Differences between Management Accounting and Financial Accounting - Essay Example

MANAGEMENT ACCOUNTING Student’s Name Course Professor’s Name University City Date Table of Contents Introduction 3 Differences between Management Accounting and Financial Accounting 3 Purpose 3 Regulatory Requirements 3 Recording 4 Objective 4 Presentation 5 Users of Information 5 Break-Even Analysis 5 Purpose of Break-Even Analysis 6 The Importance of the Different Types of Operational Budgets. 8 Salary and Salaries Operations Budget 8 Fees and Honoraria Budget 8 General Administration Budget 9 Travel and Associated Expenses Budget 9 Supplies and Equipment Budget 9 Education and Training Budget 10 Importance of Variance Analysis 10 Material Variance 11 Labor Variance 11 Overhead Variance 11 Sales Variance 12 Conclusion 12 Reference List 13 Introduction In the recent years, business organizations have adopted various strategies aimed at implementing effective management accounting practices in their operations. The adoption of management accounting has revolutionized the management of financial resources in business enterprises. Through management accounting, both medium-sized and multinational corporations have managed to implement policies that control the generation and use of financial resources. Critical aspects of management accounting and financial accounting has changed the business environment. Management accounting and financial accounting has enhanced the operations of business organizations through ensuring proper financial management, record keeping and development of financial statements relating to the business. Differences between Management Accounting and Financial Accounting Purpose Financial accounting is a system used in companies or any other enterprise for the purpose of forming a financial statement which provides more information to the clients on the progress of the institution in financial terms. Management accounting differs from financial accounting in that it comprises of accounting systems in charge of formulating policies, offer details to the managers on the operations the organization and lastly, assist the business to set appropriate strategies that aid the managers to operate efficiently and effectively. Regulatory Requirements Whereas every enterprise is required to have a financial accounting system, the management accounting section is optional. The reason is that; the stakeholders of a firm would like to be updated on how the funds are being handled. Furthermore, without an honest financial accounting, the company is unable to plan, budget and meet the expenses accurately. The management accounting department is presumed to have insignificant functions, unlike the financial system (Christensen 2016). Recording Financial accounting system contains information about financial aspects only unlike the management accounting where the information recorded is both monetary and non-monetary. Management accounting handles the manager’s information or strategies to be implemented for the future sustainability of the firm. For example, the analysis of executives’ competency level or employee motivation is non-monetary information. Objective Each category has its sole objective to be attained at the end of the day. The financial accounting system analyzes the flow of funds within the organization. After evaluation of the outcomes, the results are to be presented to the outsiders. The outsiders include; investors, lenders, suppliers, and government agencies. The information enables the stakeholders to make decisions regarding investment and the benefits or challenges they are likely to accrue from the business. Management accounting on the other side has a different objective whose focus is for internal purpose. The management accounting section should provide clear and appropriate details on how issues can be solved. The information from management accounting assists the managers in planning and making decisions. Presentation The results obtained by each of the accounting departments must be presented to various parties. Unlike management accounting, the financial accountants have a specified format of presentation. The financial analysts give their findings in the form of financial statements at the end of a fiscal year. However, management accountants only give their reports when the need arises. These reports are usually designed internally by the organization and they differ from business to business; there is no particular format of a management report. Users of Information The primary users of the information provided by finance analysts are both the external and internal parties. The report is published after the statutory auditors declare the right and fair position of the enterprise. Management accountants’ information is for use by the private managers and does not require any form of publishing or auditing. They are used internally for decision-making. Break-Even Analysis Break-even analysis is one of the methods applied by firms for them to know how the different kinds of costs interact and affect the business operations. Profit is obtained when the revenue of the company is more than the total expenses incurred. However, at the breakeven point, the total cost is the same as the revenue collected. At this point, the organization neither made losses nor profits. Entrepreneurs are advised to get vital information concerning the products cost and how they vary from time to time before they start incurring costs that may lead to a breakeven point or loss. Moreover, the