Why Financial Accounting is Important

The ownership and management of business is challenging, and keeping track of finances is one of the most obvious examples of those challenges. The specialized field that handles accounting for business is called financial accounting and provides individuals who are externally linked to that business with information on a company´s financial performance and position. This information is typically given to share or stockholders who want to piece together a value for that company based upon the information they have obtained.

It organizes the transactions of a company by writing down those transactions and creating a financial statement or financial report that summarizes the data in a balance sheet or income statement. These statements are then used by individuals externally to determine the value of a company. If the company is publicly traded, these financial statements will circulate wider, to customers, competitors and employees as well.

Management is given the task of spending business funds to help the business run economically and efficiently. Financial accounting statements can be used to assess management effectiveness by showing the spending of allotted resources and helping to assess whether management should be sent to work in another department or replaced altogether to increase the profitability of the company.

It’s important to note that it provides information to individuals who are trying to determine what a company´s worth is and it does not report that value on its own. These statements are provided to individuals who are external to a company and can circulate broadly, even reaching competitors of that company and other sources.

The FASB, or Financial Accounting Standards Board, is responsible for creating a standardized system of rules called accounting standards for financial accounting in the United States. These standards are important for financial accounting statements because so many people use these statements in so many different ways. These standards are known as generally accepted accounting principles (GAAP). Companies in the U.S. who also trade stock publicly also comply with the Securities and Exchange Commission (SEC).

This is important to stockholders and shareholders who are interested in determining the value of a company they are part owners of. Keeping track of this data helps a company to assess the value of their management and the resources they have allotted them to make their company run better, and financial statements help to determine the effectiveness of management for that company.

Managerial Accounting Vs Financial Accounting

Have you ever wondered what the differences are between managerial and financial accounting? Well, throughout this article I will be contrasting the differences between the two. Accounting includes areas such as tax, audit, cost, and information systems. However, the only area in accounting that relates to this article is cost, because cost is a subset of managerial accounting. Some of the major differences between managerial and financial accounting include but aren’t limited to GAAP, internal/external reporting, internal/external focus, and unit focus. There are many other topics that I could use for this essay, however I feel like these certain topics help describe the difference the best.

The first topic that I would like to talk about is the difference between managerial and financial accounting through GAAP (Generally Accepted Accounting Principles). A firm must follow GAAP down to the tee, however with managerial accounting there are ways around it, because managerial accounting doesn’t have to worry about following GAAP standards. One of the main points in managerial accounting is cost accounting, and the point of cost accounting is to help decision-making, budgeting, and also cost analysis. In order to effectively cost a product there are many different formulas that must be followed which don’t need to follow GAAP standards, however when the information is then transferred to the financial side of the firm, then all the GAAP principles must be followed. The number one goal of financial accounting is to have accurate financial statements so that the public, or the shareholders can continue or walk away from their investments. Also, in order to meet the SEC requirements a firm must follow all of GAAP principles.

Not only does managerial and financial accounting follow different principles, but they also have different ways of reporting their information. Managerial accounting focuses more on reporting the information to an organization in the company that will help with planning and organizing for the future. Also, each month’s information is saved, and then they will use that information to predict what will happen in the future, so all of the information collected is very useful. However, financial accounting reports information to a different group of people. The information is gathered for the month or the quarter, and then sent to the CEO, or the CFO. The next step would be for the CEO or CFO to report the information to share holders or any person who makes investments in the company. Even though there are major differences between the two each are equally as important.

Next, there is a major difference in the overall focus of the two different types of accounting. The managerial side of the firm will focus on projections for the future, because all of the information that is collected throughout the months and years will be useful in predicting what will happen in the future. However, financial accounting’s only focus is to ensure that the financial statements are correct at the end of the period. Also, financial accounting is required to make sure the ledger and the journal accounts are accurate and up to date.

Not only is there a difference in the overall focus of managerial and financial accounting, but the way in which each side expresses dollars in units. Managerial accounting focuses on unit costs, which are associated with Direct Material, Direct Labor, and Overhead. These are the three components, which make up costing a product. In order to successfully cost a product, it is important to include these three components into your overall product cost. So, managerial accounting focuses on mainly how much money are each unit worth rather than the overall price that the product sells for. However, on the other side of the spectrum in financial accounting the focus is on monetary units. Financial accounting is not worried about how much each unit costs, but care more about the sales price of each object being sold.

In conclusion, there are many differences between managerial and financial accounting, but the main differences that I decided to focus on were the differences between GAAP, reporting, focus and the unit focus. The main difference between managerial and financial accounting is that one has to follow GAAP to the tee and the other doesn’t. I can’t stress the importance of GAAP in society, because without its principles the accounting world would be helpless. Also, there are some differences in the way that managerial and financial handle there reporting and their overall focus as an entity inside of an organization. Lastly, there are some major differences between managerial and financial accounting, and either way both are extremely important, and one wouldn’t be able to run properly without the other.

