Financial and Management Accountancy to Work in Union Essay

Introduction

Present shareholders seek information about the growth and diversification of their investments; perspective shareholders seek data to visualize the growth of investments when made. Accountancy in any form is the source to generate figures, data, and reports for such purposes. The matter under consideration is whether the accountancy (whether financial or management) in operation with different entities is really serving the objectives of the shareholders, or creating hindrances in the ways of shareholders to obtain necessary information.

An effort has been made in this write up to analyze the system, nature, and working of each of accountancy approaches, and also to study the environment (i.e. standardization) under which each type of accountancy operates, so that we may reach the finding whether these approaches of accountancy are helping or creating hindrances for the shareholders.

Contents

• Introductions
• Contents
• Present Environments
• Shareholders’ Aspirations
• Management Accountancy Vs. Financial Accountancy
• Standardization is mixed in service to shareholders.
• Standardization not desirable for Management Accountancy
• The coordination required for serving the shareholders
• Conclusion

Present Environments

When we talk of accounting standards, we are referring to financial accounting and not management accountancy. Analysis and comparisons of two sets of accounts or for two or more different fiscal periods are possible only in financial accounting because it has been harmonized in recording and presentations. In other words, financial accounting has been institutionalized and standardized; and the motive seems to provide necessary accounting information to those concerned with financial statements including present or future shareholders.

Whereas management accounting is an ever-growing technique not punctuated by the norms of any prescribed standards. Two management accountants may follow different techniques to achieve a common objective. Managerial accounting is in fact a technique to ponder upon the historical presentations to foresee a well-planned future.

‘Financial Accountancy’ is basically connected with a recording of historical transactions, events, and happenings to produce reports reflecting profitability, state of affairs, liquidity, solvency, and stability of the organization. On the other hand, ‘Management Accountancy’ is exploitation, interpretation, and analysis of data collected under say financial accountancy coupled with other information in order to produce a variety of reports generally required by the top management in order to make certain business and other decisions with regard to strategic policies, control of affairs, forecasting, and analysis of performances.

Standardization of financial accountancy emerge from generally accepted accounting principles (GAAP), convention prevalent in an economy, framed laws by a country, and the effort to harmonized financial accountancy in the international arena. Financial accountancy is not a free bird. Creativity has to seek permissions for implementation at large.

Management accountancy is still a free bird and creative usher under such environments. Procedures are custom-made to arrive at a particular objective. It operates under the directions of the management and is not a legal compulsion as in the case of financial accountancy. Some advocates of management accountancy feel that management accountancy is the creative side of financial accountancy and should be encouraged. Proponents of creative accounting claim “that FASB has set the GAAP to give the managers and accountants various accounting methods from which they can select. When applying certain methods, the companies are going to choose the one that makes their financial statements better. Creative accounting assists in this endeavor.” ( Sue Chong)⁹

Shareholders’ Aspirations

Shareholders are the real owners of the organizations. As owners they are basically interested in the following three objectives:

1. Profit maximization- Every shareholder will like a bigger return or dividend on his/ her investment, and so profit maximization is his big dream.
2. Growth of the organization.- Shareholders need to achieve diversity of investments and hence interested in the growth of the entity.
3. Strength of the organization – shareholders are keen to multiply the market value of their investments.

The shareholders’ objectives are served well only when they get detailed analyzed information about different aspects of the organization. Financial accountancy prepares historical records basically for presentations in the annual general meetings where shareholders view audited financial statements and decide whether the performance of the entity is serving their above-stated objectives or not. Management accountancy is not about the collection and presentation of data in this fashion, but about the analysis of data to help management decisions to achieve objectives predetermined by the shareholders or their representatives (i.e. the board of directors). In this way, management accountancy serves the purpose very directly in order to achieve good financial results, i.e., high profitability.

Management accountancy versus financial accountancy

Since the sphere of actions of each of the types of accountancy is different from the other, its management, standardization, and functioning have to be separate from the other. Both types of accountancy have been institutionalized but only financial accountancy has been legally standardized and harmonized across organizations and industries. Management accountancy though not bound by any standardized norms, but has a creative approach that is more situational.

Let us analyze the role played by each type of accountancy in an effort to serve the shareholders of the company.

Financial Accounting

• “By definition financial accounting presents a historical perspective on the financial performance of the business.”⁵(Comparison of financial and management accounting).
• Financial Accounting involves the preparation of financial statements for the use of owners, prospective owners, management, investors, bankers, and many others.
• In order to regulate businesses and collect revenue on the income earned by entities, Governments seek financial statements for manipulations under different laws, rules, and regulations prevalent in the nation.
• Stock markets require financial statements to develop their data bank for the use of investors, and regulators.
• The formulation of financial accounting is based on rules, procedures, and conventions set under ‘generally accepted accounting principles (GAAP)’.Manipulations of procedures are allowed within prescribed limitations.
• Standards for strict adherence have been set up with legal sanctions by agencies like FASB, IASB, and accounting bodies.
• Auditors and various other agencies overseeing the implementations of standards report on the presentation of financial statements in prescribed formats. The reports are qualified whenever there is a deviation from the prescribed course, rules, and disclosure norms.

