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Financial Accounting and Managerial Accounting

The purpose of accounting is to provide information for sound economic decision making Financial Accounting is the use of Income Statements, Balance Sheets and Cash Flow Statements from the perspective of the user of these financial statements. These statements are prepared keeping in mind various stakeholders – the shareholders, employees, internal management, creditors, debtors etc. These statements also need to be prepared according to some Generally Accepted Accounting Principles (GAAP).

Managerial accounting is concerned with providing information to managers- that is, to those who are inside an organization and who direct and control its operations. Managerial accounting can be contrasted with Financial Accounting, which is concerned with providing information to stockholders, creditors and others who are outside an organization (Garrison and Noreen, 1999). Financial Accounting Financial Accounting uses Income Statements, Balance Sheets and Cash Flow Statements for communicating with the various stakeholders primarily the external stakeholders like suppliers, shareholders.

Cash flow accounting measures performance by comparing cash inflows and outflows for a certain period while accrual basis accounting compares revenues and expenses. Accrual basis accounting uses the concept of realizing cash based on when it is received and revenue recognition on a periodic basis and mostly on a quarterly basis for measuring the performance of the company. Objectivity – information should be verifiable and reliable- and Conservatism through which gains and losses are reported with equal treatment are other principles which are used in Financial Accounting.

Income Statements reflect results of the Operating Performance reflected through revenues, gains, losses, expenses. The important components of an Income Statement are Sales or Revenues, Cost of Goods Sold, Gross Profit, Operating Expenses and Net Income. Important elements of a Cash Flow Statement are Operating Expenses, Investing Activities, Financing Activities and Net increase/decrease. Managerial Accounting Managerial accounting information include: Information on the costs of an organization’s products and services.

For Example, product costs can be used for setting prices and also are used for inventory valuation and income determination Managerial Accounting makes use of various tools like Budgets, Performance reports like comparisons of budgets with actual results called variances. (Horngren and Foster, pp. 3). Other information on revenues of an organization’s products and services, sales back logs, unit quantities and demands on capacity resources assist managers in their planning and control activities (Kaplan and Atkinson, pp. 1).

Managerial Accounting Practices Traditional managerial accounting systems are mainly designed to measure the efficiency of internal processes. The new managerial accounting practices such as activity-based-costing, the balanced scorecard and bottleneck accounting indicate the developments taking place in Managerial Accounting. Unlike traditional managerial accounting which used primarily variance analysis, activity-based-costing deemphasizes direct labor or raw material as cost drivers and concentrates instead on activities (e.

g. the number of production runs per month) that drive costs. Activity-based costing gives the management of an organization a clear picture of the cost drivers and the opportunities to reduce costs (Kaplan and Norton, 2001). While some form of variance analysis is still used by most manufacturing firms, it nowadays tends to be used in conjunction with other performance reports such as the balanced scorecard.

A balanced scorecard is a set of financial measures, operational measures on customer satisfaction, internal processes and the organization’s innovation and improvement activities (Kaplan and Norton, 1992) as a strategic management system which identifies the value drivers of an organization’s strategy and a management system to align the organization to the strategy. In a traditional variance analysis, managerial accountants compare the actual sales with the budgeted sales. A traditional variance analysis however does not point out which bottleneck coursed an unfavorable difference between actual and budgeted sales.

With bottleneck accounting however, managerial accountants are able to determine the bottlenecks in an organization and to determine how much money was lost in each bottleneck. Conclusion Financial Accounting and Managerial Accounting are the two sides of the same coin that represent the unique ways of representing accounting information for the benefit of various stake holders that are external and internal to the company. The information presented, while meeting the needs of the regulators, should also be accurate, easily understandable and complete for decision making.

References Garrison, R. H. , P. E. Noreen,(1999). ‘Managerial Accounting’, Irwin McGraw Hill, Inc Horngren, C. T. and G. Foster(1987). ‘Cost Accounting, A Managerial Emphasis’, Prentice-Hall, Inc. Kaplan, R. S. and A. A. Atkinson(1989). ‘Advanced Management Accounting’, Prentice-Hall International Inc. 1989 Kaplan, R. S. , D. P. Norton(1992). ‘The Balanced Scorecard – Measures that Drive Performance’, Harvard Business Review, January – February. Solomons, D. (1952) ‘Historical Development of Costing’, Studies in Costing, Sweet & Maxwell