The Key Differences Between Financial Accounting & Management Accounting

financial accounting and management accounting

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So, the difference between Financial Accounting & Management Accounting is as clear as the name suggests. Financial accounting deals with maintaining business transactions & documenting the data for users to make valuable financial decisions.

Whereas, management accounting, also known as managerial accounting, is a relatively recent branch of accounting that addresses managerial issues. It is mostly concerned with providing financial reports to the company’s management in order for them to make sound economic judgments. 

What is Financial Accounting?

Financial accounting demonstrates the financial status of a company to outside stakeholders. This enables the board members, shareholders, future investors, creditors, and investment firms to understand how the company fared in the past.
These reports are submitted once a year and have to be made public.

Financial accounting follows GAAP guidelines which is a set of accounting standards that call for sound financial reporting and recording. The objectives of financial accounting reports, in turn, provide an overview of the company’s overall performance.

Typical financial accounting reports include

  • Balance Sheet: A preview of your company’s financial position. It shows you what assets you hold and what debts you owe at any one time.
  • Profit & Loss Statement: It demonstrates the profit your business made in the accounting period. It discloses your earnings & spendings.
  • Cash Flow Statement: Only organization that follow the accrual accounting approach creates this. The income statement of an organization may include revenue that has not yet been received and expenses that have been incurred but not yet paid. So, one can ignore this report if you use the cash accounting technique of documenting expenses.
Difference between Financial Accounting & Management Accounting

What is Management Accounting?

Managers and supervisors employ management accounting to draw inferences about a company’s day-to-day affairs. It is based on present and future trends rather than historic data or performances. 

For instance, assessing the approximate number your company should demand for an upcoming product and analyzing how profitable a forthcoming product line are both instances of managerial accounting business problems. 

The objectives of management accounting entail focusing on forecasting markets and emerging developments. This comes in handy since business leaders are frequently needed to make operational decisions in a jiffy.

Not only this, but managerial accounting also examines the entire company’s systems and procedures to identify inefficiencies in the business. This accounting style strives to eliminate these inefficiencies in order to increase profitability. 

The data that management accounting professionals uncover aids in the making of business choices in almost every facet of an organization. These professionals deliver their reports to responsible management and other key decision-makers.

To sum up, budget reports, job cost reports, income statements, inventory & manufacturing reports are some of the reports that a management accountant has to submit. These are for the internal workings and they assist in decision-making at the organizational and departmental levels.

Difference Between Financial Accounting & Management Accounting: A Comparison Table

Points of Difference Financial Accounting Management Accounting
Definition It is a discipline concerned with the maintenance of financial accounts as well as the dissemination of information to users.  It is concerned with providing data to managers that are valuable in the design of policies and daily operations for the optimum functioning of the business.
Primary Audience External parties: shareholders, creditors, lenders, banks. Internal parties: directors, managers, employees.
Report Type Balance sheet, P/L statements, cash flow statements, etc. The budget report, job costing report, production cost report, etc.
Nature of Reports The reports are available to the general public. These are generated for exclusive use by the company’s management and hence are private.
Information Monetary Monetary & non-monetary
Orientation Historical Forward-looking
Time Span It is prepared for a specific period i.e. one year. It is prepared whenever the need arises.
Guidelines & Formats Follow GAAP/IFRS regulations & a specified format. No regulations or formats are required.
Segments Majorly concerned with reporting for the whole company. It is focused on segment reporting.

Functions of Financial Accounting

  1. Systematic Recording: In a big corporation, a large number of transactions occur on a regular basis, and it is impossible to remember all of them. As a result, they must be documented in a systematic and chronological way. They are then processed through journals, ledgers, and other systems before being converted into financial statements. Systematic records refer to the application of financial accounting standards and national government rules to track every financial transaction of a company.
  1. Analyzing: The financial accounting team must analyze and summarise the entire transaction in order to check its validity and authenticity. To determine the profit or loss of a company in a given financial year, the team will analyze it in Trail Balance and summarise it in the final account.
  1. Communicating: All parties must be informed of the results of the business financial status for a certain financial year by the financial accounting team. Therefore, it will be communicated to
  • Shareholders
  • Creditors
  • Lenders
  • Bank institutions etc.
  1. Meeting Legal Requirements: The financial accounting team must adhere to all legal requirements such as having an external auditor audit the records for a specific financial year and paying tax responsibilities in accordance with the country’s tax regime.

Limitations of Financial Accounting

Historical in nature

The historical nature of financial accounting means that it gives information about past events. Therefore, it doesn’t provide any current facts that management needs to make an efficient future plan. As a result, it is correct to say that financial statements only provide a post-mortem review of past activity. It is ineffective in determining the selling price & thus causes difficulty in price fixation.

Impossible to control costs

Controlling costs in financial accounting is impossible because costs are recognized at the end of the fiscal year when the expense has already been incurred. This implies that there is nothing that one can do to control that cost. To sum up, even if it is discovered that a specific cost is higher, it will be impossible to control it.

