Financial Versus Managerial Accounting

In financial accounting, accounting information for a period is collected and simply

reported on the financial statements. Financial accounting focuses on reporting the

firm's historical results for use by external users (bankers, suppliers, and other

creditors—governmental agencies, the IRS, potential investors, and current

shareholders). Financial statements are prepared following a detailed set of guidelines

so all the firm's statements are prepared consistently—period-to-period and among

firms in different industries—so stakeholders can make meaningful comparisons.

Managerial accounting is the collection, collation, and analysis of useful information

for a firm's internal users: its managers and supervisors. The purpose is to reach

conclusions so internal decisions can be made about how to better manage the

company. Because this information is for internal use, there are no strict rules on how

the data are collated or collected nor what kinds of reports result. Instead, they can be

customized to the internal user's needs. Managerial accounting includes the following:

creating annual budgets

comparing actual results to budgeted results, determining the cause of the

differences, taking corrective actions

analyzing investment opportunities; determining which are better investments

(a building expansion, machine replacement, new marketing program, or major

safety upgrade)

Financial Accounting Managerial Accounting

Reports are for external users: owners,

lenders, regulators, IRS

Reports for internal users to assist in

planning, directing, and controlling

performance evaluation

Emphasizes financial consequences of past

activities

Emphasizes decisions affecting the future

Emphasizes objectivity and verifiability Emphasizes relevance

Emphasizes precision Emphasizes timeliness

Emphasizes summary data concerning the

entire organization

Emphasizes detailed segment reports about

different departments

Must follow GAAP Need not follow GAAP

Mandatory for external reports Not mandatory

(Garrison, Noreen, & Brewer, 2008)

Ethical Ramifications

Legal and accounting professionals must abide by certain fiduciary responsibilities:

They must always act in the best interests of their client not for their own personal

benefit. Although this seems clear, there are differences between what is legally

required and what is considered ethical.

Two scandals in the early 2000s were examples of unethical behavior by firms’ senior

executives. Incorrect treatment of accounting data lead to incorrect financial

statements, leading to incorrect value of the company's stock. Some executives

benefited personally by selling personal stock at these artificially inflated prices, a

clear violation of the executive's legal fiduciary responsibility. However, other legal

management actions may still be considered unethical.

Example #1

Near the year-end, senior managers whose bonuses are calculated based on reported

profitability may realize their profits may not be high enough to warrant significant

bonuses. Although it is legal for managers to delay various fourth-quarter discretionary

expenses, thus raising reported profits and increasing their likely bonus, it may not be

ethical.

If a marketing manager delayed or canceled some planned advertising, profits

would increase, but this would negatively impact the awareness of the

company’s products, hurting the company in the long term and hurting

shareholder value (stock price and dividends).

If a maintenance manager postponed or cancelled some planned preventive

maintenance, near-term costs would lessen, increasing that period's profits but

likely causing higher long-term costs if the equipment broke down or had an

extended period of major repairs.

Example #2

Sometimes, manufacturing managers overproduce their products not because they

anticipate higher sales but simply because that can inflate reported profits. If using

absorptive accounting, making more units than are being sold can push fixed costs into

inventory value, decreasing the amount of fixed costs on the firm's income statement,

and making profits look better than reality. This is legal but clearly unethical because it

distorts real profitability.

Return on Investment (ROI)

Certain executive bonus plans are based on the firm's overall return on investment

(ROI). Because of this, some executive teams may reject implementing projects that

have a lower short-term ROI (negatively affecting their bonuses) even though it will

benefit the firm’s and stockholders’ long-term ROI.

Reference

Garrison, R. H., Noreen, E., & Brewer, P. C. (2008). Managerial accounting (12th

ed.). New York: McGraw-Hill.