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 FINANCIAL AND MANAGEMENT ACCOUNTING: THE CONTRIBUTION TO EFFECTIVE BUSINESS AND MANAGEMENT 1 Table of Contents 2 1. Introduction 3 2. Financial Accounting 3 2.1 Role of Financial Accounting in Business 3 3. Management Accounting 4 3.1 Role of Management Accounting in Business 4 3.1.1 Planning 4 3.1.2 Control 5 3.1.3 Ascertainment of costs and income 5 3.1.4 Decision Making 6 4. Financial and Management Accounting – A comparison 6 5. Importance of Financial and Management Accounting 8 6. Benefits to Business Operations 9 7. Limitations of Financial and Management Accounting 9 8. Conclusion 10 References 12 13 Bibliography 14 1. Introduction Accounting is the process of representing financial information of any business entity in the form of various financial statements which can be used by the stakeholders to help in various decision making process. Accounting can be of two forms, viz. management accounting, used for internal purposes and financial accounting, used for external purposes. Both of these accounting forms play a very critical role in any form of business. All the accounting records serve as an evidence of the occurrence of a particular monetary transaction. A reliable and relevant accounting record helps any government institutions manage its various resources and also the accountability of any business management while taking any decisions is held responsible through correct and proper financial information (Bhimani, 2003, p. 3). Earlier, accounting procedures followed by any business entity followed a traditional approach which gave way to measuring the business performance quantitatively. But now days, any modern business is more concentrated using non-financial measures to measure the business performance and it is the daily routine task of either a public or private financial institution to prepare the business performance report accordingly. Any financial institution has its own financial limitation and thus has to work within that limitation to work for the betterment of the organisation and justify the investor’s investment in the organisation. Thus, the function of Financial and Management accounting system in business organizations lies in effectively managing its financial assets, resources and regulations. 2. Financial Accounting Financial accounting is that part of accounting which is used for external purpose of a business entity and it sets out procedures to represent the accounting records of any business in a summarised form in the form of different financial statements. These financial statements are for the purpose of use by the stakeholders of an organisation for their own decision making purposes. 2.1 Role of Financial Accounting in Business Financial accounting is used by any business as a service function. Financial accounting serves for the purpose of representing the daily transaction records of a business after recording them, analyzing them, interpreting them and then reporting them in the form of financial statements. The statements of finance are documented based on a set standard used by every country that conforms to Generally Accepted Accounting Principles (GAAP) of that particular country and this is again must be accepted by the Financial or International Accounting Standard Board. In a nutshell, GAAP is the overall governing or regulatory body of accounting practices to be followed. Any business organisation is obliged to comply with these set out principles or guidelines and is a part of the legal responsibility of the organisation. The financial statements prepared by a business organisation serve as a purpose of representing the true and fair view of the business affairs that is to be used by its stakeholders for their decision making purposes. Any business concern has mainly two different disciplines of accounting. One is general accounting and the other, accounts payable. General accounting is what discussed earlier, involves analysing and reporting of financial transactions. Accounts payable can be defined as that function of accounting which involves managing payments of procured goods and services of the organisation. In order to prevent fraudulent activities, various internal control measures are employed within the organisation and delegation of tasks given to each employee makes them responsible and accountable for their own parts (Business Public Relations Database, n.d.). 3. Management Accounting Management Accounting is that part of accountancy which is used for internal purposes of an organisation. Management accounting is mainly concerned with the financial statements prepared by the financial accountants for the use by the managers of the organisation. Management accounting is not intended for use by the outsiders of the business concern and is confidential. It does not look into the historical perspectives of the business transactions but works on the future planning and development of the organisation. 3.1 Role of Management Accounting in Business Management Accounting has a varied role in business. It can be summarized into four broad aspects of business. They are: Planning, Control, Ascertainment of costs and income and Decision making. 