Performance measurement is the process to use the parameters to measure the performance of the organization. This process of measuring performance often uses the statistical evidence to determine progress toward specific defined organizational objectives. The purpose of the measurement is to improve the performance of the entity. Performance measurement is to evaluate how well of the entity. It is to formulate a clear, coherent mission, strategy and objectives. Only in an idealized world, an organization with unlimited resources and risk-free living environment, the future can be safely predicted that they would be redundant.
Based on this information, management can analysis the data and find out the problems of the entity and make the entity more effectiveness and efficient. Effective measurement can ensure the management has a control for their subordinates. Particular action can be done after the controls. Budget is the rough tools in improving performance. The achievement of output and outcome is to determine the efficiency of the entity. It may include productivity and cost-data. The motivation of the employee is also important. The use of performance measurement including targets and goals to achieve, it can focus on the employee's thinking and their work performance. When the goals achieved, Celebration helps to improve performance of the employee, it brings attention to them. Measurements are used for learning. It acts as indicators to the managers, managers use analysis of performance in measurements to related areas by revealing irregularities and deviations from expected data results. Learning will be occurred when organizations have problems in operations or failure of goals. The entity improves by analyzing the data and finds out the solutions. All the works need to measure otherwise organizations do not know where to improve. Work will be under controls and manage after measurement of performance. Performance measures are often used to increase the competiveness and profitability of entities via support and encouragement of improvements. There are many methods to have a measurement of organization. Management Accounting and Financial Accounting are two of the performance measurement.
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Financial Accounting is concerned in the field of accounting preparation of financial statements for decision makers such as shareholders, suppliers, banks, employees, government agencies, owners and other stakeholders. Financial Accounting is used to provide the accounting information that is outside of the organization.
Financial Accounting is to record and summarized all the business transactions and events during the fiscal year. It provides information regarding the results of its operations and the financial status of the business. It is the process of summarizing all financial data during the financial period and the information is complied with accounting standards. It is under controls and governed by accounting institutions and published in the form of annual report for the benefit of investor. It is used for investor's decision making.
All the information reflects the past performance of the organization. Is it profitability or efficiency? It is concerned with revenues, expenses, assets and liabilities of the organization. Ratios analysis can identify the strengths and weaknesses and the situation of the entities. Compare the data with the industry and find out the solutions to cut cost or some improvements. Financial Accounting can be help in planning and budgeting.
The American Institute of Certified Public Accountants Committee on Terminology proposed in 1941 that accounting any be defined as, "The art of recording, classifying and summarizing in a significant manner and in terms of money, transactions and events which are, in part as least, of a financial character and interpreting the results thereof".
Management Accounting concerned in the provision and the use of accounting information to managers of the organizations to analysis the data, provide the basis to make informed business decisions that will have controls functions and better equipped in management. It is use for planning, evaluating and control within an entity and to assure appropriate use of and accountability for its resources. Management accounting also includes the preparation of financial reports for shareholders, creditors, investors and public for decision making and investment. According to The American Institute of Certified Public Accountants (AICPA), management accounting as extends to Strategic Management, Performance Management and Risk Management.
Management Accounting has a primary function in developing performance measures. It assists managers in planning can controlling their organizations. It is concerned with providing information to managers for achieving organizational goals. In many years ago, the measurements focus on the aggregate measures of financial performance. It related to Return on Investment (ROI), Economic Value Analysis (EVA) and nowadays widely on both academics and practicing management accountants and management consultants.
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The difference between 'traditional' and 'innovative' accounting practices can be referred to cost control techniques. Cost accounting is a centralization method in management accounting and variance analysis is a systematic approach to compare the actual figure and budgeted costs of raw materials and labor cost used during a production period traditionally. Most of the manufacturing firms are still using variance analysis, but nowadays the trend was changed and conjunct with innovative techniques such as life cycle cost analysis and activity-based costing (ABC). Its purpose is to specific aspects of the idea of the modern business environment. Life-cycle costing recognizes the ability of the manager of the entity, influence the cost of the product manufactured when the product is still at the design stage of the product life-cycle. Even a small change of the product, there is a significant cost saving of the products. Activity-based costing recognizes that most manufacturing costs are based on the amount of the production equipment idle time or the number of production units, to optimize the efficiency of production cycle and to effective the cost control. Both Lifecycle Costing and Activity-based costing avoid the disruptive events such as machine breakdowns and quality control failures.
