Financial Accounting vs Management Accounting

Financial Accounting and Management Accounting  are two interrelated facets of the accounting system.  They are not exclusive of each other; they are supplementary in nature.  Financial accounting provides the basic structure for collecting data. The data collection structure is suitably modified or adjusted for accumulating information for management accounting purposes.

In a broader sense, management accounting includes financial accounting.  They differ in their emphasis and approaches. They are as follows:

  1. Financial accounting serves the interest of external users (i.e. investors etc.) while management accounting caters to the needs of internal users (i.e. management).
  2. Financial accounting is governed by the generally accepted accounting principles while management accounting has no set principles.
  3. Financial accounting presents historical information while management accounting represents predetermined as well as past information.
  4. Financial accounting is statutory while management accounting is optional.
  5. Financial accounting presents annual reports while management accounting reports are of both shorter and longer durations.
  6. Financial accounting reports cover the entire organization while management accounting reports are prepared for the organization as well as its segments.
  7. Financial accounting emphasizes accuracy of facts while management accounting requires prompt and timely reporting of facts even if they are less precise.

Focus – Financial accounting emphasized the external use of accounting data. Management accounting, on the other hand, utilizes accounting data for internal uses. The major objective of financial accounting is to prepare balance sheet and profit and loss account to inform shareholders and others about the firm’s profitability and the state of its resources and obligations.  The purpose for which management accounting collects and reports relevant information is to make decisions to ensure optimum use of the firm’s resources.

Principles – The accounting profession has developed certain principles for preparing and presenting financial reports for external uses.  Financial accounting adheres to these generally accepted accounting principles. This introduces consistency and meaningfulness of data from the investors’ point of view.  They can make inter firm comparisons of performance and analyze performance trend over years when some set of generally accepted principles are followed by all firms.  Management accounting, in contrast, is not based on any set of accepted rules of principles.  Every enterprise, depending on its requirements for facts, evolves its own procedures and principles for preparing reports for internal uses.  The information should be relevant and aid management in making decisions.

Information – Financial accounting accumulates and reports historical information to investors. Financial accounting reports tell what has happened in the past.  Through balance sheet and profit and loss account, to the investors is revealed the manner in which the resources entrusted by them to the firm have been utilized.  Management accounting being a decision-making process focuses on the future.  It analyses past data and adjusts them in the light of future expectations to make plans.

Need – Financial accounting is an outcome of statute.  For example, in India, it is required under the Companies Act, 1956 to prepare balance sheet and profit and loss account for submission to shareholders and others.  The financial statements are generally required to be prepared in the formats prescribed by the law. Management accounting is the result of the management’s need of information for making decisions.  It is, therefore, optional.  Management accounting functions would differ from firm to firm. A firm may have a sophisticated, elaborate and comprehensive system while another may have a partial system only.

Timing – Financial accounting adopts twelve months (one Year) period for reporting financial performance to shareholders and other investors.  In contrast, management accounting reports are for shorter durations.  Some companies in India prepare daily budgets.  Monthly and quarterly reports are quite common.  Management accounting information is also collect ed for preparing long term plans for five or more years.  Capital expenditure plans, for example, cover a longer duration.

Coverage – While reporting the state of affairs of a company, financial accounting covers the entire organization.  Financial statements show revenues, expenses, assets and equities of the firm as whole.  For management accounting purposes, however, organization is divided into smaller units, or centers.  These centers may be headed by responsible persons.  Cost date and other information are collected and reported by these centers. Thus, data requirements of management accounting are more specific.

Reporting – Financial statements-balance sheet and profit and loss account – are subject to the verification of statutory audit.  Therefore, financial accounting stresses accuracy and precision of accounting data.  Management accounting requires information promptly for decision-making.  Continuous and speedy flow of approximate information is more useful than the precise, but delayed information.

The above points of difference between Financial Accounting and Management Accounting prove that Management Accounting is a flexible approach as compared to rigid approach in the case of Financial Accounting. In brief, financial accounting simply shows how the business has moved in the past while management accounting shows how the business has to move in the future.

Bookmark the permalink.