Management Accounting

• “Management accounts largely focus on analyzing historical performance. However, they also usually include some forward-looking elements –e.g., sales budget; cash flow forecast.”⁶(Comparison of financial and management accounting)
• Management accounting (also called managerial accounting) normally helps the management to and plan and control the operations of an organization.
• Budgets are drawn for the ensuing period. Performances are compared with budgeted targets and inferences are drawn on achievements and/ or failures.
• No standard, rules, and regulations have so far been framed for the management accountancy to follow either voluntarily or under legal compulsion.
• Management can develop any type of accounting system that contributes to the objectivity of the accounting process. No set norms or procedures have been laid down.
• Presentations of reports are as per the purposes those reports are required to serve. There are no pre-established forms or style of presentation of reports.

Standardization is a mixed bag in service to the shareholders

Ronald Ma¹² treating accounting as an economic good state “Under the free-market approach, accounting information is seen as an economic good, the optimal production of which can be determined by demand and supply factors in the marketplace, like any other economic good. Hence it is argued that there is no need for accounting regulation since market forces can ensure that optimal disclosure will take place.”

Even after these strange but somewhat truthful remarks against standardization, one thing is sure that standardization of financial accounting has the benefit of bringing uniformity into its operational style. Standardization of financial accountancy provides the following invaluable advantages:

• They serve as a coordinating device, saving time and effort, just as the rules of road speed up traffic and reduce accidents;
• Public policy should be made through a well defined, transparent process with clear outcomes; and
• They make auditing easier and useful to auditors in their negotiations with clients.”¹ (Shyam Sunder)

Certainly, standardization brings the company closer to achieving its objectives of serving the shareholders, whether present or perspective in a better way. But practically speaking there is a difference in things said and done. We find there emerges difference of opinion on standardization of financial accountancy from one quarter or the other. A lot of criticism brings down the enthusiasm of uniformity down to earth.

Whereas management accounting is not bound under a uniform code of conduct. Management accountancy operates under the freedom to invent new methods to serve the management objectives.

Sylvie Matherat¹¹ in her article ‘International Accounting Standardization and Financial Stability’ has raised two basic questions relating to financial stability from the point of view of European bankers in view of accounting standardization. These questions are:

• “ —Are the standards sufficiently prudent in today’s climate of economic uncertainty and mistrusts of the markets, and will they address the shortcomings that have recently been revalued?
• —- Is there not a risk of standard introducing artificial volatility into financial statements, impairing a proper understanding of the true position of economic agents?”

In fact, the answers to these questions are the way you look at the changing scenario of standardization. A positive approach will always find out countermeasures to fight out the volatility effect of such standardizations.

Shyam Sunder in his article ‘Uniform Financial Reporting Standards Reconsidering the Top-Down Push’ has very rightly stated that “Accounting is the language of business. As with any other language, it derives vibrancy from the changing dynamic of the meaning of the words. The value of Oxford English Dictionary arises from the encyclopedic collection of the various ways in which a word may be used, not in recommending or enforcing its opinion.”; and he goes on to say that “no language, including accounting, can flourish under the protective umbrella of punitive authoritative regulations”.²

Accordingly forcing a system does not necessarily bring out the best from the operations. Management accountancy with its capabilities to invent new vistas for excellence is bound to achieve shareholders’ dreams in more effective ways. This is the view of those advocating for the freedom approach of management accountancy.

Standardization not desirable for Managerial Accountancy

The basis of creativity is freedom, and this is particularly true in the case of management accountancy. But as per Ronald E. Hester and Ray M. Harrison⁸, ” The flourishing of corporate reporting saw the emergence of a range of activities seeking to standardize performance measurement and reporting. This stress on standardization seems paradoxical given the multiple objectives of performance measurement and reporting.”

Also, Juergen Daum says “The management accounting cannot be standardized in the same way as financial accounting. In this context, standards refer to a common approach rather than fixed, mandatory rules.”³

We noted above that the functioning of managerial accountancy is quite different from financial accountancy. Financial accountancy records events, transactions, and happenings that have already taken place. On the basis of those recordings, information and figures are gathered under recognizable heads, as prescribed by the standards. Thereafter reports are prepared on basis of such totals and gatherings. Care is taken to observe that disclosures of events, transactions and happenings are exactly as prescribed under the standards. Standardization and harmonization of presentation in the case of financial accountancy works as history cannot be changed.

The functioning of management accountancy is quite independent. Of course, it takes into account the historical recordings of the financial accountancy while analyzing the recorded figures. Management accountancy is a creative exercise. Two management accountants will draw two different conclusions while analyzing financial accountancy for future projections. Accordingly, when the concept and approach of management accountancy are different from financial accountancy, it cannot be standardized in the way of financial accountancy.

