Financial and management accounting play different roles in the running of a business. According to Hoyle, Schaefer, and Doupnik (2018, p44) “the focus of financial accounting is mainly disclosure whereas management accounting is concerned with informing the top management about the health of the business and suggesting improvements.” Financial accounting plays the role of disclosing certain information to the stakeholders of a business. The stakeholders use it to make various informed decisions regarding the link with the company in question. Management accounting contains information that is used by the management of a firm to make strategic decisions.
Various Point of Difference
Financial accounting aims to provide business performance data to outside parties. The external stakeholders include customers, investors, creditors, and competitors among others. Hence, they assist them in the formulation of informed decisions (Kaplan and Atkinson, 2015). Management accounting aims at dispensing various sensitive information to the management of the business, which will aid them to make informed decisions.
It is mandatory for every public enterprise to prepare financial statements as per the conventional guidelines. Those guidelines are stipulated by the government, company’s law, and International Accounting Standards. Management accounting is made at the discretion of a specific firm because it is not mandatory. However, the frameworks and formats of preparing management accounting are provided by institutes such as ICWAI and CIMA (Kaplan and Atkinson, 2015).
The Generally Accepted Accounting principles provide the basis of preparation of financial accounting statements (Kaplan and Atkinson, 2015). There exists no standard base for management accounting statements because they are prepared to suit the needs of a specific team.
In most cases, financial accounting statements cover the information of the past one year (Kaplan and Atkinson, 2015). Management accounting statements focuse on the future and have no specific time horizon.
The beneficiaries of financial accounting statements are external stakeholders. The recipient of management accounting statements is the internal parties attached to a particular organisation, for example, the CEO, board of directors, shareholders, managers, promoters, and employees (Kaplan and Atkinson, 2015).
There are three financial statements. They include the statement of financial position, profit and loss statement, and cash flow statement. Reports attached to management accounting are mainly daily, weekly, or yearly analysis of various factors that affect the profitability of a business (Kaplan and Atkinson, 2015).
Relevance and Precision of Data
The data contained in financial accounting statements are precise and correct because they are guided by law. In most cases, the data linked to management accounting statements cannot be accurate because they deal with the forecasted values (Kaplan and Atkinson, 2015). For instance, it is challenging to forecast production correctly.
In most nations, independent audit of reports attached to financial accounting are mandatory. On the other hand, there exists no specific requirement to carry out an independent audit of management accounting reports (Kaplan and Atkinson, 2015). However, the management at its discretion can initiate such a review if it considers it necessary.
Financial accounting statements are prepared to give the public information regarding the performance of an organisation. Therefore, financial accounting statements contain no confidential data of an individual business (Kaplan and Atkinson, 2015). On the other hand, management accounting reports contain confidential information which in most cases has business secrets of a business.
Financial accounting reports provide generalised details about the financial health of a business. On the other hand, management accounting reports are concerned with specific segments of a company, for instance, sales, production, or purchases among others (Kaplan and Atkinson, 2015).
Financial accounting takes a historical perspective. That is because it reports on what has already happened (Kaplan and Atkinson, 2015). Management accounting is futuristic because its reports contain information on what the business aims to achieve within a specific duration of time.
Nature of Information Input
The information that is used in the preparation of financial accounting reports is measurable in money form. For example, it is sales, purchases, profit, revenue, or loss; they are all reported in the form of cash (Kaplan and Atkinson, 2015). On the other hand, preparation of management accounting reports uses both financial and non-financial information.
Cost is the term used in reference to the value sacrificed by an individual or organisation to gain something in return, for instance, a good or a service. According to Hoyle, Schaefer, and Doupnik (2018, p.67), “Cost classification is the logical process of categorising the different costs involved in a business process according to their type, nature, frequency and other features to fulfil accounting objectives and facilitate economic analysis.” It is of the essence to acknowledge that every business process has a cost. That is why businesses use cost as a basis for determining the profitability of procedures they undertake.
Methods of Cost Classification
A cost classification system is used by management to identify various forms of cost. This classification system also provided the management with the basis for financial modelling (Brewer, Garrison, and Noreen, 2015). The basis for cost classification includes nature, relation to cost centre, functions, behaviour, management decision-making, production process, and time.
Cost can be distinguished by the purpose of the kind of conditions in which it was incurred. It can be treated as an expense but divided into various categories (Brewer, Garrison, and Noreen, 2015). For instance, the expense of building an office can be divided into labour, material, and other costs.
Relation to Cost Centre
A cost can be directly or indirectly connected to the cost centre (Brewer, Garrison, and Noreen, 2015). Direct costs are the prime expense that is immediately associated with a precise production process. Indirect costs are expenses which cannot be directly linked to a production process.
