Financial Accounting and Management Accounting - Case Study Example

Differences between Financial Accounting and Management Accounting When we go through literature, we find that a lot of scholars have illustrated differences between financial accounting and management, also called managerial, accounting, although both the areas of accounting work for the same purpose, that is, making accounting information available to the user. Differences are important to understand in order to get a better grasp on the concepts of financial and management accounting techniques. This paper is going to discuss some of the major differences between the two along with proper referencing. Jamal et al. (2007:9) state that the users for financial accounting are only external which mainly include shareholders, banks, government agencies, society and other potential investors; while, management accounting involves users who are internal to the system such as employees and the management of the organization. In other words, financial accounting provides information in the form of financial statements to the owners, customers, suppliers and creditors whereas management accounting serves the needs of the whole management by measuring and reporting the financial and non-financial accounting information that is required by internal users (managers and employees) for decision making. Khan, Khan & Jain (2006:5) state that the users for financial accounting belong to a relatively larger group where identities can be unknown whereas the users for managerial accounting comprise of only a small group with known identities. This can be understood like this. Investors and creditors look at the total profitability of the organization for which they need financial accounting information; whereas, managers need to know the profitability of every product along with overall profitability and, thus, managerial accounting “has a broad audience” (Heitger, Mowen & Hansen 2007:6). The idea of financial accounting is to maintain a record of financial transactions going within an organization for external reporting; whereas, the aim of managerial accounting is to make useful financial information available to the management (Patra 2006:8) to support their planning and problem solving which is also called internal reporting. In financial accounting, there are strict accounting principles that should be adhered to in order to maintain accurate financial records; whereas, in managerial accounting, there are no hard and fast rules to follow in order to ensure flexibility and convenience of the information. Financial accounting is normally carried out under Generally Accepted Accounting Principles (GAAPs) while management accounting is done under rules that are convenient to the managers and employees who take necessary actions after analyzing the overall cost and benefit of a product. Information that is to be stored by financial accounting, as stated by Jamal et al., is “historical, quantitative, monetary and verifiable”; whereas, information in managerial accounting is “current or forecasted, quantitative or qualitative, monetary or non-monetary and timely or reasonably estimated”. Hence, we can say that financial accounting information mainly deals with monetary transactions and has fewer approximations whereas managerial accounting information handles both monetary and non-monetary transactions and has many approximations. It is also important to notice here that financial accounting deals with information concerned with transactions that have happened in past, also called past information and historical accounts, while managerial accounting deals with information regarding future transactions based on decisions made from financial accounting information. In other words, financial accounting is concerned with past performance of the organization whereas managerial accounting is more future oriented though past information is also to be analyzed. Another major difference between the two areas of accounting is the format or general layout and structure of the information being presented, that is, reports. In case of financial accounting, the format of reports is generally the same in all enterprises. Financial statements, which are the end-product of financial accounting, consist of balance sheet (that shows the financial status of a company at a specific point), income statement (which is the profit and loss account showing the result of transactions over a certain time period) and cash flow statement (that shows the flow of finances over a certain time period). All companies follow the same formal and unified pattern in preparing these financial statements. This is mainly to facilitate the external users to better understand these statements as they are comparing these with those from other companies and, thus, a uniform structure is necessary. On the other hand, the format of reports in managerial accounting is not specific. The structure is informal and varies with the internal users’ needs and thus a unified structure is not needed. Also, the financial accounting reports must meet the laws defined by the country whereas the structure of management accounting reports do not have follow any law and have to be tailored according to the management’s internal requirements (Shim & Siegel 1998:1). Less detailed financial accounting reports are developed quarterly and the detailed ones are made annually based upon accounting principles and there can be delays in reports (Atrill & McLaney 1994:9); whereas, reports in managerial accounting are created as per the management’s needs. These can be as frequent as being issued daily but are mainly weekly or monthly, and are issued right after the end of a certain period that has been covered. Earlier we talked about approximations in information. Let’s elaborate it here. As we said that the management needs to issue reports rapidly after a certain period ends, it has to compromise upon precisions and accuracies to some extent in order to speed up the process. Thus, managerial accounting reports have more approximations than financial accounting reports although the latter too is not one hundred percent precise. As the financial accounting reports need to be more precise, thus they need to be reviewed by auditors and this takes extra time for these reports to reach their users. Time is also spent in printing of these reports and then getting them distributed. On the other hand, managerial accounting reports are quick as they have to be made available to the managers to make them act fast. Thus, financial accounting reports may take two or three month to reach the users while management accounting reports take only days. Another important difference is that since financial accounting information are public documents, the external users have all the rights to sue against it if a company happens to display inaccurate or fraudulent information in its financial statements. On the other hand, management accounting reports are not public property and there is less chance of their containing misleading information. Although, chances are always there for managers too of getting involved in fraudulent activities but action can be taken internally and there is no risk of getting sued by external shareholders, investors and creditors. Now, let’s discuss the most common accounting rules used today. There are the Generally Accepted Accounting Principles (GAAPs) that are certain rules of accounting which help companies to record and report their financial information in an error-free and proper way. Companies have to follow GAAPs in order to come up with unified financial reports that shareholders and creditors want to use in a convenient way. Without these principles, every company will have its own style of reports prone to error and will have to account for its transactions individually in front of external users. GAAP is being used by almost all types of firms, private and public, and makes the users adhered to specific laws and frameworks. In short, GAAP is a set of accounting principles that help external users to have a precise idea of a company’s financial position in the market. Furthermore, as business grew globally, there was need for uniform international accounting principles that could work cross border. Thus, according to Brian (1998), IASC (International Accounting Standards Committee) put forth the idea for uniform accounting principles. As a result, FASB (Financial Accounting Standards Board) was developed in 1973. All financial reports issued by FASB are exactly according to GAAPs. Putting it all together, the two areas of accounting, that is, financial accounting and managerial accounting, have both similarities and differences which need to be comprehended before handling the financial information of a company. The biggest difference is that financial accounting targets a broader audience while managerial accounting goes for a smaller set of audience consisting. Despite the differences, the purpose of both the areas of accounting is the same, that is, processing a company’s financial information. References Atrill, P & McLaney, E 1994, ‘Financial accounting and management accounting’, Management Accounting: An Active Learning Approach, illustrated edn, Wiley-Blackwell, USA. Brian, L 1998, ‘Leading the way to uniform accounting principles’, AllBusiness, viewed 21 June 2010, < http://www.allbusiness.com/accounting/methods-standards/735889-1.html> Heitger, DL, Mowen, MM & Hansen, DR 2007, ‘Financial accounting and managerial accounting’, Fundamental Cornerstones of Managerial Accounting, illustrated edn, Cengage Learning, USA. Jamal, NM, Mastor NH, Saat, MM, Ahmad, MF & Abdullah, DF 2007, Cost & Management Accounting - An Introduction, 1st edn, Penerbit UTM, Malaysia. Khan, M, Khan, MY & Jain, PK 2006, ‘Financial accounting, cost accounting, and management accounting’, Management Accounting, 4th edn, Tata McGraw-Hill, New Delhi. Patra, K 2006, Accounting and Finance for Managers, 1st edn, Sarup & Sons, New Delhi. Shim, JK & Siegel JG 1998, ‘Financial accounting vs. management accounting’, Schaums Outline of Theory and Problems of Managerial Accounting, 2nd edn, McGraw-Hill Professional, USA. Read More