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Davies and Boczko(2005) proposed that financial accounting is the classification and recording of monetary transactions of an organization in line with accounting concepts and conventions, and the presentation of this information by means of a Profit and Loss account, Balance sheet, and Cashflow statement at the end of an accounting period. It involves the use of the past performance of the organization to prepare financial statements which are mainly for its external stakeholders such as Government, Investors, suppliers e.t.c.(Horngreen et al, 2002). The external stakeholders then use these financial statements to make an informed assessment of the financial strength of the organization. Due to the importance of these financial statements, it is a requirement that their production follows a set of framework which is known as Generally acceptable accounting principles(GAAP). This framework means that in order to produce financial statements that can be perceived as credible, four basic principles must be met;
The historical cost of the item must be used.
Full disclosure of all assets and liabilities must be adhered to.
Every expense recorded must be matched with corresponding revenues accrued.
Accrual basis accounting should be used.
These principles are set by the various accounting bodies in different countries and they help in ensuring the consistency and credibility of financial statements.
The overall goal of financial accounting is to provide the financial statements to external stakeholders that will enable them to make an informed judegement of the true financial position of the company.
The limitations of financial accounting include;
1. Lack of Timeliness: This is due to the fact that financial statements are produced using historical information. This information cannot be used by an organization's internal stakeholders during planning because the events on which this information is based has already occurred in the past.
2. Non-Financial information is ignored: In the preparation of financial statements, non-financial information about an organization such as service quality, inflation, role of technology e.t.c are ignored. This information may be needed by stakeholders in order to make predictions of where the company will be in the future.
3. On-Going concerns: The financial statements display information such as assets as on-going concerns based on the assumption that the organization will continue to exist indefinitely. The actual value of the asset if sold at present cannot be determined.
All these inherent limitations means that financial accounting remains only important for external reporting, and it is of little significance in helping management make important decisions(Patel,1997).
Dyson(2007) argued that management accounting is the application of accounting principles to create, protect, and increase value for an organization's stakeholders. This argument was agreed with by Davies and Boczko(2005) who proposed that management accounting has to do with internal stakeholders in an organization using data provided from the financial statements to plan, control, and make decisions that will add value to the organization. The information produced in management accounting is primarily designed for an organization's internal stakeholders such as its managers, and this information is produced in the form of reports such as Sales forecast analysis, feasibility analysis, and Budget analysis. These reports help managers to compare budgeted performance to actual performance of economic indices such as costs and revenues.
The overall goal of management accounting is to provide credible and accurate financial reports to an organization's internal stakeholders e.g. managers and directors, which would enable them in their decision making and formulation of strategies to add value to investors.
Kulkarni and Mahajan(2008) argued that the limitations of management accounting include;
1. Scientific decision making technique: The concept of management accounting involves making decisions using scientific analytical techniques. This limits its deployment to organizations whose managers are willing to change from an intuitive decision making approach to a more scientific strategy.
2. Cannot substitute management: It is a technique that helps management make sound business decisions. It cannot take the place of having dedicated and committed managers who have the ability to take tough business decisions.
3. Garbage In, Garbage Out: The reports generated by management accounting methods is based on the data collected from financial accounting and various other sources. If these data are incorrect, then the results of the management accounting will also be incorrect and lead to poor decisions been made on the basis of these incorrect data.
DIFFERENCE BETWEEN MANAGEMENT ACCOUNTING AND FINANCIAL ACCOUNTING
Inasmuch as both concepts utilize common accounting principles to produce reports, important differences distinguish them from each other and these include;
1. Generally Accepted Accounting principles(GAAP): Drury(2008) argued that a key difference between both concepts is adherence/ non-adherence to the GAAP guidelines set by different accounting bodies in different countries. Horngreen et al(2002) proposed that management accounting do not need to follow the GAAP principles because the information produced in management accounting is primarily intended for the internal stakeholders of the organization who need it for day to day management. They also proposed that the managers in an organization have a responsibility to design an internal accounting strategy that can best work for them in attaining their financial goals. On the other hand, it is mandatory that financial statements conform to the GAAP guidelines in order to ensure the credibility and consistency of the organization to its external stakeholders e.g. shareholders.
2. AUDIT: Kulkarni and Mahajan(2008) argued that management accounting is not subject to a statutory audit by external auditors to ascertain the veracity of the reports produced due to the fact that these reports are not designed for external publication. Drury(2008) agreed with this view by proposing that the legal requirement which stipulates that financial statements should undergo an external audit is not applicable to management reports.
3. TIME FACTOR: Management accounting utilizes historical and present financial information to make future business decisions. This contrasts sharply with financial accounting that is concerned mainly with reporting on what happened in the past.
4. FREQUENCY OF REPORTS PRODUCED: Financial accounts are normally published annually or bi-annually, as compared to management accounts that can be produced periodically depending on when management needs them in order to facilitate the decision making process.
5. OBJECTIVE: The objective of financial accounting is to showcase the financial performance of the organization holistically(i.e. the whole picture) to its external stakeholders; Unlike management accounting which aims to showcase how individual business units of the organization are performing in line with pre-set targets and how this information will enable management to have a strategic review.
Using the GAAP guidelines as a standard, it is not compulsory for an organization to use its published financial statement internally because individual business units which management accounting serves to measure do not need to conform to the GAAP requirements. In addition, non-financial concepts like customer service quality and employee job satisfaction which are used internally to make decisions do not need to conform to GAAP. This view has been corroborated by Drury(2008) who proposed that GAAP requirement is only mandatory for financial accounting and not for management accounting. Taking this into consideration, the answer to the question will be that internal financial information is not subject to the same accounting concepts as those published.
Taking the view of professional responsibility and corporate discipline, it may be viewed as an attempt at professional fraud if financial figures that are stipulated in the published financial accounts are different from those which are utilized internally for planning and control. It can be argued that if an organization manipulates its internal figures, then it is likely that its external figures are also going to be manipulated in an attempt to show a better picture of the organization's finances. Hence, from this perspective, the answer to the question will be that the same strict accounting standards and conventions applicable to published financial reports should also be applicable to those used internally.
In conclusion, in an attempt to merge both perspectives, in order for an organization to ensure its overall credibility, it may choose to adopt the GAAP guidelines for its internal processes of planning and control, thus ensuring that its published figures are the same as those used internally. By doing this, the organization not only ensures its decision making processes are clear and unambiguous to all it stakeholders, but it also ensures that the professional ethics of the organization's accountants are maintained and they are not been perceived as fraudulent by external stakeholders.