The difference between financial and managerial accounting

The difference between financial and managerial accounting can often cause confusion with people as they try and build business acumen for themselves.

Let’s first look at why there are differences between the two. It’s mainly to do with who the user is. Financial accounting is presented primarily for external users such as shareholders, debt investors and government entities. Yes, internal users utilize financial accounting reports but their primary purpose is for people outside of the business. Conversely, management accounting is presented exclusively for the internal user — that’s why its called “management” accounting.

Did you catch in the above paragraph, that whereas management accounting is used exclusively by the managers, financial accounting is used primarily by external users but can also be used by the managers of the business? This is why financial accounting is often referred to as “public” accounting and management accounting often referred to as “private”.

The primary purpose of financial accounting is to report on past performance whereas management accounting is prepared to influence future performance. For example, a financial accountant would present the income statement to investors whereas a management accountant may present information on the productivity of a factory; a retail store or a group of employees (i.e. in a call center), as a basis for discussion with managers as to how the productivity might be improved.

So let’s look at some of the other specific differences between the two. Financial accounting is prepared according to GAAP (Generally Accepted Accounting Principles) whereas management accounting doesn’t have to be prepared according to GAAP. Financial accounting is objective whereas management accounting can be subjective as well as objective. Financial accounting is presented on the entirety of the organization’s performance whereas management accounting can be presented on the whole or just part of the business.

Here are a couple of examples to hopefully provide some clarity on these differences:

Example 1 – a management accountant may be asked to provide a report comparing the performance all of the retail stores of the business in the Western territory (e.g. sales, expenses and inventory turnover etc). A financial accountant would prepare information according to the entirety of the business.

Example 2 – a financial accountant will prepare a calculation of earnings per share (EPS) for a publicly-traded company at the bottom of the company’s income statement. Conversely a management accountant may use this information in some internal management report and may do some internal calculation that compares performance of the EPS to similar companies in similar industries over time.

Some of the language and the treatment of certain items within financial accounting is different to management accounting and hence the confusion is compounded. For example, in financial accounting the cost of goods sold would never include labor whereas in management accounting the cost of labor is built into the cost of goods sold.

Some of the ways, items are described are different between the two which adds to the confusion. For example in management accounting we will refer to “direct labor” and “direct materials” which are the two prime costs used up by the business to deliver the product to the customer. So in Starbucks, the management accountants are able to report on the costs that are traceable to the sale of the product. This can be very useful information for management. So if sales were $100,000 for the day, what was the cost of the labor to produce those sales and what was the cost of the product consumed by the customer (and therefore taken from the store’s inventory) that day? Financial accounting wouldn’t present store by store information on a daily basis like this and would only present the income statement (according to GAPP) for the quarter or year.

Can you see in the example above how the report provided by management accountants is able to influence management decision by store, by shift, by hour whereas the financial accounting reports for the whole of the company for say a year is just too big and too general for the individual store manager or regional manager to use to influence how we do things tomorrow?

The similarities are mainly to do with the translation of language. So in financial accounting our cost of goods sold is just the inventory that was given up to fulfill the customer order if the business is a merchandising or retail business. In management accounting we don’t use the phrase “cost of goods sold” as we will call it “direct materials” and add to it “direct labor” being the cost of the labor that produced the product. Both management and financial accounting will report “income from operations” which is essentially the profit at the operational level before deducting all the related expenses at the headquarters. The costs at the headquarters are often referred to as SG&A (selling, general and administrative expenses) — basically the overhead, whereas in management accounting these are referred to as “period costs.”

In summary, I’ve found that many leaders get confusion between the two types of reporting.

The three key differences are:

• The User — management accounting focuses on the internal user whereas management accounting focuses on the external user

• The Purpose — management accounting is trying to influence management behavior whereas financial accounting is trying to influence investor behavior

• The Whole or the Part — whereas financial accounting reports on the whole of the business, management accounting can report on the whole, but most commonly just one part of the business

I hope this has helped clarify the similarities and differences between the two types of reporting methodologies in business.

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