Difference Between Financial and Managerial Accounting
(Financial Accounting Vs Managerial Accounting):
Learning objectives of this article:
- Compare and
contrast financial and managerial accounting.
- What is
difference between financial and managerial
Financial accounting reports are prepared
for the use of external parties such as shareholders and creditors, whereas
managerial accounting reports are prepared for managers inside the
This contrast in basic orientation results
in a number of major differences between financial and managerial
accounting, even though both financial and managerial accounting often rely
on the same underlying financial data. In addition to the to the differences
in who the reports are prepared for, financial and managerial accounting
also differ in their emphasis between the past and the future, in the type
of data provided to users, and in several other ways. These differences are
discussed in the following paragraphs.
Emphasis on the Future:
Since planning is such an important part of the manager's job, managerial
accounting has a strong future orientation. In contrast, financial
accounting primarily provides summaries of past financial transactions.
These summaries may be useful in planning, but only to a point. The future
is not simply a reflection of what has happened in the past. Changes are
constantly taking place in economic conditions, and so on. All of these
changes demand that the manager's planning be based in large part on
estimates of what will happen rather than on summaries of what has already
Relevance of Data:
Financial accounting data are expected to be objective and verifiable.
However, for internal use the manager wants information that is relevant
even if it is not completely objective or verifiable. By relevant, we mean
appropriate for the problem at hand. For example, it is difficult to verify
estimated sales volumes for a proposed new store at good Vibrations, Inc.,
but this is exactly the type of information that is most useful to managers
in their decision making. The managerial accounting information system
should be flexible enough to provide whatever data are relevant for a
Less Emphasis on Precision:
Timeliness is often more important than precision to managers. If a
decision must be made, a manager would rather have a good estimate now than
wait a week for a more precise answer. A decision involving tens of
millions of dollars does not have to be based on estimates that are precise
down to the penny, or even to the dollar. In fact, one authoritative source
recommends that, "as a general rule, no one needs more than three
significant digits., this means, for example, that if a company's sales are
in the hundreds of millions of dollars, than nothing on an income statement
needs to be more accurate than the nearest million dollars. Estimates that
accurate to the nearest million dollars may be precise enough to make a good
decision. Since precision is costly in terms of both time and resources,
managerial accounting places less emphasis on precision than does financial
accounting. In addition, managerial accounting places considerable weight on
non monitory data, for example, information about customer satisfaction is
tremendous importance even though it would be difficult to express such data
in monitory form.
Segments of an
Financial accounting is primarily concerned with reporting for the
company as a whole. By contrast, managerial accounting forces much more on
the parts, or segments, of a company. These segments may be product lines,
sales territories divisions, departments, or any other categorizations of
the company's activities that management finds useful. Financial accounting
does require breakdowns of revenues and cost by major segments in external
reports, but this is secondary emphasis. In managerial accounting segment
reporting is the primary emphasis.
Accounting Principles (GAAP):
Financial accounting statements prepared for external users must be
prepared in accordance with
generally accepted accounting principles (GAAP).
External users must have some assurance that the reports have been prepared
in accordance with some common set of ground rules. These common ground
rules enhance comparability and help reduce fraud and misrepresentations,
but they do not necessarily lead to the type of reports that would be most
useful in internal decision making. For example,
GAAP requires that land be
stated at its historical cost on financial reports. However if, management
is considering moving a store to a new location and then selling the land
the store currently sits on, management would like to know the current
market value of the land, a vital piece of information that is ignored under
generally accepted accounting principles (GAAP).
Managerial Accounting Not
Financial accounting is mandatory; that is, it must be done. Various out
side parties such as Securities and exchange commission (SEC) and the tax
authorities require periodic financial statements. Managerial accounting, on
the other hand, is not mandatory. A company is completely free to do as much
or as little as it wishes . No regularity bodies or other outside agencies
specify what is to be done, for that matter, weather anything is to be done
at all. Since managerial accounting is completely optional, the important
question is always, "Is the information useful?" rather than, "Is the
- Reports to those outside the
organization owners, lenders, tax authorities and regulators.
- Reports to those inside the organization
for planning, directing and motivating, controlling and performance
- Emphasis is on summaries of
financial consequences of past activities.
- Emphasis is on decisions affecting the
- Objectivity and verifiability of data
- Relevance of items relating to decision
making is emphasized.
- Precision of information is required.
- Timeliness of information is required.
- Only summarized data for the entire
organization is prepared.
- Detailed segment reports about
departments, products, customers, and employees are prepared.
- Mandatory for external reports.
| What number did you have in mind?
Caterpillar has long been at the forefront of management
accounting practice. When asked by a manager for the cost of something,
accountants at caterpillar have been trained to ask "What are you going
to use the cost element for?" One management accountant at Caterpillar
explains: "we want to make sure the information is formatted and the
right elements are included. Do you need a variable cost, do you need a
fully burdened cost, do you need overhead applied, are you just talking
about discretionary cost? The cost that they really need depends on the
decision they are making."