will continue for a long term. The decisions should fulfil the objectives of the external; stakeholders of the company and the market. Management should take decisions so that they can compete well with the present and potential competitors and retain their market share (Agasisti, Arnaboldi and Azzone, 2006, pp.7-13). Differences between Two Approaches The objective of financial accounting is providing the tools for decision making and the responsibility of management accounting is to make decisions based on the reports prepared by the financial accountants. The main aim of financial accounting is to prepare the financial statements such as profit and loss account, balance sheet and cost sheet. The stakeholders of the company like the shareholders, the bank, government and customers are interested in the statements as they have to take the decision based on this. The objective of preparing the report is to meet the need of the external stakeholders. The shareholders of the company take the decision whether invest or not in the company further. The banks are interested for the information that the company is creditworthy or not. In contrast management accounting provides information for the people in the organization, who in turn take decisions on the basis of the financial reports and forecast budget for the next period (Shim and Siegel, 1998, p.1-2). The aim of the approach is to making the company creditworthy and maximizes the shareholders’ wealth, so that the investors find the company as a good option of investing. The return on investment should be up to the mark. For preparing the financial statements the accountants need the historical data associated with the company. They have to summarize the financial day to day data and prepare it, when the management accounting objective is to prepare the budget for the future. Moreover there is no specific standard which the management accountants have to abide by, but the financial accountants have to prepare the statements according to the formats and standards set by the ruling bodies like International Financial Reporting Standards (IFRS). The financial statements which are prepared by the financial accountants cover the information about the whole organization but the reports produced by the management accountants is only concerned with the particular products, the departments as well as different cost centres. The management analyzes the cost incurred in different cost centres and accordingly take necessary steps to control the cost and if possible to increase the profit of the company. The responsibility of the management accountants include preparing the sales forecasting reports, proper asset allocation, situational analysis, analysis of the budget and review that periodically. On the basis of the cost sheets the management come to know where the budget was allocated in the last period and how much. Based on this they have to prepare the budget. Then using the feedback and control tools like the balanced scorecard the management review the budgetary allocation and do necessary changes if needed. There is a legal requirement for the publicly traded companies to produce the audited financial statements where the management accounting reports are not the legal requirement. The formats of preparing the budget are customized as it varies from company to company depending on the needs of the specific company. The financial accountants have to disclose the adequate information for the interested stakeholders. The management accounting also requires non-financial data like the performance of the employees, their efficiency, based on which the management have to take decisions about the future. Analyzing the financial data available through the financial statement preparation and the non financial data the management of the company forecast the future performance of the company and take decisions according to that. In contrast the area of responsibility of the financial accountants is to preparing the financial statements based on the financial data only. The accounting transactions are only reflected in the financial accounting reports (Khan and Jain, 2006, p.1-5). In conclusion it can be said the financial statements are the basis of the management accounting reports and the management accounting is the basis of preparing the financial accounting statements of the next period. Benefits of Two Approaches The stakeholders of a company like the shareholders, the bank, government and management depend on the statements produced by the financial accountants. The stakeholders make decision based on the audited financial statements about their association and relation with the company in future. From a research it has been revealed that the financial statements which used to publish in the annual report are the most reliable source of information for both the professional investors (84.6%) and the individual investors (59.3%) (FASB, 1991, pp.2-3). From a research done on the basis of the responses of the investors it has been revealed that the interpretation of different investors is different towards the published financial statements. For example the best estimate about the bad debt by the management is interpreted as the minimum amount of bad debt by some investors and these factors affect their decision. The investors differently interpret the forecast done by the accountants of the company and their decision reflected in the performance of the stock in market. It is the benefit for the shareholder that they can analyze the data available from the financial statements using their own thoughts along with the interpretation of the company management (Libby, Bloomfield and Nelson, 2002, pp.784-786). The benefits of publishing the financial statements are also gained by the company. If the company management is able to publish an audited financial statement throughout then the reputation of the company become good and a good financial performance can attract more capital for the company. The company also become reliable for the creditors if they are able to meet their liability and publish that in the published financial statements. The financial accounting statements are beneficial for the government as they can assess their taxes; whether the tax has been paid by the company or not. The statements are also important for the management of the company as along with the cost sheet the financial statements are necessary for taking the decision about the future planning of the company. The objective of management accounting is to interpret the financial statements and suggest policies so that the business can be more efficient. During the process of manufacturing there may be an idle period or slackness. By analyzing the cost sheets the management accountants can come to know about the performance of different cost centres. Thus they can find the reason for the idle time and take sufficient measures for improving the operation. So the objective of management accounting is to use the resources available to them more efficiently. The management accountants interpret the financial statements and suggest necessary changes needed to the top management. According to that the management changes the policies needed for achieving the long term goal of the organization. On the basis of management accounting process the management of the company can implement needed changes in the corporate governance structure of the company. Using the management accounting process the company management can determine about the working capital for future period, fix the process of management of working capital; identify the process of managing the inventories efficiently, manage the cash properly and take decision about their future investment in the market. The implementation of a proper planning and controlling tool can assure the optimal use of the resource available to the management and thus achieving the long term and short term goal of the company. Using