Difference Between Financial Accounting and Management Accounting

Edited by Diffzy | Updated on: September 21, 2022

       

Difference Between Financial Accounting and Management Accounting Difference Between Financial Accounting and Management Accounting

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Introduction

Over the centuries, accounting has been confined only to the financial record-keeping operations of the accountant. However, in today's rapidly changing business environment, accountants are forced to reassess their roles and operations both in the organisation and in society. The job of accountants has shifted from that of a mere recorder of transactions to that of the member providing required information to the decision-making team. Accountants can work in growth areas such as forensic accounting (solving crimes related to computer hacking and theft of significant amounts of money on the internet), e-commerce (designing web-based payment systems), financial planning, environmental accounting, etc.  This realisation came since accounting can provide the kind of information that managers and other interested persons need to make better decisions. Accounting is known as the process of identifying, measuring, recording, and communicating the required data relating to economic events of an enterprise to the interested users of such. Two types of accounting are financial accounting and management accounting. Financial accounting is known as the process of recording, summarizing, and reporting an enterprise's business transactions through financial statements Managerial accounting may be defined as the process of identifying, measuring, analysing, and interpreting accounting information that helps corporate leaders make sound financial decisions and efficiently manage their daily operations.

Financial Accounting vs Management Accounting

The critical difference between financial accounting and management accounting is that financial accounting intends to provide financial information about the company to external users of accounting information like stakeholders and third-party organizations doing business with the company. Management Accounting, on the other hand, assists internal users of accounting information like the management of the company in decision making by providing quantitative and qualitative data to the managers. Financial accounting aides external users while management accounting aides internal users of accounting information. Financial accounting provides public information that is disclosed to the public. Management accounting offers private and highly confidential information about the company that is not often disclosed to the public. An enterprise is legally bound to publish information generated through financial accounting, while it is not mandatory for a company to generate management accounting information. A specific format must be maintained to develop and analyse financial accounting information. On the other hand, no format needs to be followed to generate and analyse management accounting information.

Difference Between Financial Accounting and Management Accounting in Tabular Form

Table: Financial Accounting vs Management Accounting
Parameters of Comparison
Financial Accounting
Management Accounting
 Definition
Financial Accounting can be defined as accounting that aims to provide financial information to the stakeholders and third-party organizations engaged in business with an enterprise.   
Management Accounting can be defined as accounting that provides financial information, advice, and forecast that can be utilized by the management of the enterprise.
Aim
The main aim of financial accounting is to ensure access to helpful accounting information for external users.
The foremost goal of management accounting is to provide helpful accounting information to internal users.
Type of information disclosed.
General information about the company is disclosed to the public in financial accounting.
Confidential and private information is generated by management accounting that is not generally disclosed to the public.
Legal obligation
A company is mandated to follow financial accounting.
It is not legally compulsory for a company to follow management accounting, although it is highly advised.
Format to be followed
A particular/specific format is to be followed while preparing accounts according to financial accounting.
There is no specific format that needs to be followed while preparing accounts according to management accounting.
Users
Financial accounting information is helpful to external users
Management accounting information is useful to internal users.
Past/future data
Financial accounting showcases the postpartum activities of the company. Hence it uses past information.
Management accounting provides helpful information and forecasts based on which future activities of the enterprise are planned. Hence, it aids in planning for the future and preparing forecasts.

What is Financial Accounting?

Financial accounting can be defined as the process of recording, summarizing, and finally reporting the company's business transactions through financial statements for further analysis and interpretation.. It utilizes a series of already established accounting principles and postulates. The selection of accounting principles to use during financial accounting depends on the regulatory and reporting requirements the business faces. The establishment of such accounting principles is to ensure consistent information to investors, creditors, regulators, and tax authorities. It aids the managers in keeping a systematic record of all financial transactions carried out by the firm and the preparation and presentation of financial reports to arrive at a measure of organisational success as well as financial soundness. It relates to the past period and serves the stewardship function. It is monetary in nature. It is primarily concerned with the provision of financial information to  all stakeholders.

Users of information generated through financial accounting:

  1. Investors and potential investors require information on the risks and return on investment.
  2. Lenders and financial institutions obtain information on the creditworthiness of the company and its ability to repay loans and pay interest.
  3. Suppliers and creditors need information on whether amounts owed will be repaid when due and on the continued existence of the business.
  4. Customers obtain information on the continued existence of the business and thus the probability of a continued supply of products, parts and after-sales service.
  5. Government and other regulators require information on the allocation of resources and compliance with regulations.
  6. Social responsibility groups, such as environmental groups, need information on the impact on the environment and its protection.
  7. Competitors require information on the relative strengths and weaknesses of their competition for comparative and benchmarking purposes. They need the data mainly for strategic purposes.

Purpose of Financial Accounting

The main purpose/aim of financial accounting is to keep a record of all financial transactions so that:

  1. The profit earned or loss incurred by a corporation during an accounting period can be worked out.
  2. The financial position of the company at the end of the accounting period can be ascertained.
  3.  The financial information that is required by the management and external parties can be provided.