information is relevant in making the following decisions: setting the price of the product and the total number of goods that need to be sold to make profits rather than losses. Furthermore, it helps in deciding the minimum number of products to be sold to attain the optimal benefit levels. Also, it helps financial analysts to understand and analyze the impact of price fluctuations on profitability. Purpose of Break-Even Analysis In accounting, organizations use the break-even analysis technique to forecast the business operations. The study is relevant for several reasons: to estimate the number of goods that should be produced to achieve optimal returns on the time value of money and the resources invested in the business. Break-even analysis carries out an assessment of the impact of price fluctuations on the sales and profit levels, assessing to what extent are the benefits affected by the costs encountered. Lastly, the analysis helps in the measurement of safety margins of operating within the imbalanced demand and supply. In the calculation of the break-even point, two approaches can be used, either numerical method or use of the break-even chart. Numerical break-even analysis. The mathematical calculations use the data recorded by the business that is; fixed costs level, unit selling price, the variable costs of each unit, and the contribution margin per unit. The ratio between the fixed costs and the contribution per unit forms the breakeven output. Break-Even Chart. The break-even charts approach is the visual representation of the revenues and the total costs at different times to get the break-even point. The break-even charts perform specific roles in the entity such as; the identity of units required to meet the breakeven point (Q units). Profits or loss obtained at specific points of output and the implications of the changes in the selling price to the break-even level, loss or profits. The visual presentation enables quick interpretation of the data at a glance considering that the chart is simple to understand. Construction of break-even charts is made on the x and y-axis of a graph (Ponsi 2016). The x-axis represents the revenues and cost while the y-axis shows the different levels of output at specified times. The construction is done in four simple stages. (i) Plotting the total revenue – line OA; (ii) plotting the fixed cost – line OB. In scenarios where there is no output, the fixed cost is still plotted because the number of the production does not influence the fixed cost; (iii) plotting the variable costs – line BC and; (iv) plotting the total costs – line OBC. After the chart construction, analysis and interpretation are done. The breakeven point occurs where the revenue line and total costs meet – point P. Each level of output shows a new level of either profit or loss. When the total cost exceeds the total income, the entity makes a loss – area BPO, and the reversed situation forms a profit – area APC. Units produced beyond the break-even point qualify to be called the margin of safety. The Importance of the Different Types of Operational Budgets. Classification of the resources is a strategic plan for the entity to build a solid basis for the management of funds. The classification of fiscal systems forms a structure in which recording, presentation, and reporting of the operational budgets will follow. A precise and elaborate structure enables direct transparency among the departments in the company (Kaplan 2015). Before setting up an operational budget, three factors need to be adequately addressed; political ownership, technical capacity and IT systems. There are many operational resources in a limited company such as; salaries and wages, travel and associated expenses, fees and honoraria, general administration, supplies and equipment, education and training. Salary and Salaries Operations Budget This category of budgeting covers a line of items such as basic salaries, pension, casual wages, allowances, and benefits. Budgeting and planning are done for the gross wages that required to be paid to staff within a specified period whether full or part time employees. These budgets are important since they determine the total cost of employing staff in an organization, or used when promoting or reviewing salaries. Fees and Honoraria Budget During budgeting, funds should be allocated for the purpose of accessing professional services example lawyers, trainers, editors, contractual, consultants and temporary personnel. The budgetary team needs to set aside funds to pay for future special services such as entertainment and presentation in the form of honoraria. These budgets are used to determine if an organization can afford a certain level of expertise, and if so, at what level. General Administration Budget The offices have expenses that need to be met to ensure there is normal running of the administration services such as telephone, e-mail, fax, postage, utilities, bank charges, recruitment costs and payment of subscriptions. Having an elaborate budget for this department ensures that administrators keep track of the receipts kept by cash clerk. The department will have to adhere to the accounting controls for effective implementation of the budget. Travel and Associated Expenses Budget The business should plan for the field visit, supervisory trips, fuel costs, and local travel expenses and staff meetings. Some companies also cater for the mileage reimbursements when private means are used, air tickets and costs for renting vehicles. Having this category of budgeting