Difference Between Financial Accounting And Management Accounting
Accounting is a vital function for businesses as it helps in measuring and communicating the financial information of an organization. Accounting information helps managers in decision making, investors in making investment decisions, and lenders in assessing the creditworthiness of a company.
Financial accounting and management accounting are two branches of accounting that are used to fulfill different purposes. Although they are related to each other and share some common features, there are significant differences between the two. In this article, we will explore these differences to understand why financial accounting is important for external stakeholders, while management accounting is crucial for internal decision making.
Financial accounting is concerned with the preparation and reporting of financial statements for external users, such as investors, creditors, and government agencies. It follows a set of generally accepted accounting principles (GAAP) and provides information about the financial position, performance, and cash flows of a company. The financial statements include the balance sheet, income statement, statement of cash flows, and statement of changes in equity.
On the other hand, management accounting is concerned with the use of accounting information to support managerial decision making and control functions within an organization. It provides managers with information for planning, controlling, and evaluating the performance of the organization. Unlike financial accounting, management accounting is not governed by specific rules or standards and can be customized to meet the specific needs of the organization.
One of the key differences between financial accounting and management accounting is their audience. Financial accounting is primarily for external stakeholders who rely on the financial statements to make informed decisions about the organization. These stakeholders include investors who analyze financial statements to assess the profitability and financial stability of the company, creditors who assess the creditworthiness of the company before issuing loans, and government agencies who use financial statements for taxation and regulatory purposes.
Management accounting, on the other hand, is for internal stakeholders, such as managers and employees, who need information for planning, controlling, and decision making within the organization. Managers use management accounting information to set budgets, monitor performance, and analyze the profitability and efficiency of different departments. It helps in identifying areas of improvement and making informed decisions for the future.
Another difference between financial accounting and management accounting is the time frame. Financial accounting focuses on historical data and reports on the financial performance of the organization for a specific period, usually a year. It provides a summary of the financial position of the company and its activities during that particular period. It is retrospective in nature and helps stakeholders understand what has happened in the past.
In contrast, management accounting focuses on the future and helps in planning and decision making for the organization. It involves the analysis and interpretation of past and present data to forecast future performance. Managers use management accounting techniques, such as budgeting, variance analysis, and cost-volume-profit analysis, to make decisions about pricing, product mix, and resource allocation.
The third difference between financial accounting and management accounting is their level of detail. Financial accounting provides a summarized and aggregated view of the financial performance of an organization. It reports on the overall results of the company and complies with the rules and standards set by accounting bodies. It is focused on external reporting and provides a high-level overview of the organization's financial activities.
Management accounting, on the other hand, provides detailed information about specific areas of the organization. It breaks down the financial data into smaller components to assist managers in decision making. It can provide cost information for individual products, departments, or projects, allowing managers to allocate resources efficiently and assess the profitability of different areas of the organization.
Furthermore, financial accounting is mandatory for all companies as it is required by law in most countries. Companies are legally obligated to prepare financial statements in accordance with the accounting standards and disclose them to external stakeholders. Failure to comply with financial accounting standards can result in penalties and fines.
Management accounting, on the other hand, is not mandatory and can vary from one organization to another. It is up to the management to decide what information they need to run the organization effectively. Management accounting systems can be customized to meet the specific needs of the organization and can vary in terms of complexity and sophistication.
In conclusion, financial accounting and management accounting are two different branches of accounting that serve different purposes. Financial accounting focuses on the preparation and reporting of financial statements for external stakeholders, while management accounting provides information for internal decision making and control functions. Financial accounting is retrospective in nature and reports on past financial performance, while management accounting focuses on the future and helps in planning and decision making. Financial accounting provides a summarized view of the organization's financial activities, while management accounting provides detailed information for specific areas of the organization. Both types of accounting are essential for the smooth functioning and success of an organization.