Management and Financial Accounting

Accounting is usually seen as having two distinct strands, Management and Financial accounting. Management accounting, which seeks to meet the needs of managers and Financial accounting, which seeks to meet the accounting needs of all of the other users. The differences between the two types of accounting reflect the different user groups that they address. Briefly, the major differences are as follows:

    • Nature of the reports produced. Financial accounting reports tend to be general purpose. That is, they contain financial information that will be useful for a broad range of users and decisions rather than being specifically designed for the needs of a particular group or set of decisions. Management accounting reports, on the other hand, are often for a specific purpose. They are designed either with a particular decision in mind or for a particular manager.

 

    • Level of detail. Financial reports provide users with a broad overview of the performance and position of the business for a period. As a result, information is aggregated and detail is often lost. Management accounting reports, however, often provide managers with considerable detail to help them with a particular operational decision.

 

    • Regulations. Financial reports, for many businesses, are subject to accounting regulations that try to ensure they are produced with standard content and in a standard format. Law and accounting rule setters impose these regulations. Since management accounting reports are for internal use only, there are no regulations from external sources concerning the form and content of the reports. They can be designed to meet the needs of particular managers.

 

    • Reporting interval. For most businesses, financial accounting reports are produced on an annual basis, though many large businesses produce half-yearly reports and a few produce quarterly ones. Management accounting reports may be produced as frequently as required by managers. In many businesses, managers are provided with certain reports on a monthly, weekly or even daily basis, which allows them to check progress frequently. In addition, special-purpose reports will be prepared when required (for example, to evaluate a proposal to purchase a piece of machinery).

 

    • Time horizon. Financial reports reflect the performance and position of the business for the past period. In essence, they are backward looking. Management accounting reports, on the other hand, often provide information concerning future performance as well as past performance. It is an oversimplification, however, to suggest that financial accounting reports never incorporate expectations concerning the future. Occasionally, businesses will release projected information to other users in an attempt to raise capital or to fight off unwanted takeover bids.

 

  • Range and quality of information. Financial accounting reports concentrate on information that can be quantified in monetary terms. Management accounting also produces such reports, but is also more likely to produce reports that contain information of a non-financial nature such as measures of physical quantities of inventories (stocks) and output. Financial accounting places greater emphasis on the use of objective, verifiable evidence when preparing reports. Management accounting reports may use information that is less objective and verifiable, but they provide managers with the information they need.

We can see from this that management accounting is less constrained than financial accounting. It may draw on a variety of sources and use information that has varying degrees of reliability. The only real test to be applied when assessing the value of the information produced for managers is whether or not it improves the quality of the decisions made.

The distinction between the two areas reflects, to some extent, the differences in access to financial information. Managers have much more control over the form and content of information they receive. Other users have to rely on what managers are prepared to provide or what the financial reporting regulations state must be provided. Though the scope of financial accounting reports has increased over time, fears concerning loss of competitive advantage and user ignorance concerning the reliability of forecast data have led businesses to resist providing other users with the detailed and wide-ranging information that is available to managers

Accounting Financial Statements – The Balance Sheet

The balance sheet, also called the statement of financial position, contains three items: assets, liabilities, and stockholders’ equity. It is dated at the moment in time when the accounting period ends. The accounting equation that is a big part of the financial statements is: assets equal liabilities plus stockholders’ equity. When working with a balance sheet: the total assets must equal the total liabilities and equity.

The first part of the balance sheet is assets. There are two main categories of assets: currents and long-term assets. Current assets are expected to be converted to cash in the next twelve months or one business operating cycle (if longer than a year). Cash is the most liquidated asset. Short-term investments are stocks and bonds that a company intends to sell within the next year. Accounts receivable are the amounts the company expects to collect from customers. Notes receivable are amounts that the company expects to collect from a customer who signed a promissory note. A company also includes inventory, which is a current asset, into the balance sheet. Prepaid expenses are also a part of the asset side of the balance sheet because the company will benefit from them in the future.

Long-term assets include plant, property, and equipment, intangibles, and investments. Plant, property, and equipment (PPE) include land, buildings, computers, store fixtures, etc. Accumulated depreciation is also included on the balance in the long-term assets area. It is the amount of depreciation from PPE at the end of the year. It is subtracted from the cost of PPE to determine its book value. Intangibles are assets with no physical form such as patents. Investments are long-term assets because the company does not expect to sell them within the next year.