3.1.1 Planning Both long-term and short-term planning is included in the role of management accounting in planning. Long-term plan of a business organisation includes planning for a period of three to five years or even more and mostly the top management people of the organisation is involved in this type of planning. Long-term planning can also be termed as strategic planning of an organisation. Short-term planning extends up to one financial year and involves preparation of yearly budgets of a business which can pave way to achieving the long-term plans of the business. Short-term plans are thus the functional budgeting plans of an organisation extending to one year. 3.1.2 Control Management accounting extends to control function of an organisation as well. Managers of a business entity ensure that the organisation is heading towards right direction and each business operations are in accordance with the set out plan of the organisation. The budgetary control over business operations are achieved by comparing the actual cost and revenue figures with that of the planned or budgeted figures and then these differences are recorded which is termed as variances. These variances must be within acceptable limits planned beforehand. If it is unacceptable then proper corrective measures are taken to correct the situation. This can be termed as scorekeeping function on management accounting, whereby every functional unit of the organisation is well aware of the fact about what is expected of them to be in conformity with the business plan. 3.1.3 Ascertainment of costs and income Ascertainment of costs and income is the most important and principal task of management accounting. Management accounting can at times be named as cost accounting as well. Management accounting helps in ascertaining different incurred costs of an organisation: i. Costs of different raw materials used by the organisation for its production purposes, etc. ii. Overhead costs like labour costs, etc. iii. Costs of finished goods, products or services rendered by the organisation iv. Costs incurred in areas of different functional operations performed by the organisation. v. Departmental or divisional costs of business. vi. Process costing. vii. Costs of services rendered to different sections of an organisation by one part of the organisation. viii. Inventory and delivery costs. Ascertainment of each of these costs may not be required by a particular organisation but a management accountant along with other managers will decide upon which of these costs are to be ascertained, which in turn will depend on the products produced, services rendered, organisational structure, etc. Likewise, ascertainment of costs will determine the incomes involved. 3.1.4 Decision Making Management accounting plays crucial and critical role in decision making process of an organisation. Every business organisations are to undertake so many varied decisions on a regular basis. These strategic decisions have a strong impact on the future prospects of the organisation (Foster, 2009, p.9). Information required for decision making process is very much different fundamentally from financial information used for the above mentioned three processes, viz. planning, control or ascertainment of costs. For a decision taken to be effective for an organisation, the forecasted or projected financial information must be relevant to the particular decision that is to be under taken. These revenue and cost information required for the decision making process are termed as relevant costs or relevant revenues. A few examples of different common decisions taken and its corresponding relevant financial information required are as follows: a. Decision to either make or buy: The decision to choose from whether to buy a particular product or to manufacture it is governed by the costs involved in each of the cases and there by taking the decision to choose the most cost-effective decision. b. Decision to increase the output: The management has to decide on the increase in output by taking into consideration the increased costs and revenue involved. c. Decision to invest on the production of a new product: Feasibility of such investments and running costs that are to be incurred should be taken into consideration while taking such decisions. d. Decision to stop or suspend an activity: Information regarding the costs that can be avoided and unavoidable costs are necessary for the management to take such decisions. (Bendrey, Hussey & West, 2003, p. 4-10) 4. Financial and Management Accounting – A comparison As discussed earlier Management Accounting is the internal aspect of a business organisation and Financial Accounting is the external aspect of the organisation. Management accounting is required to carry on the managerial functions within the organisation, whereas financial accounting is required to provide information to the outsiders, mainly the stakeholders of the organisation (Bennett, 2002, p. 4). Management accounting tasks start only when financial accounting is over. Thus, management accounting differs considerably from financial accounting in many different aspects and they can be summarised as given below: Recipients: Internal management people of an organisation receive the management accounting statements, whereas the outsiders like the shareholders, creditors, investors, etc. are the recipients of financial statements prepared by the financial accountants. Requirements and periods of reporting: Financial accounting is required to be in accordance with legal requirements following certain accounting standards and is required to be reported annually. Compliance is the key in case of financial accounting. Standards are there to bring in uniformity of