Concepts of Accounting: Managerial versus Financial

Accounting is a vast and expansive discipline. One of the key differences in how managerial and financial accounting vary but also how both forms of accounting are extremely important to the health and success of a company. Within these accounting concepts, it is also important to understand the differences between a functional versus absorption income statement, how the cost of goods sold is different from the contribution margin and when the contribution margin is necessary to use.

Managerial accounting and financial accounting differ from each other in several respects. First, managerial accounting reports are internal, created to allow managers to analyze performance and makes adjustments where needed to optimize results. These reports also help managers know which direction to go within the company in order to enhance planning, encouragement of staff and control. By contrast, financial accounting is an externally prepared report, created for entities outside a particular organization, such as shareholders and regulators. Secondly, managerial accounting also has an impending focus, with its ultimate goal of helping managers create solid plans for the future of their organizations, whereas financial accounting uses the past to articulate previous figures. Since the past does not always determine the immediate future, managerial accounting reports are preferred by management for presently needed decisions.

Thirdly, managerial accounting also directs its attention to very specific data applicable to a particular problem a manager is facing. Financial accounting, rather, contains objective data on the whole picture, and therefore, is much too broad for singular issues. Fourthly, managerial accounting is also much more focused on speed than accuracy. Because managerial accounting relaysinformation about a specific problem to internal decision makers, it is important that a decision often be made with slightly less reliable data, in a faster amount of time, compared to financial accounting, which is much more accurate in its figures, but lacks the quickness in its delivery. Further, managerial accounting is segmented for groups within a particular company, and financial accounting takes a summary of the company as a whole and is responsible for all finance reporting of company earnings.

Fifthly, managerial accounting also adheres to different rules. When creating reports, because they are for certain users inside the company, the reports do not have to follow the Generally Accepted Accounting Principles (GAAP) whereas it is required in financial accounting that these guidelines are followed because there needs to be a way to measure the validity of the report by outside establishments. Finally, managerial accounting is a non-mandatory process and is determined by numerous problems that come up which warrant figures for a decision. Financial accounting, on the other hand, is required by law from the Securities Exchange Commission (SEC) and other tax establishments to make sure a company is not committing fraud. Because of the requirement of financial accounting, there are more accounts in this field than managerial accounting ("Difference between financial and managerial accounting," n.d.).

Looking at functional versus absorption income statements, there are differences in both the presentation and usage of each of these versions. Functional income statements focus on a particular facet of the company and thus is much more specific than an absorption income statement. These statements also use fixed manufacturing overhead, over a period of time, which is used to determine costs over a range of time. In fact, “on a case-by-case basis, including fixed manufacturing head in a product cost analysis can result in some very wrong decisions” ("Principles of Accounting," n.d., Ch. 23). Again, this is because the functional income statements are used to account for the bigger picture and a sum of costs over time. Absorption income statements, by contrast, use the fixed manufacturing overhead in calculating product costs so it is much more appropriate to use this form of an income statement for individual circumstances. Functional income statements are also often used by companies to determine costs that can fluctuate, and this report is an attempt to ease the shortcomings in absorption income statements, since it is used to determine the full and not specific case costs of a company.

In examining and contrasting the concept of the cost of goods sold versus contribution margin, there are noticeable differences. The cost of goods sold accounts for both flexible and fixed costs related to the manufacturing procedures of a company, whereas the contribution margin only accounts for flexible expenses and shows the money left over after those expenses are covered. These expenses include things that can vary with different production needs or outcomes such as material and labor. The contribution margin is often used because it is an easier figure to obtain ("Principles of Accounting," n.d., Ch. 23). The contribution margin is the beginning point for calculations that help businesses figure out what to produce, how much and how these goods should ultimately be priced. Like managerial accounting, contribution margin reports are used for internal purposes. The contribution margin is also used to determine the amount of profit after each individual sale after subtracting variable costs ("Principles of Accounting," n.d., Ch. 18).

In studying accounting standards and the principles within, it is easy to see how variable and complex it is. While both managerial and financial accounting is important, it is even more important to recognize and understand the differences. In addition to the makeup of these reports, functional and absorption income statements also help to assist individual companies in different, but equally important ways. Finally, determining costs in goods sold and contribution margin provide companies with different strategies to account for fixed and variable costs.

References

Difference between financial and managerial accounting. (n.d.). Financial Accounting Vs Managerial Accounting-Difference between Financial and Managerial Accounting. Retrieved October 22, 2013, from http://accounting4management.com/financial_accounting_vs_managerial_accounting.htm

Principles of Accounting. (n.d.). Principles of Accounting. Retrieved from http://www.principlesofaccounting.com/chapter18/chapter18.html

Principles of Accounting. (n.d.). Principles of Accounting. Retrieved from http://www.principlesofaccounting.com/chapter23/chapter23.html