Management accounting has a fundamental role in performance measurement. Performance measurement in management accounting concerned either the use of performance measures to evaluate divisional and managerial performance or the use of standard costing and variance analysis to control production activities. It can help the management to find out the solution for improvement. The analysis of data can also help management forecasting and planning. Forecast the future and control the cost of manufacturing products. Management Accounting can be used for the overview of the whole internal structure of the organization to facilitate their control functions within an organization. Return on Capital Employed (ROCE) is one of the tools of management accounting. Since management accounting stresses on control costs and responsibilities. Thus, it is helpful in setting up effective and efficiently organization framework.
"Management accounting change is very much path-dependent. Changes occur in management accounting because of major external changes such as competition and modernization. Also, management accounting changes come form the introduction of taken-for-granted external techniques such as budgeting, capital budgeting, and planning." (Gary Spraakman, 2005)
Difference between Management Account and Accounting
Management Accounting is mainly for internal used of the organization. Reports can be generated for any period of time such as half year or quarterly. And Financial Accounting is mainly used for outside of the company, such as public, investor or banker. Financial Accounting always created by monthly based such as fiscal year. The figures of the Financial Accounting are historical, factual and the value is predictive. In the other hand, the value of Management Accounting is forecasting value.
Financial Accounting is a quantitative data and Management Accounting is qualitative data. Quantitative date is used for preparation of financial statement, it is used for decision making of investors and qualitative data is used for planning, forecasting and budgeting, it is used by management of the organization for improvement.
Limitations of Financial Accounting
Financial Accounting is the past performance of the entity. That mean the organization has a good performance in last year which does not mean it will has a profitable performance in coming year. It is a historical data of the entity, it only reflects the fact in past. Financial Account only recorded the historical cost and no impact for the future uncertainties. Financial Accounting does not provide the ways to increase profit or improvement. In case of loss, we do not know whether loss can be reduced or converted into profit under cost controls or cost reduction. Also financial accounting does not show us which department is performed well or not. Which department incurs loss or how much does it loss? Additionally, financial accounting does not provide the cost of products manufactured and how to reduce the wastage. It is not helpful to the management for the strategic making if the replacement of the asset, expenses can be reduced. And it is easy to have a mistake to overvalue or undervalue, so the reliability of the financial account will be reduce. Accounting ratio is one for the financial accounting and limitation as below:
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Ratios are only based on the information which is recorded in the financial statements. Financial statements are also subject to some restrictions. Therefore, ratios are obtained by these restrictions also. For example, changes in non-financial but the important thing are not related to the financial statements of the business. Financial statements are a very large extent the impact of the accounting practices and concepts. Personal judgments involved a large part in determining the number of financial statements.
Ratio is useful to determine the efficiency of the business only when they are compared with the past. However, this comparison only measure the past performance and it may not be correct to predict the future. External environment, management policies and government policies may affect the future operations of the organization.
Changes in the price level will affect the effectiveness ratios calculated in different time periods. In this case, the ratio analysis may not be clearly indicate that the trend of solvency and earnings of the entity. Therefore, financial statements should also consider the adjusting price level changes and if a meaningful comparison is to pass the accounting ratios.
There is no fixed standard can lay the ideal ratio. There are no widely accepted standards or rules of thumb for all ratios can be accepted as standard. It makes it difficult to explain the ratios. Ratio is the only means of financial analysis, not an end in itself. So there is a personal bias, as same ratio may interpret in different way for different people. A single ratio is not to covey meaning too much. In order to create a better interpretation of the ratio, calculate a number which is likely to confuse the analyst and not to help him in any good decision making. Not only the different nature of the industry, the organization's comprehensive portfolio of similar, different sizes and accounting procedures, it will affect the ratio comparison. The ratio was more difficult and misleading.
Limitations of Management Accounting
Management accounting is in the process of development. Therefore, it is subject to the restrictions on all forms of new discipline.
