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According to Frank Wood and Alan Sangster, accounting is defined as the process of identifying, measuring and communicating economic information to permit judgments and decisions by users of the information. In other words, it records all business transactions either buying or selling transactions and then, by analyzing the information obtained, it helps for decision making. Accounting helps an organization to identify the financial performance of the business and see whether the company is making a loss or a profit. Records are made both in non-profit or profit organizations. Accounting started because people needed to record business transactions, to know whether they were financially successful and it helps to know how much they owned and how much they owed.
TYPES OF ACCOUNTING
Financial accounting provides information primarily to people outside the organization. Let us take an example of a large corporation like IBM. All business activities involve people and those people who have an interest in how the business is run is called the shareholders. In the corporation of IBM, there are more than 600,000 shareholders. However, each shareholder cannot take part directly in the running of IBM. This needs to be maintained. Thus, many thousands of shareholders are not allowed to get access to much information of the firm. Hence, that is the reason why shareholders delegate most of their decision-making power to the corporation's board of directors and officers. The shareholders should have the information so as to have an idea of the performance of the organization. Also, it indicates whether the business is better off or no. In the diagram below, it shows the different stage in an organization which allows instruction to be passed down from senior management to lower levels of management.
Organizational Chart of a Typical Corporation
Financial Accounting is concerned with the preparation of a firm financial statement. That is, the preparation of annual Trial Balance, Income Statement, Statement of Financial Position that is the Balance Sheet and the Statement of Cash Flow. For examples, employees, creditors, debtors, banks, shareholders and among others.
Trial Balance: It is a list of debit balances taken from the ledger at the end of the financial year. The main objective of preparing a trial balance is to check the arithmetical accuracy of the ledger accounts. That is, to know whether the ledger accounts is correct.
Income Statement: The main purpose of preparing an income statement is to calculate: Gross profit or loss and Net profit or loss.
Statement of Financial Position: Its main purpose is to show the financial position of a business that is, what the business owns and what the business owes. In other words, it is a statement of assets and liabilities.
ADVANTAGES OF FINANCIAL ACCOUNTING:
Access to information
The main advantage of financial accounting is that the business gets easy access to the information about an organization. The information which is obtained is helpful because this allows knowing the data about revenue, expenses, assets and liabilities. Also, it helps for decision-making for the upcoming periods. Moreover, it is beneficial to investors who examine the outcomes of financial accounting that is, the financial statements, as it gives an idea which business to invest in. This information helps to make budget and plans for the future to deal with new financial problems and to face competition to other businesses.
Government system necessitates businesses to carry out financial accounting. This means that the process has the benefit of keeping a business in line with regulatory agencies and free from fines and disciplinary action. Also, financial accounting information is a component of transparency and business ethics. In other words, it consists of honest and accurate information for investors, competitors and market analysis. Moreover, information is important for the organization from financial accounting for examples, profits after deducting all expenses and the value tax paid, so as to get their annual income tax returns.
DISADVANTAGES OF FINANCIAL ACCOUNTING:
By using financial accounting in an organision, it is sometimes very costly. This is mostly the case of a large organization. In small organization, the owners should keep systematic records. Therefore, they need to have times for accounting. However, instead of losing their time for accounting, they could have spent their time working with employees or to improve their business' products and services. On the other hand, in a large organization, there is the employment of accounting sectors where there are good specialists with high quality standards. These specialists earn professional salaries and require profits, offices and equipments to carry out their work. In other words, the organization has to use the information obtained from financial accounting so as to get an advantage on financial benefit. On the contrary, this can be risky as lots of money can be losing in this method.
Timing problems can be also a drawback to an organization. This is mostly the case when the business selects a wrong method of accounting for its activities. For example, a cash method is much better for a small organization to use than a large one. This is because this method cannot account for the outstanding payments and account receivables. This, if by mistake a large organization have chosen cash method instead of accrual method, the business may risk to face problems and if a small organization chooses the accrual method, unnecessary problem and expenses will be taken. Thus, it will be a waste of time.
Management accounting is concerned with the information which assists managers to manage efficiently. That is, to make good decisions, to plan for the future and to exercise control. Management needs information from both financial accountant and cost accountant. The main functions of management accounting can be illustrated as follows:
Cost accounting: This is to classify and calculate cost of production.
Capital expenditure decisions: This helps to give an approximation of future expenses and revenues. In other words, it is called budgeting.
Capital structure decisions: It is to provide data on which investment decisions can be made. Also, it helps to manage costs and manage the flow of cash.
Dividend decision: It includes tax.
Therefore, management accounting helps to identify all the important aspects that an organization's decisions are based. Moreover, this helps in taking the steps in the future and to decide what have to be done for every sectors. This type of accounting does not only calculate the costs but also shows how much cost to be saved in the coming periods.
ADVANTAGES OF MANAGEMENT ACCOUNTING:
Making future decisions
Management accounting concentrates more on future decisions-making. Thus, with the help of past financial data, it gives an idea about the performance of the business. Through this, decisions can be made so as to make the business profitable and to grow in size. For example, if the business is not making profit, then the manager can take actions to improve or to change their methods of working so as not to face liquidity problems and to prevent losses in the future.
No restrictions on format or content
In addition, management accounting is for internal use only like top management. Therefore, in this situation, there is no need to follow strict guidelines, restrictions on format or content like for the case in financial accounting.
Decisions can be made any time
Management accounting is flexible in nature. This, it can be prepared anytime and as frequent as required. It is not necessary to make it year by year but can be made weekly or monthly report to monitor progress or take actions.
DISADVANTAGES OF MANAGEMENT ACCOUNTING:
Lack of standardization
In financial accounting, reports are subjected to accounting regulations and standardized format like the Generally Accepted Accounting Principles (GAAP). On the contrary, this is not the case for managerial accounting. Here, managers make their own systems and metrics to calculate the capital of the business. However, its drawback is that one accountant's method can vary from another's method. Therefore, this can lead to irregularities while measuring financial standards and evaluations.
Over-emphasis on quantitative information
Quantitative data helps in decision-making. Nevertheless, management accounting concentrates too much on quantitative information and ignores factors that cannot be calculated in dollars and cents. It can measure the amount of wages which can be saved and some increases in cost that might occur. For example, import duties. However, it cannot calculate savings related to goodwill. Thus, this may be a problem that may arise.
Since the managers make their own systems and metrics to know the performance of the business, this may lead to problems as the manager will apply its personal opinion and if he has taken a wrong decision, this may affect the organization. For example, if a manager is required to measure the productivity of workers, he may concentrate more on outputs and not take into consideration of the worker inputs that can have an intense effect on the whole productivity. This, this may lead to a bad effect on the business and upon the employee also.