Types of Accounting: Financial, Cost, Management Accounting

  • Post last modified:28 March 2021
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What is Financial Accounting?

Financial Accounting the process of identifying, measuring, and communicating economic information to permit informed judgements and decisions by users of the information.

Financial Accounting Definition

the art of recording, classifying, and summarising in a significant manner and in terms of money transactions and events which in part, at least of a financial character, and interpreting the results thereof. The American Institute of Certified Public Accountants

Objectives of Financial Accounting

A modern accounting system has to accomplish the following four objectives:

  1. To identify financial events and transactions that occur in an organisation.
  2. To measure the value of these occurrences in terms of money.
  3. To organise the accumulated financial data into meaningful information and
  4. To analyze, interpret and communicate that information to a broad range of persons and groups, both within and outside the organisation.

Functions of Financial Accounting

The major functions of Financial Accounting are summarised below :

  1. Recording
  2. Validating
  3. Communicating
  4. Interpreting

Recording

Since all business transactions cannot be kept in memory, they have got to be systematically recorded and pass through journals, ledgersand worksheets before they could take the forms of final accounts. This aspect of financial accounting has assumed considerable importance with the limitation of human memory.

Validating

With the universal acceptance and enforcement of accounting principles, every recorded entry in the books of accounts maintained by abusiness unit gives validity or authenticity to all such transactions so recorded.

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Communicating

This is an important function of financial accounting. Accounting serves as a language for communicating the financial fact about the enterprise or activity most effectively to all concerned interested in using and interpreting them.

Interpreting

These aspects help in unfolding the total financial picture of an undertaking and investing the same with more meaning.


Limitations of Financial Accounting

The fast-changing conditions and environmental factors have brought the limitations of Financial Accounting as follows :

  1. Financial Accounting does not provide detailed cost information for different departments, processes, products, jobs in the production divisions. Similarly, separate cost data are not available for different services and functions in the administration division. Management may need information about different products, sales territories, and sales activities which are also not available in Financial Accounting.

  2. Financial Accounting does not set up a proper system of controlling materials and supplies. Undoubtedly, if material and supplies are not controlled in a manufacturing concern, they will lead to losses on account of misappropriation, misutilisation, scrap, defective, etc. They may, in turn, influence the reported net income of a business enterprise.

  3. The recording and accounting for wages and labor is not done for different jobs, processes, products, departments. This creates problems in analysing the cost associated with different activities. This also does not provide a basis for rewarding workers and employees, for the above-average performance.

  4. Financial Accounting contains historical cost information which is accumulated at the end of the accounting period. This accounting does not provide day-to-day information about costs and expenses. This is the reason why much dissatisfaction has been shown with external financial reporting. The historical cost is not a reliable basis for predicting future earnings, solvency, or overall managerial effectiveness. Historical cost information is relevant but not adequate for all-purpose. It is now rightly contended that current cost information should be reported along with historical cost information.

  5. It is difficult to know the behavior of cost in financial accounting as expenses are not assigned to the product at each stage of production. Expenses are not classified into direct and indirect and therefore cannot be classified as controllable and uncontrollable. Control of cost which is the most important objective of all business enterprise cannot be achieved with the aid of financial accounting alone.

  6. Financial Accounting does not process an adequate system of standards to evaluate the performance of departments and employees working in department. Standardization is now applied to all elements of the business. Standards need to be developed for materials, labour, and overheads so that a firm can compare the work of laborers, workers, supervisors and executives with what should have been done in an allotted period of time.

  7. Financial Accounting does not provide to analyses the losses due to various factors, such as idle plant and equipment, seasonal fluctuations in the volume of business etc. It does not help management in taking important decisions about expansion of business, dropping of a product line, starting a new product, alternative methods of production, improvement in product, etc. the managerial decisions about these business matters have now become vital to the survival and growth of business enterprises.

  8. Financial Accounting does not provide cost data to determine the price of the product being manufactured or the service being rendered to the consumers. It is also not possible to prepare detailed cost reports for the purpose of comparison and analysis between two periods of time within an enterprise and also for making inter-firm comparisons.

  9. Change in the economic conditions of the country has a direct impact on the business position of an organization. The conditions of inflation or deflation change significantly the value of the business. Such a change is not depicted in the financial accounts as the accounts of the business have to be maintained on the basis of cost concept. With the result, the balance sheet of an organisation fails to give true and fair view of the business.

  10. The serious limitation to Financial Accounting is that it can only be understood by such persons who have accounting knowledge.