representation of financial statements, so that they can be easily compared by the stakeholders, investors, etc. on equal terms across different businesses. Management accounting requirements on the other hand are set by the organisation itself depending on their particular needs and requirements. The period of reporting management accounting may vary. Some aspects may be required to be reported daily and others on a monthly or quarterly or on an annual basis. Thus internal management is responsible for the periods of reporting in management accounting. Contents of reporting: Financial statements prepared through financial accounting are well regulated. They are required to comply with the legislative requirements and accounting standards. Generally Accepted Accounting Practice (GAAP) is applicable as well, depending on the country in which the organisation is situated. The contents of management accounting reports have no such compliance and vary from one organisation to other. Details: As mentioned earlier, the contents of financial accounting reports are regulated. As a result of that, the financial accounts contain financial reports in a summarised manner for the organisation as a whole and not separately for each department of subsidiaries of the organisation. But in management accounting, it contains the detailed analysis of each department or subsidiaries and the various costs involved are presented in a more detailed manner (Bendrey, Hussey & West, 2003, p. 4-10). 5. Importance of Financial and Management Accounting In today’s world accounting, whether it is financial or management accounting, both plays a vital role in any form of business. Records of receipts and delivery of goods are information about cash inflows and cash outflows are recorded and maintained by the accountants. The financial accountants also provide financial statements to summarise the financial position of any business entity. Financial accounting provides information about the whereabouts of all the financial transactions taking place in the business. The information thus provided is complete and accurate in every aspect. The financial statements prepared through financial accounting provide a true and fair view of the business concern and everyone knows how the business concern is performing financially. Those financial statements are trustworthy because they are well regulated. Thus the history of a business is recorded in these financial statements. Financial accounting also helps keep control over the day to day activities of a business (Ryan, 2004, p.219). Financial and management accounting is the basis of any financial decision taken for a business. Management accounting paves way to take vital decisions for a business concern which helps it to carry on its business in a prospective way. Also financial accounting producing financial reports in a timely manner provides a reliable source for decision takers like investors. Future cash flows of any business concern is quite uncertain, and with proper and accurate management accounting, it helps any business concern to manage its cash in the most efficient way, thus leading to a prosperous business in the coming future. Management accounting helps any business to look forward and take decisions which help the business to prosper in future. Information derived from management accounting helps a business entity to achieve its future goals and objectives (Houque, 2006, p. 3). Management accounting also helps to measure the effectiveness and efficiency of any business organisation. Cost effectiveness is another crucial aspect of any business concern and management accounting assists such cost effectiveness and cost control decisions taken by the organisation thereby increasing its revenue earning capacity. Success or failure of any business concern is not dependent on quality or quantity of assets possessed by the organisation but on how well those assets are managed and management accounting helps for such cause. There are numerous examples of organisations which are highly successful despite having scarcity of resources or assets as well as organisations reaching to their downfall in spite of having abundant assets and resources, like Enron Corporation and WorldCom. Now, proper functioning of management accounting occurs only when reliable and accurate financial reports are provided by financial accounting. Thus financial and management accounting goes hand in hand and are a crucial as well as critical part of any business processes (Neely, 2002, p. 41-50). 6. Benefits to Business Operations Strategies in accounting aim at successfully competing along with keeping the sustainability within the industry. It is quite important for any organisation to remain focussed on certain specific strategies within management accounting that are essential for its sustainable growth. Efficient, effective and reliable financial reports are the sources of making future improvements by an organisation. Financial information can be used by the business organisation to plan for its future course of actions in order to make efficient utilization (George, 2009, p. 23-30). Financial statements are prepared on the basis of the cash flows generated by the organisation. Any business concern is benefited from management accounting by developing profitable business strategies. Management accounting helps each and every individual associated with the organisation know their responsibilities and perform accordingly