The ultimate goal of accounting is to provide information that
is useful for decision-making. Users of accounting information are
generally divided into two categories: internal and external.
Internal users are those within an organization who use financial
information to make day-to-day decisions. Internal users include
managers and other employees who use financial information to
confirm past results and help make adjustments for future
activities.
External users are those outside of the organization who use the
financial information to make decisions or to evaluate an entity’s
performance. For example, investors, financial analysts, loan
officers, governmental auditors, such as IRS agents, and an
assortment of other stakeholders are classified as external users,
while still having an interest in an organization’s financial
information. (Stakeholders are addressed in greater detail in
Explain Why Accounting Is Important to Business
Stakeholders.)
Characteristics, Users, and Sources of Financial Accounting
Information
Organizations measure financial performance in monetary terms.
In the United States, the dollar is used as the standard
measurement basis. Measuring financial performance in monetary
terms allows managers to compare the organization’s performance to
previous periods, to expectations, and to other organizations or
industry standards.
Financial accounting is one of the broad categories in the study
of accounting. While some industries and types of organizations
have variations in how the financial information is prepared and
communicated, accountants generally use the same
methodologies—called accounting standards—to prepare the financial
information. You learn in
Introduction to Financial Statements that financial
information is primarily communicated through financial statements,
which include the Income Statement, Statement of Owner’s Equity,
Balance Sheet, and Statement of Cash Flows and Disclosures. These
financial statements ensure the information is consistent from
period to period and generally comparable between organizations.
The conventions also ensure that the information provided is both
reliable and relevant to the user.
Virtually every activity and event that occurs in a business has
an associated cost or value and is known as a
transaction. Part of an accountant’s
responsibility is to quantify these activities and events. In this
course you will learn about the many types of transactions that
occur within a business. You will also examine the effects of these
transactions, including their impact on the financial position of
the entity.
Accountants often use computerized accounting systems to record
and summarize the financial reports, which offer many benefits. The
primary benefit of a computerized accounting system is the
efficiency by which transactions can be recorded and summarized,
and financial reports prepared. In addition, computerized
accounting systems store data, which allows organizations to easily
extract historical financial information.
Common computerized accounting systems include QuickBooks, which
is designed for small organizations, and SAP, which is designed for
large and/or multinational organizations. QuickBooks is popular
with smaller, less complex entities. It is less expensive than more
sophisticated software packages, such as Oracle or SAP, and the
QuickBooks skills that accountants developed at previous employers
tend to be applicable to the needs of new employers, which can
reduce both training time and costs spent on acclimating new
employees to an employer’s software system. Also, being familiar
with a common software package such as QuickBooks helps provide
employment mobility when workers wish to reenter the job
market.
While QuickBooks has many advantages, once a company’s
operations reach a certain level of complexity, it will need a
basic software package or platform, such as Oracle or SAP, which is
then customized to meet the unique informational needs of the
entity.
Financial accounting information is mostly historical in nature,
although companies and other entities also incorporate estimates
into their accounting processes. For example, you will learn how to
use estimates to determine bad debt expenses or depreciation
expenses for assets that will be used over a multiyear lifetime.
That is, accountants prepare financial reports that summarize what
has already occurred in an organization. This information provides
what is called feedback value. The benefit of reporting what has
already occurred is the reliability of the information. Accountants
can, with a fair amount of confidence, accurately report the
financial performance of the organization related to past
activities. The feedback value offered by the accounting
information is particularly useful to internal users. That is,
reviewing how the organization performed in the past can help
managers and other employees make better decisions about and
adjustments to future activities.
Financial information has limitations, however, as a predictive
tool. Business involves a large amount of uncertainty, and
accountants cannot predict how the organization will perform in the
future. However, by observing historical financial information,
users of the information can detect patterns or trends that may be
useful for estimating the company’s future financial performance.
Collecting and analyzing a series of historical financial data is
useful to both internal and external users. For example, internal
users can use financial information as a predictive tool to assess
whether the long-term financial performance of the organization
aligns with its long-term strategic goals.
