Accounting can be segregated into two types – financial and managerial. The two have a lot in common, but their main differences lie in the fact that they have different audiences. Financial accounting is directed to users outside the firm – investors, creditors, suppliers and regulators. Publicly traded companies generally want this information to be widely circulated and easily obtained. Without available information, investors are not going to invest their funds, creditors will not make loans and suppliers will not provide much needed credit. Furthermore, the Securities Exchange Commission (SEC) requires this information to be published. To see just how easily available this information is, do a quick Google search. Type the name of the publicly traded company in which you are interested along with “financial statements.” You will instantly get their entire audited financial statements.
Managerial accounting, as the name implies, addresses the needs of management. The information needs of management are decidedly different than the needs of outside investors. Furthermore, this information is proprietary. Most companies don’t want you or their competitors to know such things as their variable costs per unit, their breakeven point for different products, or their manufacturing overhead rates.
Financial accounting is regulated by the SEC and the Financial Accounting Standards Board (FASB). Together, they establish the rules for financial accounting. These rules are the so-called “Generally Accepted Accounting Principles”. Other organizations such as the American Institute of Certified Public Accountants (AICPA), the Institute of Management Accountants (IMA) and the American Accounting Association (A.A.A.) play a lesser role in establishing accounting principles, but the FASB and the SEC are the primary forces in the establishment of G.A.A.P.
It’s important for firms to follow G.A.A.P for external reporting. To enable you, as a potential investor, to choose between investing in two or more different companies, the companies must all follow the same rules for measuring revenues, expenses, assets and liabilities. Otherwise, you will have no basis for comparing their respective performances. It would be like comparing apples and oranges – or perhaps big apples and little apples. “Good” financial accounting, therefore, is that which consistently follows common rules laid forth by these two organizations.
Managerial accounting on the other hand is not regulated. A management accountant might say, “Rules? What rules? We don’t need rules.” And he or she would be right. The sine qua non of managerial accounting is simple: does it provide managers with the information they need to plan, organize, control and make good decisions? If it does, it’s good. If it doesn’t, it isn’t. It’s that simple. A well-designed accounting system provides good information, and good information leads to good decisions.
A common set of rules for management accounting, unlike financial accounting, doesn’t make sense. Why so? The management of different types of companies have very different needs when it comes to information. The manager in a manufacturing firm will need different types of information than the manager in a department store, who in turn will need different information than a bank manager, and so on.