for the betterment of the organisation. A reliable and relevant financial accounting procedure always helps in the better business operations of an organisation. Management accounting more often or not reduces the operational expenses of a business. Management accounting also imparts budgetary control within the organisation, thereby helping to reduce cash expenses incurred by the organisation (Botten, 2007, p.335-337). Financial returns get a boost as a result of sound managerial accounting. Management Accounting leads to proper planning, both short-term and long-term planning, to help business organisation achieve its goals and objectives. Management accounting helps business managers manage the business in a more effective way. Management accounting also help determine the strengths and weaknesses of a business and depicts the overview of business loss or profit. Thus, both financial and management accounting is of great importance to any organisation and is highly beneficial for any business operations that are to be performed (Collier, 2005, p. 5). 7. Limitations of Financial and Management Accounting Financial statements prepared through financial accounting have its limitations too. These financial statements are based on historical records and facts. But a business entity is concerned about future and not it’s past. So the past records of an organisation may not give a true picture of what is going to happen in future (Smith, 2007, p. 7). Future is always uncertain and thus there is always a risk associated with any prediction of future. For example, an investor will invest in a business only after it is more certain about the future prospects of the business. Financial statements give only the overall profitability of an organisation but the net profit figures are unknown. Personal judgement of accountants is included in the financial statements and it may not be correct always (Milgate, 2004). Intuitive decisions taken to avoid lengthy procedures to come at conclusive decisions in management accounting may lead to faulty decisions which may not be correct (Drury, 2007, p. 11). It is very difficult for small business concerns to adopt management accounting due to high cost concerns involved in implementing management accounting systems. Management accounting is only in its evolutionary state and it will take time to into full effect in business and this is the reason management accounting produces differing results from one organisation to other (Heidmann, 2008, p. 33). 8. Conclusion Both financial and management accounting is a critical part of any organisation. They play a vital role to make or break a business. Effectiveness and Efficiency of business organisations depends on sound financial and management accounting systems involved in any business concern. Every business entity must be well aware of their financial position and performance to identify key areas or issues concerning a business. Financial and management accounting paves the right way to a business. Management accounting with the help of financial accounting helps evaluating the performance of a business. With set goals and objectives, these two forms of accounting show how a business is heading towards achieving its goals and objectives. Financial and management accounting are linked to each other and both move towards the same goal of increasing business performance. In today’s competitive world both these accounting systems together helps a business concern to sustain and prosper. Management accounting caters to the needs and responsibility at all levels of management in an organisation. Management accounting shows how a particular objective is attainable and the manner in which courses of actions that are to be followed by the organisation to achieve those objectives. Management accounting deals with the relevant information that is required for proper growth of a business organisation. Organisation of management accounting system is prepared in accordance with the needs and requirements of an organisation. Profit maximisation and cost minimisation is the key to the success of any business organisation and management accounting helps for its cause. Thus management accounting is a key performance measure of an organisation. Honesty and integrity are another two important aspects of financial and management accounting. All the financial statements prepared must indicate true facts and figures of organisational activities. Thus to conclude, financial and management accounting are the two cornerstones of any business and they play a quite crucial and effective role in any form of business (Hopwood, 2008, p. 25-31). References Bhimani, A. (2003). Management Accounting in the Digital Economy, Oxford: Oxford University Press. Business Public Relations Database (no date) Accounting’s Role in Business Finance [Online] Available at: http://www.ipranet.org/accountings-role-in-business-finance.html [Accessed on February 26, 2012] Foster, G. (2009). Cost accounting: a managerial emphasis (Ed.13). London: Pearson Prentice Hall. Bendrey, M, Hussey, R. & West, C. (2003) Essentials of management accounting in business UK: Cengage Learning EMEA Bennett, J. J. (2002). Environmental management accounting: informational and institutional developments. London: Springer. Ryan, B. (2004) Finance and Accounting for Business London: Cengage Learning EMEA Smith, J. (2007). Handbook of Management Accounting. 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