Methods of performing Financial Accounting

  1. Cash basis of accounting:  As per the theory cash basis of accounting, entries are made in the book of accounts only when cash is received or when cash is paid (according to the situation rather than when the receipt or payment becomes due. For e.g: if factory rent for the month of June 2022 is paid in April 2022, it would be recorded by the firm in their books of accounts in April 2022. Similarly, if goods are sold on credit in April and payment is made in June, then the transaction will be recorded only in June, when the payment for goods sold has been received. Therefore, this implies that cash basis of accounting goes against the matching principle which clearly states that revenue of a specific period must be matched with that period’s cost. Thus, this method is inappropriate for many organisations. This is because profit is calculated as a difference between the receipts and payments made for the specific period and not on the happening of the transactions.
  2. Accrual basis of accounting: As per the theory of accrual basis of accounting revenues and costs are recorded in the books of accounts in the period in which they occur rather than in the period when they are paid. Thus, the monitory effect of a transaction is given utmost importance while recording transactions. This is a more appropriate basis for the calculation of profits. This is because it is in line with the matching principle

What is Management Accounting?

Management accounting deals with the provision of necessary accounting information to people within the organisation to enable them in decision-making, planning and controlling business operations. Management accounting draws the relevant information mainly from financial accounting and cost accounting which helps the management in budgeting, assessing profitability, taking pricing decisions, making capital expenditure decisions and so on. Besides, it generates other information (quantitative and qualitative, financial, and non-financial) which relates to the future and is relevant for decision-making in the organisation. Such information includes sales forecast, cash flows, purchase requirements, workforce needs, environmental data about effects on air, water, land, natural resources, flora, fauna, human health, social responsibilities, etc.

Benefits of Management Accounting

  1. Decision-making- Techniques from all fields like costing, economics, statistics, etc., are used in management accounting. It provides charts, tables, forecasts, and various such analysis that makes the process of decision-making easier and more justified.
  2. Planning- Managerial accounting has failed to establish strict standards. It is a continuous and ongoing process. Thus, financial information is presented to the management at regular intervals. They may be presented weekly, monthly, or quarterly. Thus, managers can analyse the data to plan the activities of the enterprise.
  3. Strategic management- Management accounting is not mandatory by any law. Thus, it can have its own structure according to the company’s requirements. This means that if the company feels certain areas need more in-depth analysis, it can do so freely. This allows them to focus their attention on core areas. The information presented to them enables them to make strategic management decisions.
  4. Identifying problematic areas in business- If a product is not performing well or if a department is running on unexpected losses, managerial accounting helps identify the underlying cause. This will allow the management to get ahead of the problem.

Limitations of Management Accounting

  1. Data is sourced from financial accounting – Decisions taken by the management are naturally sourced from the data provided by financial accounting. If this data is inaccurate, management accounting results in erroneous outcomes.
  2. Less knowledge – Management has insufficient understanding of economics, finance, statistics, etc. This often results in inaccurate computation.
  3. Outdated data – The management team receives historical information, which may change eventually when management is making the decisions. Since this data is not updated from time to time, it causes problems.
  4. Expensive – Tremendous investment is required to set up as well as maintain a management accounting system.

Main Differences Between Financial Accounting and Management Accounting In Points

  1. The primary objective of financial accounting is to provide financial information to the stakeholders and third-party organizations engaged in business with an enterprise. Management accounting on the other hand is inclusive of financial information, advice, and even provides forecasts that may be utilized by the management of the company.
  2. The aim of financial accounting is to provide information to external users, while the objective of management accounting is to provide information to internal users.
  3. The general information that can be disclosed to the public is generated by financial accounting. On the other hand, management accounting generates highly confidential information that is not generally disclosed to the public.
  4. A company is legally bound to follow financial accounting, while there is no legal compulsion to follow management accounting, although it is highly recommended.
  5. Financial accounting is used by external users, while management accounting is used by internal users.
  6. Financial accounting analyses past information and is thus essentially a postpartum of activities of the enterprise. Management accounting forecasts future policies and formulates estimates for the future. Hence it is a futuristic activity.
  7. Financial accounting needs to be prepared following a specific format, while management accounting does not need to follow any particular format.

Conclusion

Accounting is known as the process of identifying, measuring, recording, and communicating the required information relating to economic events of an organisation to the interested users of such. Two types of accounting are financial accounting and management accounting. Financial accounting is known as the process of recording, summarizing, and reporting a company's business transactions through financial statements. Managerial accounting is defined as the process of identification, measurement, analysis, and interpretation of accounting information that helps business leaders make sound financial decisions and efficiently manage their daily operations. Both types of accounting serve different purposes and aid different categories of people. This article has attempted to explain the differences between the two in a tabular form as well as in points. It has defined the concept of financial accounting in detail and elaborated on its purpose, users, and methods. Further, it has also explained the concept of management accounting, its benefits, and its limitations.

References

  1. Class 11 NCERT accountancy textbook volume 1
  2. www.topper.com

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"Difference Between Financial Accounting and Management Accounting." Diffzy.com, 2022. Sun. 25 Sep. 2022. <https://www.diffzy.com/article/difference-between-financial-accounting-and-management-accounting-669>.



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