What is Cost Accounting?

the process of accounting for cost from the point at which expenditure is incurred or committed to the establishment of its ultimate relationship with cost centres and cost units. In its widest usage it embraces the preparation of statistical data, the application of cost control method and the ascertainment of the profitability of activities carried out or planned

Objective of Cost Accounting

The main objectives of Cost Accounting are mentioned below :

  1. To aid in the development of long-range plans by providing cost data that acts as a basis for projecting data for planning.
  2. To ensure efficient cost control by communicating essential data costs at regular intervals.
  3. To determine the cost of products or activities.
  4. To identify profitable areas of business.
  5. To provide management with information in connection with various operational problems

What is Management Accounting?

Management accounting is the process of measuring and reporting information about economic activity within organizations, for use by managers in planning, performance evaluation, and operational control.


Difference Between Financial Accounting and Management Accounting

Sr.NoPointsManagement AccountingFinancial Accounting
1Primary Users of InformationManagement accounting aims at preparing reports and supplying information to management for planning, controlling and decision-making. The information generated under the accounting system is used by members of management at different levels. The nature of internal reports and data varies for different levels of management in conformity with their information requirements for analysing business operations and for planning and control purposes. Thus, different sets of information could be developed under managerial accounting and supplied to different persons responsible for activities in the organisation.The users of financial accounting statements are mainly external to the business enterprise. The financial statements prepared under financial accounting show how there sources have been used by a business enterprise during a specific period of time and thus are useful to external users in making sound economic decisions. These financial statements are relevant to management but are not adequate for the purpose of planning, control and decision-making. External users include shareholders, creditors, financial analysts, government authorities, stock exchange, labour unions, etc.
2NatureManagement accounting is mainly concerned with the future plans and policies, whereas financial accounting is concerned with historical records relating to the past. Management rely on the past records for formulation of future plans and hence, the interdependence of management accounting and financial accounting can not be overemphasized.The historical nature of financial accounting service limited the purpose of throwing light on the events and results of the past. The forward looking management accounting greatly helps the management in improving the results in the future through various tools and techniques of budgeting and budgetary control, standard costing, profit planning. etc.
3Accounting
Method
Management accounting is not based on the double-entry system. The data under management accounting may be gathered for small or large segments activities of an organisation and monetary as well as other measures can be used for different activities in the firm. The only constraint regarding managerial accounting principles and methods is that they should be useful for management purposeFinancial accounting follow the double-entry system for recording, classifying, and summarizing business transactions. This accounting process results in aggregate balances of all accounts maintained in firm’s books.
4Accounting PrinciplesManagement accounting is not bound to use the“generally” accepted accounting principles. It can use any accounting technique or practice which generates useful information. Besides, data developed in management accounting may be facts, estimates, projections, analyses, etc.Financial accounting data is primarily meant for external users. The “generally accepted accounting principles” are important in financial accounting and are used extensively while recording, classifying, summarising, and reporting business transactions. The use of GAAP adds creditability and reliability of financial statements and creates confidence among the financial statement users.
5Obligatory TimeIn modern time, a business concern is free to install any system of management accountingIt is more or less obligatory on the part of every business concern to adopt financial accounting for disclosing the results of the business to the rightful owners.
6Time spamManagement accounting reports and statements are prepared whenever needed. Reports may be prepared on a monthly, weekly, or even daily basis. Frequency of reports is determined by particular planning, controlling, and decision-making need.Financial accounting data and statements are developed for a definite period, usually a year or a half-year. It requires that financial statements be developed and presented at regular time intervals. Company annual reports may be prepared semiannually or quarterly but the important point is that they are prepared on a regular basis.
7Legal FormalitiesSince a business concern is free to install the system of management accounting. There is no statutory regulation fixing the norms and standards for the preparation and presentation of accounting statements. Needless to state that these statements can be adapted to the changing needs of the management since they are meant for internal use.Financial accounting statements are standardized and meant for external use. The preparation and presentation of annual final accounts of companies are governed by the provisions of the Companies and income Tax Act in force.
8Unit of MeasurementBesides the monetary units, the management accountant may find it necessary to use such measures, a number of labour hours, machine hours and product units for the purpose of analysis and decision-making. The common objective in all measurement, reporting and data analysis in managerial accounting is usefulness fora particular purpose. Historical cost and past transactions are essential to financial accounting but may be secondary to managerial accounting as they are not of much use to managementAll information under financial accounting is in terms of money. That is, transactions measured in terms of money have already occurred. In comparison managerial accounting applies any measurement unit that is useful in a particular situation.
9Purpose of ReportThe reports and data developed in management accounting are known as specific purpose reports designed for a particular user(manager) or particular decision. Managerial accounting uses internal reports to evaluate the performance of entities, product lines, departments, and managers.Financial accounting produces information and reports which are general-purpose reports in order to serve the informational needs of many external users such as shareholders creditors, potential investors, customers, suppliers, regulatory authorities, employees, and the general public. Financial accounting is concerned with overall firm performance rather than individual segments or departments.
10FocusManagement accounting provides detailed and disaggregated information about products, individual activities, divisions, plants, operations, tasks, or any other responsibility centers.Financial accounting focuses on the company as a whole. Sometimes financial accounting, some information is given about different products or lines of activity due to financial reporting requirements as provided in the CompaniesAct/other rules and regulations.

