In this complex world of business, accounting serves as a key tool to arrive at the right decisions, which will have an impact on efficiency, profitability and long-term sustainability. Financial accounting and management accounting are two important branches of accounting that have an entirely different purpose; it is very crucial for any business analyst who needs to control the cost and evaluate the performance to understand the difference between financial cost and management accounting.
Whilst financial accounting is largely confined to external reporting, management accounting has internal working, reporting detailed records for actions to be taken. Now, let us try to define it in more detail to understand what distinctions need to be drawn and how these practices are implemented in a commercial context.
Financial Accounting: Focus on External Reporting
Financial accounting is primarily the action of providing information that would be useful to users of the financial statements other than the management of the business, such as investors, creditors and government supervisory bodies. It entails the process of presenting historical and financial information that is prepared in a format that is universally agreed upon to provide a measure of a business firm’s financial status during a particular period.
Both management and financial accounting do not retreat from Indian Accounting Standards (IND AS), generally accepted accounting principles (GAAP) or International Financial Reporting Standards (IFRS) based on the location. These regulations create a standard, constant and comparable factor to institutions/ organisations and an external user can then make sound financial decisions.
As indicated, financial accounting mostly relies on past events — it deals with the preparation of records of accounts of events that have already transpired. It gives an accurate financial position of the company at a point, in time without any adjustments for past or future events. However, it is recognised that financial accounting’s focus is somewhat restricted in this respect, in that it doesn’t help very much with the making of forward-looking decisions: and that’s where management accounting comes into its own.
How does management accounting serve as an organisational instrument for decision-making?
It is not a report to users or to the public but is an internal control system that provides relevant and timely information to the management of the company. Certainly, management accounting differs from financial accounting not only in terms of focus but also in the principles regulating it while Indian Accounting Standards (IND AS), generally accepted accounting principles (GAAP) or international financial reporting standards (IFRS) apply to the latter, the former is somewhat freer in this respect. It offers the necessary data to an organisation’s managers to facilitate daily operations within and across departments besides helping the organisation to control costs and plan for the future.
Cost accounting reports are also more detailed than financial statements and they give information based on departments, products, regions or any other relevant section. These reports can be prepared at any time be it daily, weekly or even monthly depending on what the management needs. Management accounting is often used by a business analyst to evaluate the KPI rates, distribute resources, and define sectors requiring cost containment or workflow optimization.
Contrary to financial accounting, which is mainly historical, management accounting is more or less futuristic. They include forecasts, budget, and variance analysis so that necessary decisions can be taken for achieving the goals set both operationally and strategically. Thus, management accounting also uses and analyses non-financial information like trends in the market or customer satisfaction indexes as well as provides a more extensive outlook.
How is Cost Accounting a Key Component of Management Accounting?
Creation costing is normally a branch of management costing where the concentration is devoted to the accurate valuation of costs of manufacturing products. It takes time to follow direct costs such as materials and labour as well as marginal costs such as overheads to ascertain the correct cost of offering the product. This assists businesses in dissecting profitability to an extent and enables pricing strategies, cost containment and ultimately profit enhancement.
However, as a system of accounting for the cost it plays a significant role in internal decision-making and as such acts as an interface between the management and financial accounting.
Cost accounting information about costs is used in the preparation of financial statements, especially in the cost of sales, notably in inventory valuation. Thus, awareness of the methodological distinctions between financial cost and management accounting enables business analysts to distinguish clearly between compliance reporting and internal analytical and decision-making resources.
There are several differences between financial cost and management accounting but they also share several roots of similarities.
Purpose
Financial accounting for preparing reports for users outside the business including stockholders, creditors and the government.
On the other hand Management accounting works with the concept of accruing information for the exclusive purpose of management decision making and to monitor and regulate cost within the business.
Standards and Regulation
Financial accounting is necessitated by legal requirements that guide its implementation such as Indian Accounting Standards (IND AS), GAAP or IFRS hence it is standardised.
On the other hand Management accounting is actually an unauthorised branch and does not have the rules and restrictions set for financial accounting.
Focus on Time
Financial accounting is mainly backwards looking as it records and communicates financial information up to the time it is prepared.
On the other hand Management accounting looks into the future preparing projections, forecasts, and variance to be of help in decision making.
Reporting Frequency
The financial accounting reports are often done on a quarterly or annual basis.
On the other hand Management accounting reports can be made on any frequency to suit the requirements of a business organisation and may include daily reports, weekly reports, monthly reports etc.
Level of Detail
In contrast, financial accounting provides comprehensive summaries of performance.
On the other hand Management accounting gives more specific information at a time, even down to costing by product lines, departments, or geographical locations.
Audience
In the case of interest to the company’s solvency, financial accounting is important for the external user.
Conversely, Management accounting is aimed at internal users such as managers, business analysts, financial planners as well as other users who require more detailed information that is suitable for operational use.
Conclusion
Comparing and contrasting the financial cost and management accounting is the key to the analysis of the functioning of businesses. While financial accounting stands as the informational view of the organisation for the users outside the organisation, management accounting prepares the internal users with the information that could enhance operational efficiency, contain cost and also plan for the future. They are both essential to the financial process, although their major concentration and uses are different.
Managers themselves might prefer one of the two approaches but for a business analyst, it is important to be able to switch between the two. While financial accounting provides information about the company on the balance sheet, management accounting contains the analytical tools that are needed to build this balance sheet in the future. Knowledge of the difference between financial cost and management accounting makes it possible for a business to be in a position to meet all the external responsibilities as well as the internal ones.