the process the cash flow of the business can be controlled by the company management as well as the critical business decisions can be taken by the management. Limitations Though the financial accounting and management accounting reports help the company to meet the query of the stakeholders, there are some limitations of these types of statements. The information provided in the financial statements which are used by the external stakeholders of the company is based on the historical financial data. The historical data may not be able to indicate the future of the company. So it is tough for the external stakeholders like the shareholders, the banks and the government to take right decision about the company. The financial accounting statements only based on the financial data of the company which alone is not sufficient to take the decisions for the external stakeholders. The non-financial factors like the economic conditions of the country also affect the future financial condition of the company, though it is beyond the control of the management. Also there are the factors like working environment in the organization, management efficiency which are not disclosed in the financial accounting reports. Financial accounting reports don’t disclose the cost associated in the manufacturing process, so it is tough to take making decisions for the shareholders about the efficiency of the company management to control the costs. Some heads of reports prepared by the financial accountants are based on the personal judgement of the accountants like the bad debt provision, methods of depreciation etc. The management accounting also has certain limitations. The management accountants have to take decisions on the basis of the financial statements. The accuracy of the decision of the management depends on the correctness of the financial data available to them. They have to allocate the budget to assure that the resources available to the company are used efficiently. But this budget is allocated only basis of the assumptions. There is a huge probability that the budget allocation is not right, as it is only assumed on the basis of the historical data. The economical policy, market condition can change in the next financial period. Due to this the situation can arise that the resources are not used optimally. The scope of management accounting process is broad which can make it difficult for implement the necessary processes. Management accounting system installation in a company incurs high cost which is also a limitation of the system. For getting success from management accounting process there should be a good coordination and relationship between the financial accountants and the management accountants. A good relationship between the two can assure a good understanding of the financial statements by the management accountants and then interpret those statements. Management accountants can offer some changes for assuring more efficiency in the business, there may be a need of change in the rules and regulations which can be resisted by others, as everyone in the organization doesn’t have the same objective. From a study done on 75 managers it has been revealed that the broad scope of the management accounting enhanced the performance of marketing than production which is the most important part of conducting the business (Mia and Chenhall, 1994, p.9-10). It can be said from the research that the broad scope of management accounting hampers the performance of the managers and thus the resources available to the company are not optimally used. Conclusion It can be derived from the report and the previous research conducted on the topic that both the approaches have significant contribution for effective business and management. The objective of financial accounting is to produce the financial reports like profit and loss account and balance sheet which is mainly used by the external stakeholders of the company, when the objective of management accounting is to suggest the future paths to the company management after analyzing the financial statements produced by the financial accountants and the cash flow statement. The external stakeholders of the company like the shareholders of the company, the government, the creditor can understand the financial position of the company at a certain date and based on the reports they can take decision about their future association with the company. The company management should produce the financial reports focusing on the areas where the stakeholders are interested and they should also assure that the provided information is transparent and properly audited. Though the installation process of management accounting is high the need of this approach can’t be avoided. By using this approach the management accountants can find out the inefficiency that exists currently in the company and suggest the remedial way to the company management. Depending on this the company management can make the necessary changes, allocate the budget; so that the operation can be more efficient and the resources available to the company can be utilized optimally. The business will be continued as per the recommendations of the management accountants and the result of that would be summarized by the financial accountants for preparing the financial statements for the next period. Depending on those statements the stakeholders would take decision for future. So it can be said that both the approaches are related and depend upon one another for the purpose of effective business and management. Reference Agasisti, T. Arnaboldi, M. and Azzone, G., 2006, Strategic Management Accounting in Universities: the Italian Experience. Springer Science+Business Media, August, 2006, pp. 7-13, Available from: http://web.ebscohost.com/ehost/pdfviewer/pdfviewer?sid=885af874-2d74-4756-a879-4196752ad3d7%40sessionmgr113&vid=1&hid=112. [Accessed: 7/2/2012]. Bushman, R. and Smith, A., 2001, Financial accounting information and corporate governance, Journal of Accounting and Economics, p.242, Available from: http://public.kenan-flagler.unc.edu/faculty/bushmanr/bushman-smith.pdf. [Accessed: 7/2/2012]. FASB., 1991, Benefits, Costs, and Consequences of Financial Accounting Standards, pp.2-3, Available from: http://www.pcfr.org/downloads/05_07_Meet_Materials/FASBBenefitsCostsSR1991.pdf. [Accessed: 8/2/2012]. Khan, M. and Jain, P. (2006). Management Accounting. India: Tata McGraw-Hill Education. Libby, R. Bloomfield, R. and Nelson, M., 2002, Experimental Research in Financial Accounting, Accounting Organizations and Society, 27(2002) pp. 784-786, Available from: http://web.cenet.org.cn/upfile/64296.pdf. [Accessed: 8/2/2012]. Mia, L. and Chenhall, R., 1994, The Usefulness of Management Accounting Systems, Functional Differentiation and Management Effectiveness, Accounting & Organizations and Society, Vol. 19,No. 1,pp. 1-13,1994, Available from: http://eprints.undip.ac.id/2426/1/DA-Modrating-1.pdf. [Accessed: 7/2/2012]. Shim, J. Siegel, J. (1998). Schaum's outline of theory and problems of managerial accounting. 2nd ed. United States of America: McGraw-Hill Professional. Wu, S. Koo, M. and Kao. T, 2005, Comparing the Value-Relevance of Accounting Information in China: Standards and Factors Effects. pp. 15-18, Available from: http://www.business.illinois.edu/accountancy/research/vkzcenter/conferences/france/papers/Wu_Koo_Kao.pdf. [Accessed: 7/2/2012]. Warren, C. and Reeve, J. (2006). Managerial Accounting. 9th ed. United States of America: Cengage Learning. Micro Business Publications, 2008, Fundamentals of Management Accounting, p. 7, Available from: http://www.microbuspub.com/pdfs/chapter1.pdf. [Accessed: 13/2/2012]. Appendices Figure: Characteristics of Managerial Accounting and Financial Accounting Data Source: (Warren and Reeve, 2006, p. 3) Figure: Inputs, Accounting Department and Outputs of Managerial and Financial Accounting Data Source: (Micro Business Publications, 2008, p. 7) Read More