difference between managerial and financial accounting essay

difference between managerial and financial accounting essay

Understanding the Difference between Managerial and Financial Accounting

1. Introduction

As noted in Chapter 2 and throughout Chapter 4, modern organizations can be really complicated beasts. They are composed of an abundance of contracts, non-contractual relationships, social interactions, and complex externalities. Managers are needed to make a vast variety of decisions, and the Internet of Things has put even more pressure on every manager to make more decisions faster and better. Very few of those managers, however, could or would spend most of their professional lives learning all of the stuff taught in business schools. We’ve got to help make them effective quite quickly. That’s what we and all of a sudden managerial accounting practitioners do best.

In our introduction to this chapter, we described managerial accounting in two sharply different ways. On the one hand, we noted that some students think the entire subject is no more than a tool to help managers carry out their daily tasks. They see managerial accounting as “bean-counting” combined with some elementary algebraic skills to facilitate various analyses. At the other extreme, some might envision really deep and important stuff, where managerial accounting is thought of as the glue that holds organizations together. By this view, elements of managerial accounting can be found in every nook and cranny of a complex organization, and the purpose of the subject is to provide managers with tools and techniques to handle their strategic leadership responsibilities. In Chapter 9, we describe this managerial accounting concept in more detail, so it may not be exactly what you think.

2. Key Concepts in Managerial Accounting

Part 2 of the framework is about information. There are two types of information that are useful to businesses – information that helps us about the future and information that helps us explain the past. While businesses also focus on the past because we are curious about what happened, businesses focus more attention on the future than the past because the future helps us make decisions. There are two types of information that help businesses look ahead – information about the world and information about a business. Businesses need to know where the economy is going, in general, so that they can employ resources to create or deliver the things that individuals value most. In doing this, businesses also need to know where the markets will be in order to make that value exchange. However, information about a business is of particular value in head – specific insight into how each unique firm is positioned with their own unique products, with their own unique resources, and with their own unique constraints regarding how they can deliver that service or product.

Key concepts in managerial accounting. There are five parts to the conceptual framework of managerial accounting. Part 1 of the framework is about management. Management is responsible for seeing that the combination of resources is used to create or deliver value. Management is also responsible for seeing that a business can continue to create or deliver value. In order to accomplish these responsibilities, management is responsible for creating an environment that provides insight into determining the abilities of the firm and its opportunities. Management uses this insight to make informed decisions as circumstances change to create value and increase the longevity of the business. The business is then responsible for mining those opportunities in the best possible way. Management also has to set policies and provide incentives to ensure that the right people are in the right places and that they are striving toward common goals that return the greatest value to the business.

3. Key Concepts in Financial Accounting

Efficient capital market theory: It is an important assumption for accounting purposes. The theory says that the market price of a company’s stock provides useful information for investors because all pertinent information about a company is fully and rapidly reflected in the stock price. Thus, the task of financial accounting is to provide external users with relevant and faithful representation of the company’s financial condition. But recent alleged accounting wrongdoings (e.g., Enron, WorldCom, Adelphia, etc.) have brought effective market criticism.

Managerial accounting is concerned with the preparation of operating budgets, which helps in estimating the costs for the future. Managerial accounting is more used for a company’s internal decision-making and operating budget preparation. Managerial accounting is managerial in behavior rather than mandatory. Managerial accounting is concerned more about the future and less about the past. Managerial accounting is more flexible with respect to dimension, criteria, and so on, for example, budget criteria. For managerial accounting, there is no historical reason. Managerial accounting may or may not use a double-entry bookkeeping system.

Financial accounting is concerned with the preparation of the income statement and balance sheet in a way that will help present the financial condition of the business to the users of financial statements. Financial accounting is geared towards external users and is generally very formal in nature, with little room for flexibility, estimates, hunches, etc. The language of business is identified as financial accounting. Financial accounting is primarily utilized by individuals outside of the company, including creditors, lenders, brokers, and directors. Managers utilize financial accounting to aid in decision making. Financial accounting is predicated on historical costs or values. Financial accounting may have flexibility with respect to criteria, etc. Financial accounting utilizes a double-entry bookkeeping system.

4. Comparison of Managerial and Financial Accounting

While the users of managerial accounting are primarily inside the organization, financial managerial accounting is different from production management accounting in a couple of critical ways. Almost every large company has production management accounting systems. These systems are primarily designed to provide internal management with detailed, cost-related performance measures also generated for internal decision-making purposes. Product management accounts are important to operations; they track and monitor a company’s inventory levels, depreciation schedule, and other items necessary to prepare the operating budgets and cash flow estimates; establish the cost-related measures needed to make management decisions, in addition to signaling the need for management’s corrective action; measure nonfinancial, as well as financial key performance measures that are critical to evaluate, control, and improve the areas of operations; these areas may include production volumes and product costs; and provide assistance in pricing and product focus that is vital to a company’s success. However, there are clear variations between managerial accounting and other company-specific accounting, including production management accounting.

Financial accounting provides general purpose information. It is specifically designed to bring together the entire financial reporting needs of those outside of the firm (e.g., external users). Consequently, it serves the public and has specific rules, or generally accepted accounting principles. In contrast, managerial accounting is the provision of relevant and understandable financial and nonfinancial information to people within an organization, thus facilitating management and employees at all levels in efficiently achieving the goals of the firm.

What are the differences between managerial and financial accounting? Most substantial differences can be subdivided into one of two categories: (1) differences that result from the nature and type of data. Financial accounting focuses on financial data, whereas managerial accounting also includes both financial and nonfinancial data (as well as the data that have already occurred in financial accounting); and (2) differences that result from the users of the reports. Financial accounting focuses on external users, whereas managerial accounting focuses on internal users. More specifically, these differences are considerable.

5. Conclusion

The main objective of financial accounting, like managerial accounting, is to provide important financial information to company stakeholders/users related to company security and predictions about future cash supplies. The objective and benefits will be useful if the process follows several alternative and appropriate rules and standards. Businesses must ensure their financial reports are clear and convey relevant information. Therefore, financial accounting follows a specific set of rules and guidelines while preparing reports. These rules and guidelines come from various bodies and are officially accepted through a process of setting up, analyzing, revising, and implementing. Many bodies exist to establish standards for financial accounting, including the Financial Accounting Standards Board (FASB), Securities and Exchange Commission (SEC), and the International Accounting Standards Board (IASB).

Financial accounting provides reports at the end of a period to the external stakeholders of a company, educating them on how the company is doing. These reports must adhere to the rules and guidelines established by accounting’s governing body. For example, publicly owned companies must publish yearly reports for the benefit of shareholders. Suppliers, banks, and the government also benefit from the information provided by financial reports.

Managerial accounting is not about preparing financial documents for external stakeholders, but about supervising and overseeing the company’s operations in a beneficial and productive way. The process connects the dots between raw material and the final product. The end result is information with a privacy level, matching the needs of the company as stated at the beginning of the managerial accounting process. This helps the company make important decisions to create a sustainable competitive advantage.