No means to assess the performance

It does not offer any information to evaluate the performance of various individuals and departments. Also, it does not ensure that expenditures do not surpass an acceptable limit for a given volume of work.

Limited to a specific period of time

By simply examining one reporting period, one can get an inaccurate picture of a company’s financial status or cash flows. A business’s typical operational performance may differ from one period to the next, either due to a rapid surge in sales or seasonal impacts. To get a better picture of ongoing outcomes, look at a large number of simultaneous financial statements.

Inadequate information for reports

Financial accounting records information about a company’s financial operations as a whole rather than on an individual basis. It does not focus on information about specific products, departments, and so on.

Functions of Management Accounting

  1. Forecasting & Planning: Management accounting is intrinsically linked to forecasting & planning by presenting data and reports for decision-making. These reports assist business executives in estimating the impacts of multiple actions in order to achieve their objectives. The management accountant uses statistics principles, capital budgeting, marginal costing, etc to plan the business ahead.
  1. Organizing: By analyzing distinct activities and delegating primary roles, the management accountant assists managers in administering the business’s human and non-human assets. They seek to organize the company’s accounting and finance functions in a modern manner.
  1. Coordinating: To maximize revenue and productivity, management accounting offers several coordination tools such as budgeting, financial analysis, interpretation, financial reporting, and so on. It assists management with the reconciliation of cost and financial accounts, developing budgets, establishing standard costs, and analyzing cost deviations.
  1. Controlling: This is done to monitor, measure & correct actual outcomes to ensure that the goals and expectations of a company are met. The control reports can throw some light on a company’s actual and expected performance. These reports can help you take the remedial action you need to keep your operations under control. A manager focuses on what’s missing and can be done if there are discrepancies between budgeted and actual outcomes.
  1. Financial Analysis: It’s the process of analyzing financial data like the balance sheet, cash flow statement, and P/L statement. This helps in getting an idea of an organization’s financial status and operating performance. It also aids in anticipating the organization’s future outcome and effectiveness.
  1. Communication: A management accounting professional creates a variety of reports in order to communicate findings to managers, maintain significant control over their operations, and help management to make smart decisions. Via published accounts and returns, they also inform the external parties about the company’s performance.

Limitations of Management Accounting

Dependency on other accounting types

Management accounting relies heavily on cost and financial accounting for planning and forecasting. Therefore, the better maintained the cost and financial reports are, the better will be the management accounting report.

Lack of knowledge

To be a successful management accountant, one must have a thorough grasp of subjects like financial accounting, cost accounting, statistics, economics, engineering, sociology, etc. However, these skills seem to be lacking in most of these professionals.

Focuses on data only

One prepares & presents various alternatives to management under the management accounting system to address an issue. The management has the option of choosing any one of the many options provided or even discarding them all. As a result, management accounting can merely provide data and not recommend how to proceed.

Wide scope

The scope of management accounting is pretty wide because it takes into account both monetary and non-monetary transactions in a company. The management accountant’s lack of expertise and experience can lead to data preparation that is erroneous and untrustworthy.

Costly affair

The expense of setting up a management accounting system is too high. As a result, a small business cannot afford to pay for such a setup. Furthermore, a system’s utility is limited to large companies.

Lack of objectivity

Another significant disadvantage is that personal bias and preconceptions undermine the objectivity of management accounting decisions. So, from the acquisition of data to its presentation in financial reports, there is a chance of manipulation. This can impact the overall accuracy of management accounting.

Similarities Between Financial & Management Accounting

While we pointed out many differences between financial and management accounts, they tend to co-exist sometimes. Going forward, let us find out how they can be similar in multiple ways.

  1. They co-exist to provide accounting information to the users.
  2. Both accounting types will be responsible for generating financial reports.
  3. One can measure & determine the costs for various accounting periods, departments and sections in both accounting types.
  4. Both of them collects and categorizes accounting data in order to prepare financial reports.
  5. For the purposes of cost accumulation and cost allocation, both systems utilize the same accounting concepts and practices.
  6. Both practices require education and expertise in accounting.

In A Nutshell

When it comes to financial accounting vs management accounting, most organizations use both, even if they aren’t aware of it. It’s vital to stay up-to-date with your company’s financial health at all times, and not just when you’re thinking about launching a new product line.

Both financial & management accounting relies on your financial transactions. Hence, it assists in ensuring the accuracy of financial data given in business finance reports for external parties. It also aids in the accuracy of estimates based on existing data and past performance.

To keep up with the ever-changing environment, you must have impeccable management and financial accounting system. You may help your business function in a more effective and efficient manner & boost profitability by incorporating advice from the management side. In conclusion, this makes it evident how much the use of management accounting is crucial.

Subsequently, you may open yourself up for massive growth by using financial accounting to keep the external parties informed. Despite the fact that the two approaches of accounting have different objectives, thriving companies of all sizes depend on both to stay at the top of their game.

0 Source: GreatLearning Blog

By AlJazeera