Management accountancy is basically associated with the management function of the organization. Simply speaking, “the term ‘management’ has a different meaning in different perspectives. In general, we can say that management is a process that involves planning, managing resources to accomplish the set objectives, and measuring the results got”¹⁰(mamangement-Hub.com). It is in this perspective that management accountancy needs to be evaluated while comparing it with financial accountancy.

The coordination required for serving the shareholders

Financial accountancy reports come in prescribed packages. The user knows that ‘Annual report’ of a company will contain its financial statements and independent auditors report on those statements. But in the case of management accountancy, no such predetermined way of reporting exists. Management accountancy serves internally to the organization, whereas financial accountancy present reports also for external uses. In a way, financial accountancy is a show window of the organization, and management accountancy plays the role of a critique ready to bring realities out before the management. What if both approaches work together to bring the best out of the available resources. The result would be the generation of qualitative reports under both approaches and shareholders would be served better.

Financial accountancy and management accountancy have to perform together to meet the aspirations of shareholders, whether current or future. Though these two schools of accountancy operate with different approaches, the ultimate objective is to serve the company in order to meet the objectivity of the shareholders. It is true that financial accountancy has been standardized under GAAP and other parameters, but the management accountancy also has the inbuilt quality of creativity to achieve management objectives. In fact, both approaches to accountancy need to work together, wherever applied simultaneously.

As per Juregen Daum, “a new approach to management accounting is needed. One that supports decision making and financial accounting, just like management accounting and cost accounting did in old days.”

John J.Ballow, Robert J. Thomas, and others in the article ‘Getting a True Picture of Shareholder value’ have emphasized that GAAP (financial Accounting) coupled with a number of management accounting tools can provide invaluable information and disclosure about financial statements to the shareholders. The article states that “The proliferation of non- GAAP supplement disclosures – EBITDA is a good example—are also ways that companies are trying to improve disclosure”.⁴

The combination of both approaches of accountancy will guarantee an open flow of information without multiple or duplicate recordings of transactions. Financial accounting is a central processor of the available historical data. Management accountancy, if build on this comprehensive data, will allow all sorts of analysis to bring about desirable and comprehensive reporting.

With rapid internationalization, the need for standardization in management accountancy techniques for control purposes is being considered an emergent issue. But Andreas Holfen⁷ in his study ‘Management control systems in German Multinationals- Balancing Global Standardization and Local customization’ points out that ” Financial accounting is dependent on governmental accounting regulations, such as the International Financial Reporting Standards(IFRS) for German financial consolidated statements. Therefore, shareholders represent the most important recipients of financial accounting information. Conversely, management accounting and control focus on assisting managers in achieving the goals of the organization and thus measure and report financial and non-financial information internally.”

This clearly shows that performing independently for any accountancy approach is not possible as no system of accountancy can be said to be perfect. Management accountancy has to borrow some collective information from financial accountancy for analysis purposes, or it has to develop a data-gathering process in its system itself, which again will be time-consuming and costly for the organization. This will also lead to the duplicity of the work.

When one approach of accountancy has achieved a decent level of standardization, the management accountancy should make use of that standardization in furthering the process of developing the best reports for the shareholders via management reporting. In other words, working in tandem or together will bring not only efficiency into the results, but some sort of standardization will get transferred to management accountancy as well.

The idea is that shareholder should not miss their goals in differentiating approach of two schools aiming for the same objectives.

Conclusion

No doubt management accountancy is creative, but the importance of financial accountancy cannot be undermined simply because it has to operate obediently as per standards framed under GAAP and other conventions.

There is no doubt that management accountancy can manipulate the historical data provided by standardized financial accountancy to the benefit of shareholders. But when performing alongside financial accountancy, management accountancy will serve better to the real owners of the company, namely shareholders. There is no need for management accountancy to be bound by standardization. The idea is that shareholders should not be left in a lurch. Both the school of accountancy should work together to help shareholders in achieving their goals and need not create hindrances because of one-upmanship.

References

1. Shyam Sunder, Uniform Financial Reporting Standards Reconsidering the Top- Down Push, The CPA Journal Online, 2007 issue. Web.
2. ibid.
3. Juergen Daum, The Missing Link. Web.
4. John J. Ballow, Robert J. Thomas and others, “Getting a True Picture of Shareholder Value’, Outlook Journal, 2005. Web.
5. Comparision of financial and management accounting, tutor2u, 2007. Web.
6. ibid.
7. Andreas Hoffjan, Management Control Systems in German Multinationals- Balancing Global Standardization and local Customization, page 5, 2007. Web.
8. Ronald E. Hester, Roy M. Harrison, Global Environment Change, page 167. Web.
9. Sue Chong, The Ethics of Creative Accounting. Does it All Add Up? Creativity, Principles, and Accuracy, 2007. Web.
10. Management- Hub.com, What is management?. Web.
11. Sylvie Matherat, International Accounting Standardisation and Financial Stability, 2007. Web.
12. Ronald Ma, Financial Reporting in the Pacific Asia Region, Chapter 5, Standards Setting Issues and the International Accounting Standards. Web.