Definition of Financial Cost and Management Accounting

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Both financial costing and management accounting compile data about a company's operations. However, the information is presented by each method in different formats and is used for different purposes. Let's explore how each method works and who uses it.

What Is Financial Costing?

Reports and financial statements prepared using financial cost accounting methods are primarily intended for presentations to outside parties, such as lenders, regulatory agencies and shareholders.

Financial statements use a classification of cost accounting to produce a balance sheet, income statement and cash flow statement. They record data from five classifications: assets, liabilities, equity, revenues and expenses.

Financial cost accounting uses a set of generally accepted accounting principles known as GAAP. The goal of these principles is to produce consistent, standardized information to creditors, regulators, investors and tax agencies.

Classifications of Data Produced by Financial Cost Accounting for Financial Statements

Assets

Assets on the balance sheet include cash, accounts receivable, inventory, plant and equipment

Liabilities

The liability side of the balance lists accounts payable, current debt and long-term loans.

Equity

Equity shows the total capital contributions made by the company's shareholders

Revenues

Revenues on the income statement consist of all sales, discounts and returns.

Expenses

Expenses listed on the income statement include all of the costs of operating the business. These expenses cover such items as costs for materials, labor, rent, insurance, office salaries, legal fees, advertising and utilities.

Limitations of Cost Accounting Methods

  • Provides only quantitative information. Does not gauge such information as brand awareness and customer opinions of product quality.

  • Only records historical costs. Does not look to the future.

  • Does not consider price level changes, i.e. inflation. Figures from operations could increase each year giving the impression of improved performance when inflation-adjusted data would present a different picture.

What Is Management Accounting?

Management accounting produces reports and performance data for use by the company's internal personnel. This information is intended to aid management in making well-informed decisions for meeting the organization's goals. The data for these reports and key performance do not necessarily come from the company's financial statements.

Management accounting information assists managers in:

  • Formulating business strategy and making strategic decisions.
  • Planning operations for short-, medium- and long-term operations.
  • Determining the best capital structure.
  • Designing compensation programs for executives.
  • Creating returns to shareholders.
  • Controlling operations for the most efficient use of resources.
  • Measuring and reporting relevant non-financial data to management and shareholders.

Examples of Management Accounting

Management accounting is not required to follow any specific system or set of rules. It can be in whatever form management wants if it provides a performance metric and helps to make decisions that improve performance.

For example, if you're a retailer, you might want to count the number of people who enter your store on a Saturday and relate that figure to total sales for the day and compared to advertising expenses for the week before. This type of data is not set by any accounting standards and does not come from the company's financial statements.

Labor productivity is always a major concern for any business. For instance, a plumbing contractor would want to relate the revenue produced by service calls to the actual labor hours spent on the jobs.

Relationship Between Financial Accounting and Management Accounting

The key difference between the types of cost accounting and management accounting is that reports from cost accounting must follow GAAP standards and regulations. On the other hand, managerial accounting can be in whatever form managers want and drawn from other sources, such as putting a clicker in the store's door to count traffic.

The other difference between the two accounting methods is their use and who sees them. Statements prepared by GAAP standards are used by outside parties, while managerial accounting reports and performance metrics are intended for internal use only.

References

About the Author

James Woodruff has been a management consultant to more than 1,000 small businesses. As a senior management consultant and owner, he used his technical expertise to conduct an analysis of a company's operational, financial and business management issues. James has been writing business and finance related topics for work.chron, bizfluent.com, smallbusiness.chron.com and e-commerce websites since 2007. He graduated from Georgia Tech with a Bachelor of Mechanical Engineering and received an MBA from Columbia University.

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