The core five business functions which involve cost include R&D processes, administration, production, distribution, and selling (Brewer, Garrison, and Noreen, 2015). Hence, they act as one of the main ways of categorising cost in its function. Production cost is made up of indirect and direct expenses incurred by an organisation in producing a commodity or service. Administration cost is the expense of running managerial activities such as rent, telephone, stationery, electricity, and others. Selling price is an indirect expense resulting from events such as promotions, customer service, advertisement, and research, among others. Distribution cost is the expense incurred when making services and commodities reach the intended client. The cost of running a research and development department is essential in enabling the firm to modify existing products to suit the market needs.
The price attached to any organisation process can be differentiated based on its volatility, especially concerning the short-run behaviour of business activity. In this case, a cost can be classified as fixed, variable, or semi-variable (Brewer, Garrison, and Noreen, 2015). Fixed costs are the expenses which are hardly affected by a temporary change; they include rent, salary, lease, and depreciation among others. Variable costs are expenses that are directly affected by the quantity of production (Banerjee, 2015). They include commissions, raw materials, and packaging among others. Semi-variable costs are affected by business activity moderately. They include supervision, management, and maintenance costs.
It is not in all cases that cost is incurred to generate some value. At times, costs are used as a decision-making tool by management (Brewer, Garrison, and Noreen, 2015). In that case, the cost can be categorised into marginal, un-avoidable, avoidable, abnormal, normal, sunk, imputed, relevant, replacement, opportunity, or differential.
Classifying cost with production process is common in the manufacturing industry. All manufacturing processes are attached to different types of expenses (Brewer, Garrison, and Noreen, 2015). Those costs include operation, process, batch, joint, and contract among others.
The liability, importance, and nature of a cost vary with time. For instance, a specific cost can be treated as a priority today, but in the future, it might not be relevant. In that case, various categories of cost are derived from the time variable (Brewer, Garrison, and Noreen, 2015). They include estimated, standard, pre-determined, and historical costs.
Importance of Cost Classification
Cost classification is a section of managerial accounting. Reports derived from cost classification aid managers to control the production process by defining the firm’s goals. Studies indicate that “Cost classification has simplified the work of the management, accountants, economists, researchers, and many others because it facilitates the process of cost control, cost reduction, and cost management” (Banerjee, 2015, p24). Hence, it promotes the management, accountants, economists, researchers, and others to make informed decisions. Cost control is facilitated by the fact that the managers forecast production cost and come up with ways of minimising the expenses (Banerjee, 2015).
Marginal and absorption costing are the two approaches used in the valuation of inventory. However, their context is different. In marginal costing, the marginal cost is calculated by bifurcating variable cost and fixed cost. According to Banerjee (2015, p.23), in marginal costing, “only variable costs are charged to operation, whereas the fixed cost is excluded from it and are charged to profit and loss account for the period.” Marginal costing technique identifies the variable cost of production and helps management in determining the impact of those expenses on the profit. Besides, it shows how management can increase revenue by adjusting the levels of output. It is of the essence to note that in marginal costing, all fixed costs are regarded as period costs, while variable costs are assumed as product-related costs. Hence, fixed costs are recorded in the profit and loss account. Also, they are not considered when valuing inventory.
According to Banerjee (2015, p18), “Absorption Costing is a method for inventory valuation whereby all the manufacturing expenses are allocated to the cost centres to recognise the total cost of production.” It is a traditional method of ascertaining the cost. The context of marginal costing is different from that of absorption costing method, which is also referred to as full costing. That is because absorption costing technique assesses whether variable or fixed costs are absorbed by the production process. It is of the essence to note that absorption costing method is in most cases used for reporting purpose (Banerjee, 2015). That is because it aids management to include all costs that have been incurred in production. The core aim of absorption costing is to total cost of production from the selling point of a particular product. That is why expenses are divided into three categories, namely process costing, job costing, and activity-based costing.
Some people prefer absorption costing, while others use marginal costing. However, they both serve their users well, but it is important to have explicit knowledge of their difference before reaching a conclusion on which one to use. According to Banerjee (2015, p.16), “the differences in the profits generated in the income statement by the two costing systems because the absorption costing procedure, apportions the fixed cost of production to the output whereas the marginal costing system ignores it.” Therefore, it is essential for management to have a precise knowledge of the methods that suit the organisation better than the others.
Calculations are done in the Excel sheet attached.
The importance of marginal profit statement, breakeven point in units, breakeven sales, target sales, and the margin of safety is that they help management to make strategic plans for the business.
The assumption made in coming up with the marginal profit statement, breakeven point in units, breakeven sales, target sales, and the margin of safety is that the corporate tax rate remained constant.
Banerjee, B., 2015. Fundamentals of financial management. PHI Learning Pvt. Ltd..
Brewer, P.C., Garrison, R.H. and Noreen, E.W., 2015. Introduction to managerial accounting. McGraw-Hill Education.
Hoyle, J.B., Schaefer, T.F. and Doupnik, T.S., 2018. Fundamentals of advanced accounting. McGraw-Hill Education.
Kaplan, R.S. and Atkinson, A.A., 2015. Advanced management accounting. PHI Learning.