Difference Between Management Accounting and Cost Accounting

Sr.NoPointsManagement AccountingFinancial Accounting
1Prime ObjectivesManagement accounting aims at the presentation of the cost data, to the extent required, wherever and whenever they are required together with other relevant information to the management for taking decisions.Costing accounting aims at ascertaining the cost of goods and services. It lays emphasis on the stage-by-stage computation of costs. For the cost, ascertainment different techniques and systems of costing are used under different circumstances.
2Data coverageCost data form a part of managerial reports but not the sole aspects. Report includes both the quantitative and qualitative informationCost reports deal mainly with the costs incurred or budgeted and standards, variances, savings, etc. Cost reporting is a continuous process and may be daily, weekly, monthly, etc.
3Use of ReportsManagement reports are useful only to the management but not to both internal and external parties.Though cost reports are meant for management, they are useful even to the external parties.
4Control of appropriate authorityPreparation of reports as per the rules of any appropriate authority etc. No such rigidity is there in the case of managerial reports. The procedure, format etc. can be modified from time to time depending upon convenience and requirementsCost accounts and reports are to be prepared as per certain rules, principles, procedures, etc. as specified by the appropriate authority(e.g. ICWAI) to the industry to which the company belongs to. It has been made obligatory to keep cost records under the companies Act
5Statutory
verification
Management reports are not subject to any statutory audit. Of course, there is a management audit. But, it is voluntary and it evaluates the managerial functions, decisions, etc. However, management reports include both the objective and the subjective data.Cost accounts and reports, in many cases, are subject to statutory audit (i.e. cost audit). Hence they should be prepared, as far as possible, in an objective manner.
6NatureManagement accounting is mainly concerned with future plan policies. Management rely on past records for formulation of future plans and hence, the interdependence of management accounting and cost accounting cannot be over-emphasized.Cost accounting is concerned not only with historical costs but also with predetermined costs. This is because cost accounting does not end with what has happened in the past and extends to plans and policies to improve the performance in the future. Mostly cost accounting helping indetermination of selling price.
7Subjects Matter and ScopeManagement accounting is also known as managerial accounting or Accounting for Management or management-oriented accounting, etc. It is also known as internal accounting, identifies, collects, measures classifies, and reports information that is useful to managers in planning, control, and decision-making.Cost accounting and costing are often used interchangeably. accountancy is the widest of all the terms and embraces not only costing and cost accounting but also cost control and cost audit. Cost accountancy is used to describe the principles, conventions, techniques and systems which are employed in a business to plan and control the utilisation of its resources.

Key Terms

  1. Accounting: Accounting is the language of business – language as to solvency, profitability, efficiency, and health of the business.

  2. Financial Accounting is a discipline, which is employed in industry and commerce to record, classify and summarize the mercantile transactions that occur in an organization.

  3. Cost Accounting: Cost Accounting is concerned with the application of cost to the job, product process, and operations. It is concerned with the development of standard unit cost.

  4. Cost and statistics: is concerned with generating statistical and analytical cost information to all departments of the organization.

  5. Forecasting & Budgeting: are concerned with the preparation of cash forecast, profit and loss forecast, and budgeted balance sheet as well as preparation of budgets in keeping with the requirement of operating and other departments.

  6. Audit : is concerned with the central aspect of accounting. It is concerned with accounting control.

Summary

Phases in the evolution of Accounting

  1. Stewardship Accounting
  2. Financial Accounting
  3. Cost Accounting
  4. Management Accounting
  5. Social Responsibility Accounting
  6. Inflation Accounting
  7. Human Resource Accounting

Use of Accounting Information

Finance accounting information is intended primarily to serve external users. Finance Accounting information is used by a variety of groups and for diverse purposes

Application of Accounting information

  1. Accounting information is useful for
  2. Score keeping
  3. Attention Directing
  4. Problem Solving

Structure of Accounting

Accounting can be broadly classified into three types :

  1. Finance Accounting
  2. Cost Accounting
  3. Management Accounting.

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