Management accounting acquires information from financial accounting and other records. So management accounting depends on the correctness and reliabilities of these basic records. The limitations of the financial accounting records are also the limitations of management accounting.
Management accounting is just a tool for management. It is not a substitution as the final decision is made by management instead of management accounting. There is a heavy cost for installation of management accounting system. That mean that only a big organization can afford those investment cost.
Personal judgment is incurred in the financial accounting records. This result in bias or deviation, the reliability of the records will be reduced. The basic installation of management accounting change related to the establishment of the organization. Framing new regulations also require that the number of affected persons, which are likely to form some resistance or others. Management accounting is only in a developmental stage. There is no exact standard in its concepts. The result is depended on the data of the management choose.
Management accounting provides data rather than a decision. It is only notice, not rules. This limitation should also be borne in mind while using the techniques of management accounting. A wide range of management accounting, it will have many difficulties in the implementation process. Management needs information form the accounting and no-accounting sources. This has led to imprecise and subjective to the conclusion through it.
Analyzing the Changing Environment
In April 2006, FASB's establish a draft about the Fair Value Measurement, FASB has renewed attention between historical cost measurement and fair value measurement in financial statements.
There is a strongest argument for the move from historical cost to fair value accounting. But historical cost financial statements do not provide relevant information to investors. So it is the fact that the market price of some listed companies in the New York Stock Exchange is five times the value of its assets. The result is to highlight the deficiencies of historical costing account.
The fair value of the exposure draft would establish a framework for measuring assets and liabilities at fair value. But critics expressed concern with the proposal. So FASB has issued a numerous standards to require the use of or provide guidance for calculation fair value measurements in financial accounting in recently years. This change means a lot from the previous practice of deliberate movement away from the historical cost of financial statement toward the fair of market value.
Supporters of fair value accounting believe that historical cost financial statements are not relevant because they do not provide information on the current value. Dissidents in the fair value of the information provide that the financial statements at fair value are not reliable, do not use financial decisions. This trade-off should be the core of any discussion on the use of fair value in financial statement. Despite the advantages of more relevant information, changes to fair value accounting have been a great resistance. The main parameters of fair value accounting are that it is not reliable. "Relevant information that is unreliable is useless to an investor. We must, therefore, be clear about the nature of the claim being made for an accounting number described as reliable." (Financial Executive, March/April 2004)
Management bias is the limitation of the fair value accounting. It may results in inappropriate fair value measurements and misstatements of earnings and equity capital. The overvaluation or undervaluation will not reflect the facts of the organization.
One of the benefits of historical cost financial information, it generates revenue figure is not based on assessment other estimate methods. Therefore, the income statement is not likely to be manipulated by management. As the historical cost is not depending on the estimate value, so the data is more reliable. Furthermore, fair value measurements may be less reliable than historical cost measure because fair value accounting provides management the opportunity to manipulate the bottom line.
The development of reliable methods for measuring fair value, the result is that more reliable, verifiable and auditable of the financial statement. The investors believe that the information reported in financial statements is reliable and reflect the organization financial situation. The argument between historical cost and fair market values will not end soon. But a more efficient system for presenting financial information and economic transactions to boards of directors, analysts and investors is the final result they hope.
Nowadays, organizations need to enhance the competitiveness by performance measurement. Due to the technology changed rapidly, to evaluate the current performance is most important. So both management accounting and financial accounting have the fundamental role in performance measurement.
Financial Accounting records the date to date transaction of the organizations. It is concerned the preparation of financial statement. The accuracy is the key point to record business transactions. As basic on these information, the process of summaries the business transaction is used to provide the information to the people outside of the organization. Under the govern standards, it reflects all the past performance of the organization.
Based on the financial accounting, management accounting is concerned the provision and use of accounting information to management to analysis the data. It is used for planning, budgeting and further decision making and control functions. According to the Chartered Institute of Management Accountants (CIMA), Management Accounting is "the process of identification, measurement, accumulation, analysis, preparation, interpretation and communication of information used by management to plan, evaluate and control within an entity and to assure appropriate use of and accountability for its resources. Management accounting also comprises the preparation of financial reports for non-management groups such as shareholders, creditors, regulatory agencies and tax authorities".