The second part of the balance sheet is liabilities. Liabilities are also split into two categories: current and long-term liabilities. Current liabilities are debts paid within one year or one operating cycle. Accounts payable is the company promises to pay a debt arising from a credit purchase. Income taxes payable are tax debts owed to the government. Short-term borrowings are notes payable that the company has promised to pay back within one year. Salaries and wages payable are amounts owed to employees. Long-Term liabilities are payable after one year.

The last part of the balance sheet is stockholders’ equity. The Stockholders’ equity is assets minus liabilities. There are two parts to stockholders’ equity: paid-in capital and retained earnings. Paid-in capital is the amount the stockholders have invested in that company. The basic part of paid-in capital is common stock where a company issues stock to the stockholders as evidence of their ownership. Retained earnings are the amount earned by income-producing activities

Financial Accounting Versus Cost Accounting

Before we go to differentiate Financial & Cost Accounting we must have knowledge what these both terms really are. As we define both terms these would automatically be differentiated.

Financial Accounting:

Financial Accounting is a systematical way to prepare the financial statements of an organization is order to get the true and fair view profit or loss. These financial statements are organized for decision making, stockholders, Banker, Supplier, Shareholders, Government Agencies, and other stakeholders. The basic requirement to prepare financial statement is to examine and reduce the dead expenses by measuring the expenses and income status and to reporting the result to interested users. These statements are organized for outsiders who do not take part in day to day organizational activities.

Simply we can say, “Financial accounting is the process which includes recording, interpreting & summarizing date taken from financial records of an organization and bring it out in an annual report for the benefit of people outside the organization”.

In depth financial accounting contains some principles, Concepts & Equation.

Financial accountants organize financial statements based on Accounting Principles which are generally accepted by a specific country. Financial statements must be prepared according to the (I FRS) International Financial Reporting Standards.

Accounting Equation: (ASSETS = LIABILITIES + OWNER’S EQUITY).

Accounting Cycle:

1. Voucher.
2. General Journal.
3. General Ledger.
4. Cash Book.
5. Trail Balance.
6. Trading profit & Loss Account.
7. Balance Sheet. Cash Flow Statement.

First of all the transaction occurs and noted in the form called Voucher. All transactions are available in vouchers. Then one specific form is created called General Journal. All transaction recorded in one form. The next step is Called Posting in which all separate heads/accounting recorded separately in different form/accounts called General Ledger. Cash Book is maintained to record the payments and recipes or organization. By the help of General Ledger the Trail Balance prepared which provides the items of Trading, profit & Loss account and Balance Sheet which shows the financial position and the health of the Organization. And lastly Cash Flow Statement is prepared to drive the accrual inflow & outflow of cash.

Cost Accounting:

Cost accounting ascertains budget and actual cost of production, operations, departments, process and the analysis of variance. Cost accounting is used to support decision-making to reduce cost of organization and improve its profitability. Cost accounting does not require standards as (GAAP) Generally Accepted Accounting Principles, as its primary use is for internal management, rather than outside people. Some of managerial accounting approaches are mentioned as under;

• Managerial Costing.
• Activity based Costing.
• Standard Cost Accounting.
• Resource Consumption Accounting.

Three Classical Cost Elements:

• Raw Material.
• Labor.
• Factory Over Head/Indirect Expenses.

Cost Accounting is being used to help the managers to understand & reduce the running cost of an Organization. Most of Cost varied with the rate of production which is called “Variable Cost” like money spent on labor, power to run a factory, direct material etc. Unlikely variable cost, some costs remain the same even while busy period or during null production. These costs are call “Fixed Cost” like Depreciation on Assets, Rent of building etc.

In cost accounting some statements are prepare. Majors are Income Statement, Cost of Goods Sold Statement, and Cost of Production Report.

Income Statement:

Income statement is prepared to drive the net income/profit of the organization. In the process all direct Expenses related to purchase of Goods/material are less from Sale and the retained amount is called Gross Profit. Then all indirect expenses related to sales, Admin & Financial Charges are deducted from (GP) Gross Profit, retained amount after deduction is called (NP) Net Profit/income.

(CGS) Cost of Goods Sold Statement:

Cost of Goods sold statement is prepared to drive the total cost which is spent on the purchasing to sell the produced Goods. In the preparation process first of all the Closing Martial of last year is added in purchase of Martial, which is called “Total Material Available for Use” and Material Used is deducted from it. The remaining amount is called “Cost of Material Consumed”. Then the cost of Labor and (FOH) Factory Overhead added in cost of material consumed. The total of this is called “Total Factory Cost” after that Opening stock of work in process is added and closing stock of work in process is deducted from Total Factory Cost. The amount which drives after this is called “Cost of Goods Manufactured”. Lastly the Opening Stock of Finished Goods is added and Closing Stock of Finished Goods is deducted from Cost of Goods Manufacture and the Answering amount is Called “(CGS) Cost of Goods Sold”