Skills to Develop
- Compare characteristics of financial and managerial accounting
Question: The issue facing the president at Sportswear is a common one. Companies prefer not to disclose more information than is required by U.S. GAAP, but they would like to have more detailed information for internal decision-making and performance-evaluation purposes. This is why it is important to distinguish between financial and managerial accounting. What is the difference between information prepared by financial accountants and information prepared by managerial accountants?
Financial accounting1 focuses on providing historical financial information to external users. External users are those outside the company, including owners (e.g., shareholders) and creditors (e.g., banks or bondholders). Financial accountants reporting to external users are required to follow U.S. Generally Accepted Accounting Principles (U.S. GAAP)2, a set of accounting rules that requires consistency in recording and reporting financial information. This information typically summarizes overall company results and does not provide detailed information.
Managerial accounting3 focuses on internal users—executives, product managers, sales managers, and any other personnel within the organization who use accounting information to make important decisions. Managerial accounting information need not conform with U.S. GAAP. In fact, conformance with U.S. GAAP may be a deterrent to getting useful information for internal decision-making purposes. For example, when establishing an inventory cost for one or more units of product (each jersey or hat produced at Sportswear Company), U.S. GAAP requires that production overhead costs, such as factory rent and factory utility costs, be included. However, for internal decision-making purposes, it might make more sense to include nonproduction costs that are directly linked to the product, such as sales commissions or administrative costs.
Question: It’s clear that financial accounting focuses on reporting to outside users while managerial accounting focuses on reporting to inside users. What specific characteristics would we expect to see in managerial accounting information?
Managerial accounting often focuses on making future projections for segments of a company. Suppose Sportswear Company is considering introducing a new line of coffee mugs with team logos on each mug. Management would certainly need detailed financial projections for sales, costs, and the resulting profits (or losses). Although historical financial accounting data from other product lines would be useful, preparing projections for the new line of mugs would be a managerial accounting function.
Another characteristic of managerial accounting data is its high level of detail. As noted in the opening dialogue between the president and accountant at Sportswear Company, the financial information in the annual report provides a general overview of the company’s financial results but does not provide any detailed information about each product. Information, such as product profitability, would come from the managerial accounting function.
Finally, managerial accounting information often takes the form of nonfinancial measures. For example, Sportswear Company might measure the percentage of defective products produced or the percentage of on-time deliveries to customers. This kind of nonfinancial information comes from the managerial accounting function.
Table 1.1 summarizes the characteristics of both managerial and financial accounting.
|Managerial Accounting||Financial Accounting|
|Users||Inside the organization||Outside the organization|
|Accounting rules||None||U.S. Generally Accepted Accounting Principles (U.S. GAAP)|
|Time horizon||Future projections (sometimes historical if in detail)||Historical information|
|Level of detail||Often presents segments of an organization (e.g., products, divisions, departments)||Presents overall company information in accordance with U.S. GAAP|
|Performance measures||Financial and nonfinancial||Primarily financial|
Follow-Up at Sportswear Company
Question: What did the president at Sportswear Company learn about product profitability from the information provided by the managerial accountant?
The president at Sportswear, Dana Matthews, learned that the hats product line was much more profitable than expected, accounting for 55 percent of the company’s profits even though initial estimates were that the hat segment would account for 40 percent of company profits. Conversely, the jerseys product line was much less profitable than expected, accounting for 45 percent of the company’s profits.
There are many issues associated with determining product profitability, including how to allocate costs that are not easily traced to each product and whether the product revenue and cost information is accurate enough to make important managerial decisions. These important issues will be addressed throughout the book.
Financial accounting provides historical financial information for external users in accordance with U.S. GAAP. Managerial accounting provides detailed financial and nonfinancial information for internal users who use the information for decision making, planning, and control purposes.
Review problem 1.1
- Suppose you are the co-owner and manager of a retail store that sells and repairs mountain bikes. Provide one example of a financial accounting report that would be useful to you and your co-owner. Provide two examples of managerial accounting reports that would be useful to you as the manager.
- Provide two examples of nonfinancial measures used by a pizza eatery that serves food in the restaurant and offers delivery services.
- For each report listed in the following, indicate whether it relates to financial or managerial accounting. Explain the reasoning behind your answer for each item.
- Projected net income for next quarter by division
- Defective goods produced as a percentage of all goods produced
- Income statement for the most current year, prepared in accordance with U.S. GAAP
- Monthly sales broken down by geographic region
- Production department budget for the next quarter
- Balance sheet at the end of the current year, prepared in accordance with U.S. GAAP
- Financial accounting reports provided to owners typically include the income statement, statement of owners’ equity, balance sheet, and statement of cash flows. All are prepared in accordance with U.S. GAAP. Managerial accounting reports prepared for managers might include a quarterly budget for revenues and expenses for each segment of the business (e.g., bike sales and bike repairs), returns for defective merchandise as a percent of total monthly sales, income projections to be used in deciding whether to open a new store, and projected sales for each bike model. (There are many correct answers to this problem. Use Table 1.1 as a guide in determining the accuracy of your answer.)
- Examples of nonfinancial measures include percentage of on-time deliveries, percentage of burned pizzas, average time required to prepare pizza for restaurant customers (from taking a customer’s order to providing the pizza at the customer’s table), and results of customer satisfaction surveys. (These are just a few examples. There are many correct answers to this problem.)
- The answers appear as follows. Be sure you explained your answers.
- Managerial accounting—information is for future projections and involves segments of the company
- Managerial accounting—nonfinancial detailed measure of defective products 3. Financial accounting—historical information prepared in accordance with U.S. GAAP
- Managerial accounting—detailed information provided monthly
- Managerial accounting—information is for future projections and involves a segment of the company
- Financial accounting—historical information prepared in accordance with U.S. GAAP
- Provides historical financial information to external users.
- A set of accounting rules that must be followed to provide consistency in reporting financial information to external users.
- Focuses on internal users, including executives, product managers, sales managers, and any other personnel in the organization who use accounting information for decision making.