Managing Accounting Essay on Financial Accounting v Management Accounting This essay compares and contrasts the roles of financial

and management accounting and evaluates the usefulness of both of the two accounting disciplines to the organisational decision making process. The American Accounting Association (1966) defined accounting as "the process of identifying, measuring and communicating economic information to permit informed judgments and decisions by users of the information. Key elements to this definition are that there is preparation and communication of economic information to the users and that the purpose of the information is to help the users make informed judgements and decisions" either about their relationship with the organisation or about management of organisational resources. There are different interested parties to organisational activities like management, employees, customers, suppliers, investors, government etc who rely on the accounting information to make decisions. These stakeholders can broadly be divided into internal (management and employees) while the rest are external stakeholders. This categorisation will help to contrast the roles of financial and management accounting information. Financial Accounting is the classification and recording of the monetary transactions of an entity in accordance with the established concepts, principles, accounting standards and legal requirements and their presentation by means of income statements, balance sheets and cash flow statements, during and at the end of the accounting period (CIMA Official terminology, 2000). By this definition, all business activities that can be quantified in financial terms are recorded, summarised and presented in a standardised format to enable users easily understand monetary performance and position of the business. On the other hand, management accounting is the application of the principles of accounting and financial management to create, protect, preserve and increase value so as to deliver the value to the stakeholders of profit and not-for-profit enterprises, both public and private (Official terminology, 2000). Form the definition, the focus of management accounting is to provide information for the management of resources to achieve organisational objectives. The two accounting disciplines are fundamentally the same in that they originate from the company transactions which have been recorded over a period of time. While financial accounting will classify, summarise and report the records in accordance to standards, management accounting will use the records to produce detailed analysis of information as required by management. Secondly, the information used under both functions have general qualities of completeness, relevance, timeliness, cost effectiveness and easily understandable. The information that make up both accounts originate from the same systems. The key element to both of them is that they communicate economic information to help make informed judgements and decisions. There are however differences between the two. Firstly, while management may use financial accounting information to evaluate past performance, financial statements are prepared to primarily enable stakeholders external to the organisation understand the operations of the business. Organisations interact with its stakeholders as investors (providers of finance), customers (buyers 1

and consumers), suppliers (raw materials and consumables) etc. These stakeholders have to make economic decisions regarding their relationship with the organisation and the financial statements are the major source of information that forms the basis of their decisions. They use financial figures provided to interpret past performance and financial position and forecast the future. Management accounting information is prepared for use by management internally for decision making. Organisational activities are based on plans (strategic, tactical and operational) that the organisation pursues to achieve objectives. These financial plans have to be communicated, monitored and controlled; all of which are management activities. For example, decisions for new product development, machinery acquisitions, costing, divestment, to produce or buy, rent or build etc all require supporting relevant and timely information. This is the information that is provided by the management accounting. Various tools are used in the process like budgeting, variance analysis, customer/product analysis, investment appraisals etc to enable effective decisions made. Secondly, the information provided by financial statements relates to the past performance of the business with little predictive value for users. Users interpret the past using tools like ratios to predict the future. Management accounting information is mostly concerned with the future; providing management with the roadmap to future operations of the business. Thirdly, financial accounting information is prepared and presented in compliance with the prescribed concepts and standards to enable users (most of whom may not have finance background) understand the figures and allow them to compare performances of other companies. This allows for more objective data to be reported. Management accounting information is prepared to suit the specific requirement of management and is therefore prepared and presented as management sees fit. This allows management to use the framework they easily understand. The result is highly subjective information that cannot reliably be used to compare performance of other companies. Fourthly, it is a legal requirement for companies to produce financial statements, at least for tax purposes. There is no legal requirement for companies to prepare management accounts. The information is therefore only prepared if management considers the information to be relevant to their decision making process and that the benefits of preparing the information exceed the cost of doing so. Fifthly, the information reported under financial accounting covers longer period, mostly semiannually and annually. For some private and public limited companies, external auditing may be requires to express opinion on the final financial statements. Management accounting information is prepared for shorter periods depending on the requirements of management. This allows management to monitor and control performance as urgently as activities are carried out. Lastly, the main focus under financial reporting is financial performance of the business. Thus, nonfinancial information is not addressed, leaving the users with the task to mine the non-financial information by themselves. Although there are more disclosures by directors these days in the form of operating and financial review, the information provided is brief. Management accounting information may include more of non-financial information, for example the impact of a new system to the productivity of the workforce. The figures provided under management accounts are mostly explained by the non-financial information provided.

Although the emphasis under financial accounting is for external users, management also uses the information for the decision making process. Management needs to know the profitability of the business and work out important performance variables like return on capital employed, liquidity position, working capital cycle, gearing position, price/earnings ratio etc. This will easily reflect the risks like credit, liquidity, financial etc that the company is exposed to. Management will often use the information from the financial statements as starting point in evaluating and planning the firms overall activities (www.cambridgepub.com). Thus, planning for decisions like the reward systems, dividends policies therefore originates from the published financial information. Management will also use financial information to compare its performance to the competitors and perhaps use it for benchmarking decisions in the business. Managerial accounting is useful because it provides the information that management requires to formulate strategic, tactical and operational decisions. Clearly, the information requirement of management is more than that of other stakeholders. Management requires more detailed, timely and relevant information that will enable it to plan, control and evaluate the activities of the business. Johnson and Kaplan (1987) explain how management accounting system must provide timely and accurate information to facilitate efforts to control costs, to measure and improve productivity, and to devise improved production processes. The management accounting system must also report accurate product costs so that pricing decisions, introduction of new products, abandonment of obsolete products, and response to rival products can be made. Management accounting therefore provides information that enables management to make decisions for value creation and achievement of competitive advantage and analysing the relevance to day to day decisions that enable achievement of overall objectives of the organisation.

References ACCA (2009), Management Accounting, Study text, Third Edition, BPP Learning Media Ltd, London CMA (2006), Fundamentals of Management Accounting, Study text, Kaplan Publishing Foulks Lynch, Wokingham ACCA (2009), Financial Accounting (International), Study Text, Third Edition, BPP Learning Media Ltd, London Paul M. Collier (2009), Accounting for Managers: Interpreting Accounting Information for DecisionMaking, Third Edition, John Wiley & Sons Ltd, London. http://www.cambridgepub.com/managerialaccounting_6e/MA_6e_CH01_Website.pdf, accessed on 09th November, 2012 http://highered.mcgrawhill.com/sites/0073526703/student_view0/ebook/chapter1/chbody1/comparison_of_financial_and _managerial_accounting.html, accessed on 10th November, 2012