ensures that the supervisor or the manager before allocating funds proper procedures have been followed for approval. Secondly, the budget specifies the occasions qualified for funding thus eliminating the malicious trips organized. Besides, there are rules that are established to govern the travel expenses. Supplies and Equipment Budget For satisfying services, every company needs to have materials to carry out the various departments. The company needs office supplies, furniture, computers, printers, equipment, clinic supplies, motor vehicles software, cleaning supplies and other relevant material. The purchase can only be made if the funds have been allocated for the purpose. The budget gives the managers assurance that funds are available to meet the buying and supplies requirements for a specified period (Bogsnes 2016). Having a budget acts as a monitoring tool that ensures strict adherence to the expenditures set for best services. Education and Training Budget Teaching and training is a critical section in every company. It serves as an advancement tool for the staff to improve the new technology. Education and training enable the firm to evaluate the relevant people to perform specific tasks within the entity. The budget under this category covers; traveling costs, venue expenses, rental equipment, registration fees, special events, meals, and training materials. Importance of Variance Analysis The measuring tool in the determination of variance is standard costing so that an organization can evaluate the performance of the production section. The difference between the standard cost of a product and its actual cost is known as the variance. The value could be in favor or against the business expectations. The favorable condition is when actual performance is more than the standardized value, and the reverse is unfavorable. The analysis of variance is essential to the management to ascertain the amount of variation, the remedial action that can be applied, individuals responsible for the negative performance and what cause the imbalance between the actual and budgeted performance. There are four unique types of variance namely material variance, sales variances, overhead variances, and labor variance (Pilleboue 2015, p. 124). Material Variance Material variance refers to the difference between the actual materials used to produce the actual products and the standard value of materials that produced the real output. When actual costs exceed, the standard cost variance is unfavorable. For further analysis, the material various is divided into sub-section for more accurate calculation of variance about materials; price, usage, mix, and yield. The more precise analysis of each factor enables the organization to know which factor affects materials positively and which is negative. Labor Variance Labor variance stands for the imbalance between the standard work required to produce the actual output and the actual salaries paid. The labor variance is analyzed in different forms; cost variance, wage rate, efficiency idle time, mix, revised efficiency, and yield. Each of the variables is measured separately to highlight the strengths and weakness in the labor resources. Overhead Variance Overhead Variance is described as the aggregate indirect labor costs, indirect material cost, and the incidental expenses. An overhead variance occurs when the actual overhead cost differs from the standard cost of overhead for actual production. This category is concerned about the technical; capacity of a firm. The costs expenses could either be variable or fixed. Sales Variance Sales variance refers to the cost of goods sold variations. An entity obtains profit by finding the difference between the cost incurred and the revenue from sales. The difference between the targeted sales and actual sales directly affect the profit levels of the firm. The primary role of the sale variance is determining the difference in the benefits. There are only two possible methods used in the calculation of the sales difference; the sale value method and profit method. Conclusion Management accounting and financial accounting have played a critical role in the operations of both small, medium-sized and global business organizations. Both management and financial accounting have boosted vital business activities. Various aspects of management accounting such as break-even analysis, operational budgets and variance analysis ensure the adoption of effective measures aimed at improving the management of financial resources in a company. The presence of different types of operation budgets such as general administration budget creates an enabling environment for the evaluation of the financial performance in the business. Reference List Bogsnes, B 2016, Implementing beyond budgeting: unlocking the performance potential, John Wiley & Sons. Christensen, HB, Nikolaev, VV and Wittenberg‐Moerman, R 2016, ‘Accounting information in financial contracting: The incomplete contract theory perspective’, Journal of Accounting Research, 54(2), pp. 397-435. Drury, CM 2013, Management and cost accounting, Springer. Kaplan, RS and Atkinson, AA 2015, Advanced management accounting, PHI Learning. Pilleboue, A, Singh, G, Coeurjolly, D, Kazhdan, M and Ostromoukhov, V 2015, ‘Variance analysis for Monte Carlo integration’, ACM Transactions on Graphics (TOG), 34(4), p.124. Ponsi, E 2016, Technical Analysis and Chart Interpretations: A Comprehensive Guide to Understanding Established Trading Tactics for Ultimate Profit, John Wiley & Sons. Read More