External users also use the historical pattern of an
organization’s financial performance as a predictive tool. For
example, when deciding whether to loan money to an organization, a
bank may require a certain number of years of financial statements
and other financial information from the organization. The bank
will assess the historical performance in order to make an informed
decision about the organization’s ability to repay the loan and
interest (the cost of borrowing money). Similarly, a potential
investor may look at a business’s past financial performance in
order to assess whether or not to invest money in the company. In
this scenario, the investor wants to know if the organization will
provide a sufficient and consistent return on the investment. In
these scenarios, the financial information provides value to the
process of allocating scarce resources (money). If potential
lenders and investors determine the organization is a worthwhile
investment, money will be provided, and, if all goes well, those
funds will be used by the organization to generate additional value
at a rate greater than the alternate uses of the money.
Characteristics, Users, and Sources of Managerial Accounting
Information
As you’ve learned, managerial accounting information is
different from financial accounting information in several
respects. Accountants use formal accounting standards in financial
accounting. These accounting standards are referred to as
generally accepted accounting principles (GAAP)
and are the common set of rules, standards, and procedures that
publicly traded companies must follow when composing their
financial statements. The previously mentioned Financial
Accounting Standards Board (FASB), an independent,
nonprofit organization that sets financial accounting and reporting
standards for both public and private sector businesses in the
United States, uses the GAAP guidelines as its foundation for its
system of accepted accounting methods and practices, reports, and
other documents.
Since most managerial accounting activities are conducted for
internal uses and applications, managerial accounting is not
prepared using a comprehensive, prescribed set of conventions
similar to those required by financial accounting. This is because
managerial accountants provide managerial accounting information
that is intended to serve the needs of internal, rather than
external, users. In fact, managerial accounting information is
rarely shared with those outside of the organization. Since the
information often includes strategic or competitive decisions,
managerial accounting information is often closely protected. The
business environment is constantly changing, and managers and
decision makers within organizations need a variety of information
in order to view or assess issues from multiple perspectives.
Accountants must be adaptable and flexible in their ability to
generate the necessary information management decision-making. For
example, information derived from a computerized accounting system
is often the starting point for obtaining managerial accounting
information. But accountants must also be able to extract
information from other sources (internal and external) and analyze
the data using mathematical, formula-driven software (such as
Microsoft Excel).
Management accounting information as a term encompasses many
activities within an organization. Preparing a budget, for example,
allows an organization to estimate the financial performance for
the upcoming year or years and plan for adjustments to scale
operations according to the projections. Accountants often lead the
budgeting process by gathering information from internal (estimates
from the sales and engineering departments, for example) and
external (trade groups and economic forecasts, for example)
sources. These data are then compiled and presented to decision
makers within the organization.
Examples of other decisions that require management accounting
information include whether an organization should repair or
replace equipment, make products internally or purchase the items
from outside vendors, and hire additional workers or use
automation.
As you have learned, management accounting information uses both
financial and nonfinancial information. This is important because
there are situations in which a purely financial analysis might
lead to one decision, while considering nonfinancial information
might lead to a different decision. For example, suppose a
financial analysis indicates that a particular product is
unprofitable and should no longer be offered by a company. If the
company fails to consider that customers also purchase a
complementary good (you might recall that term from your study of
economics), the company may be making the wrong decision. For
example, assume that you have a company that produces and sells
both computer printers and the replacement ink cartridges. If the
company decided to eliminate the printers, then it would also lose
the cartridge sales. In the past, in some cases, the elimination of
one component, such as printers, led to customers switching to a
different producer for its computers and other peripheral hardware.
In the end, an organization needs to consider both the financial
and nonfinancial aspects of a decision, and sometimes the effects
are not intuitively obvious at the time of the decision.
Figure 1.3 offers an overview of some of the differences
between financial and managerial accounting.
Figure 1.3 Comparing Reports between Financial and
Managerial Accounting. (attribution: Copyright Rice University,
OpenStax, under CC BY-NC-SA 4.0 license)