Financial accounting reports are prepared for external parties such as shareholders and cred- itors, whereas managerial accounting reports are prepared for managers inside the organiza- tion. This contrast in orientation results in a number of major differences between fi nancial and managerial accounting, even though they often rely on the same underlying fi nancial data. Exhibit 1–3 (page 8) summarizes these differences.
As shown in Exhibit 1–3 , fi nancial and managerial accounting differ not only in their user orientation but also in their emphasis on the past and the future, in the type of data pro- vided to users, and in several other ways. These differences are discussed in the following paragraphs.
Emphasis on the Future
Since planning is such an important part of the manager’s job, managerial accounting has a strong future orientation. In contrast, fi nancial accounting primarily summarizes past fi nan- cial transactions. These summaries may be useful in planning, but only to a point. The future is not simply a refl ection of what has happened in the past. Changes are constantly taking place in economic conditions, customer needs and desires, competitive conditions, and so on. All of these changes demand that the manager’s planning be based in large part on esti- mates of what will happen rather than on summaries of what has already happened.
LEARNING OBJECTIVE 1 Identify the major differences and similarities between fi nancial and managerial accounting.
Topic Tackler
PLUS 1–1
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E X H I B I T 1–3
Comparison of Financial and Managerial Accounting
• Reports to those inside the organization for:
Planning
Directing and motivating Controlling
Performance evaluation
• Emphasizes decisions affecting the future.
• Emphasizes relevance.
• Emphasizes timeliness.
• Emphasizes detailed segment reports about departments, products, customers, and employees.
• Need not follow GAAP.
• Not mandatory.
Accounting
Financial and Operational Data
Managerial Accounting
• Reports to those outside the organization:
Owners Lenders Tax authorities Regulators
• Emphasizes financial consequences of past activities.
• Emphasizes objectivity and verifiability.
• Emphasizes precision.
• Emphasizes summary data concerning the entire organization.
• Must follow GAAP.
• Mandatory for external reports.
Financial Accounting
• Recording
• Estimating
• Organizing
• Summarizing E X H I B I T 1–2
The Planning and Control Cycle
Decision Making Formulating long- and short-term plans (Planning)
Measuring performance (Controlling) Comparing actual to
planned performance (Controlling)
Implementing plans (Directing and Motivating)
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Relevance of Data
Financial accounting data should be objective and verifi able. However, for internal uses managers want information that is relevant even if it is not completely objective or verifi - able. By relevant, we mean appropriate for the problem at hand. For example, it is diffi cult to verify estimated sales volumes for a proposed new store at Good Vibrations, but this is exactly the type of information that is most useful to managers. Managerial accounting should be fl exible enough to provide whatever data are relevant for a particular decision.
Less Emphasis on Precision
Making sure that dollar amounts are accurate down to the last dollar or penny takes time and effort. While that kind of accuracy is required for external reports, most managers would rather have a good estimate immediately than wait for a more precise answer later. For this reason, managerial accountants often place less emphasis on precision than fi nancial accoun- tants do. For example, in a decision involving hundreds of millions of dollars, estimates that are rounded off to the nearest million dollars are probably good enough. In addition to placing less emphasis on precision than fi nancial accounting, managerial accounting places much more weight on nonmonetary data. For example, data about customer satisfaction may be routinely used in managerial accounting reports.
Segments of an Organization
Financial accounting is primarily concerned with reporting for the company as a whole. By contrast, managerial accounting focuses much more on the parts, or segments , of a company.
These segments may be product lines, sales territories, divisions, departments, or any other categorization that management fi nds useful. Financial accounting does require some break- downs of revenues and costs by major segments in external reports, but this is a secondary emphasis. In managerial accounting, segment reporting is the primary emphasis.
Generally Accepted Accounting Principles (GAAP)
Financial accounting statements prepared for external users must comply with generally accepted accounting principles (GAAP). External users must have some assurance that the reports have been prepared in accordance with a common set of ground rules. These common ground rules enhance comparability and help reduce fraud and misrepresentation, but they do not necessarily lead to the type of reports that would be most useful in internal decision making. For example, if management at Good Vibrations is considering selling land to fi nance a new store, they need to know the current market value of the land. However, GAAP requires that the land be stated at its original, historical cost on fi nancial reports. The more relevant data for the decision—the current market value—is ignored under GAAP.
Managerial accounting is not bound by GAAP. Managers set their own rules concerning the content and form of internal reports. The only constraint is that the expected benefi ts from using the information should outweigh the costs of collecting, analyzing, and summarizing the data. Nevertheless, as we shall see in subsequent chapters, it is undeniably true that fi nan- cial reporting requirements have heavily infl uenced management accounting practice.
Managerial Accounting—Not Mandatory
Financial accounting is mandatory; that is, it must be done. Various outside parties such as the Securities and Exchange Commission (SEC) and the tax authorities require periodic fi nancial statements. Managerial accounting, on the other hand, is not mandatory. A company is completely free to do as much or as little as it wishes. No regulatory bodies or other outside agencies specify what is to be done, or, for that matter, whether anything is to be done at all. Since managerial accounting is completely optional, the important question is always, “Is the information useful?” rather than, “Is the information required?”
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Management must accomplish its objectives by working through people. Presidents of com- panies like Good Vibrations could not possibly execute all of their company’s strategies alone; they must rely on other people. This is done by creating an organizational structure that permits effective decentralization.
Decentralization
Decentralization is the delegation of decision-making authority throughout an organization by giving managers the authority to make decisions relating to their area of responsibility. Some organizations are more decentralized than others. Because of Good Vibrations’ geographic dispersion and the peculiarities of local markets, the company is highly decentralized.
Good Vibrations’ president (often synonymous with the term chief executive offi cer, or CEO) sets the broad strategy for the company and makes major strategic decisions such as opening stores in new markets; however, much of the remaining decision-making authority is delegated to managers at various levels throughout the organization. Each of the company’s numerous retail stores has a store manager as well as a separate manager for each music category such as international rock and classical/jazz. In addition, the company has support departments such as a central Purchasing Department and a Personnel Department.
The Functional View of Organizations
Exhibit 1–4 shows Good Vibrations’ organizational structure in the form of an organization chart. The purpose of an organization chart is to show how responsibility is divided among