Management accounting vs financial accounting

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Introduction

In the beginning of 1850, the accounting scholar Robert S.Kaplan comments, "Despite considerable change in the nature of organizations and the dimension of competition during the past 60 years, there has been little innovation in the design and implementation of cost accounting and management control system."

With the globalization of the financial markets, the financial reporting norms are becoming stricter. However despite that, there are increased incidences of various corporate scandals and regular cases. The question thus raise is to design a system of responsible accounting where the statements don't just convey the number but rather convey a more responsible form of accounting. The answer may lie in the field of management accounting. This report discusses the current role of financial accounting and how it can be made more responsible. In this regard the contribution of management accounting to the assessment of long term objectives of the company would be explored.

Definition

IFAC define management accounting as:

"the process of identification, measurement, accumulation, analysis, preparation, interpretation, and communication of information used by management to plan, evaluate, and control within an organization and to assure use of and accountability for its resources. Management accounting also comprises the preparation of financial reports for non-management groups such as share holders, creditors, regulatory agencies, and tax authorities."

It also says that: "Management account is used by management to plan, evaluate, control, assure accountability."

Traditional financial accounting

The primary aim of the financial accounting is to inform the various stakeholders' information about the performance of the company during a particular time period in the form of numbers. These numbers are used to provide objectivity to the financial statements (Libby,Libby & Short, 2001). However it is important to understand that numbers alone may not present a wholesome picture of the organization due to a myriad of reasons. Some of these reasons are discussed below.

The financial statements present the summary of all the financial transactions that have happened in an entity during the given reporting period in a presentable format. These statements follow a particular accounting system spelled by the concerned regulatory authorities so as to ensure uniformity and comparability in the system. However these statements are silent on the likely future transactions and condition of the company. These statements do not tell the investors about the extent to which the company has achieved its long term objectives (Kumar, 2009).

There are certain limitations to the financial accounting. Firstly, the numbers in isolation have limited usage since they may not be used to derive meaningful conclusions, For example, the income of a financial trading company may have increased and the shareholders may feel satisfied with the excess returns. But what is not represented in the annual report is the amount of risk the company undertook to earn that profit. Similarly even though a company may post good numbers, but still its growth in financial numbers is inferior to that of the peers (Articlesbase, 2010).

There are certain costs and benefits which are not represented in the financial statements which limits its usage. The various social and environmental costs and benefits of doing the business are currently not reflected in the financial statements. With the increasing focus on environment and triple bottom line reporting systems, the importance of these costs and benefits are likely to increase in the near future. Further there may be various off balance sheet transactions that may not find any mention in the financial statements (Kumar, 2009).

There is always scope for manipulation in the financial statements. With the accounting norms giving immense discretion to management regarding accounting of various transaction and related assets and liabilities, misrepresentation and window dressing are a common phenomenon in the corporate. An example in this regard could be regarding the valuation of goodwill and other intangible assets which have assumed unprecedented importance in the modern knowledge driven economy (Articlesbase, 2010). This potentially can explain the fall of various companies like Enron which apparently had strong set of numbers just before their collapses.

Conclusion

Based on the above arguments, it can be concluded that financial accounting at best is just a glimpse of the various transactions during a particular period. These numbers in isolation without the views and comments from the management may be grossly insufficient in accurately accessing the progress of the organization. It is the management who is actually fully aware of the current business scenario and the financial numbers cannot replace the comments of the management.

Management Accounting Vs Financial Accounting

Management accounting refers to the practice of preparation and circulation of various reports related to various aspects of the working of the organization for the internal usage of the management. The guiding principles of management accounting are significantly different from financial accounting. Some of these differences are enumerated below.

Type of information

While financial accounting is primarily concerned with the review of the past performance of the company, managerial accounting is more focused towards the future of the company. Further the reports under managerial accounting are often non financial in nature reflecting diverse topics such as customer satisfaction, employee satisfaction, business scenario and the competitive scenario. Further these reports may also aim at predicting the future business dynamics and the potential company responses. Moreover they could also be related to the feasibility studies and potential new product launches in the future. Usually these reports are of immense significance, as it is used by the management to base important decisions. Further these reports are confidential in nature and are not meant for circulation outside the organization (Bushman, 2007).

Regulation and Standardization

While financial accounting has prescribed accounting norms to be followed, the reports under the management reporting do not have standardized formats dictated by an outside agency. The various processes and procedures regarding the formulation and presentation of various reports under management accounting are dictated by the management of the organization. Further these processes may be flexible at the discretion of the top executives (Accounting for management, 2010).

Time period

The financial accounting requires that financial statements be released after specific time intervals which are determined by the professional regulatory bodies. However in case of management accounting the frequency of reporting may be daily, weekly, monthly, quarterly or yearly depending on the information requirements of the top management (Bushman, 2007).

Other differences

There is no legal requirement of management accounting of either a public or private firm unlike financial accounting which is mandatory for publicly traded firms. Further in contract to financial accounting, the reports generated under management accounting do not need to be ratified by an outside agency like auditor (Accounting for management, 2010).

Management Accounting - The possible solution

It seems that management accounting may be the solution to the various problems that the traditional financial accounting presents. A brief discussion on the role of management accounting in assessing in the progress of the organization is briefly explored below.

It covers various diverse topics besides the financial numbers hence measures a more holistic growth of the organization. The management never views financial numbers in isolation but also consider the other long term objectives of the company. The aim of the company is to aim for sustainable growth of the concerned stakeholders. Hence on a regular basis a stakeholder analysis is done to understand the impact of the business on the various stakeholders and to make requisite changes if required.

Management accounting rather than the past performance tends to focus on the preparation of the organization for the various measures that may be required for the achievement of long term objectives. These reports may be in the form of feasibility study of new product launches, future sales estimation and the expected changes in the consumer behaviour. Hence in this manner this makes the organization proactive in understanding the future business environment and making necessary adjustments.

Since the management is aware of the various facets of the company, the sanctity of the management reports cannot be questioned at least on deliberate tampering with the information. Further there is always a threat of getting fired in case incorrect information is passed to the management. Hence the management reports usually have correct data and the various employees are usually required to give the correct interpretation.

Since these reports have no particular norms to follow, various costs and benefits related to the environment and society are also cleared reflected. This is of particular importance to the management of various companies in wake of becoming more sensitive to corporate social responsibility. Further with the society becoming more sensitive to various environmental costs and government initiatives like tax on carbon emissions, the environment costs are an integral cost of the various project appraisal reports these days.

Hence from the above discussions, it is clear that the management accounting presents a better analysis of the current progress of the organization and helps in a fair assessment of its future path.

Conclusion

On the basis of the above arguments, it can be concluded that the traditional financial accounting consisting of only numbers may not be effective in assessing the progress of the organization for achievement of its objective due to various reasons including limited information, inherent ambiguity and sanctity of the numbers. The solution of these problems may lie in the practice of management accounting which is more wholesome in its information, intent, relevance and accuracy. Further, the management accounting has a focus towards to evaluating the business environment for the future and prepare the company for the fulfilment of its objectives on a sustainable basis.

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