Taking a closer look at the different branches of accounting is the proper first step to gain a better understanding of the organizational and procedural integration of management accounting in an enterprise. Management accounting is one part of the overall accounting discipline; other areas comprise financial accounting, auditing, and tax accounting.
While these separate fields of accounting overlap in certain cases and are closely intertwined, it does not harm to distinguish among them—especially because typical job descriptions and fields of work in accounting usually position themselves around such a distinction.
Divisions of accounting
Auditing comes along with a disciplined and systematic approach to evaluating a specific subject matter within the organization, e.g., departments, divisions, processes, procedures, statutory records or other documents. It can be divided into external and internal auditing. An external auditor is an independent third party engaged by the company to be audited, while an internal auditor is employed by the firm he/she audits.
The task of an external auditor is mostly to examine the organization’s financial statements, which depict the financial situation of the company and its operational performance in the previous year. He/she checks whether these statements represent a true and fair view (free of material misstatements) as required by the law, and have been prepared in conformity with the generally accepted accounting principles. Finally, he/she expresses an opinion/judgment through an audit report.
However, there are also other areas to be audited to ensure accurate preparation or execution, and that they are free of material misstatement—whether due to fraud or internal errors. A few of these areas are project management procedures, risk management systems and internal controls, quality management, information systems, and general compliance. An audit, for instance, gives the organization a chance to improve the effectiveness, reliability, and integrity of operations and to diminish (potential) sources of error in the area audited.
B. Financial Accounting
Financial accounting focuses on providing information to external parties like banks, investors, customers, or suppliers. Therefore, it periodically issues financial statements, which reflect the organization’s financial position and operational performance during the previous year. Usually, these statements comprise the statement of financial condition (balance sheet), the profit and loss statement (P&L), as well as the statement of cash flows.
The fact that those financial statements pertain to the previous fiscal year also indicates that financial accounting essentially deals with historical data (already accrued transactions), adding relatively low value to future-oriented management decisions. Normally, you won’t find a financial accountant participating in strategic business planning.
The preparation of financial statements is not only a legal requirement but also necessary to raise money for most companies. In addition to business plans, etc., such statements play a vital role in credit approval processes. To ensure integrity, transparency, and trust, publicly traded companies or enterprises exceeding specific size-related criteria usually have to comply with a set of specific accounting principles: the core set referred to as Generally Accepted Accounting Principles (GAAP). Financial statements issued outside the organization have to adopt these standards or practices while being prepared and standardized.
Eventually, GAAP helps investors or creditors compare the financial results of differing enterprises, branches or market areas better. All companies in a country adhere to an identical set of accounting guidelines. This means that the financial information provided is characterized by accuracy, consistency, and comparability on a year-to-year basis.
Apart from country-specific GAAP, the International Accounting Standards Board (IASB) issues the International Financial Reporting Standards (IFRS) as subsequent guidelines to the formerly released International Accounting Standards (IAS). In the meantime, many countries require the financial statements of publicly-traded companies to be prepared in accordance with IAS/IFRS.
If you want to describe the difference between GAAP and IFRS in brief, you could use the terms “rules” and “principles.” GAAP is more or less based on obligatory guidelines or rules—those made for specific cases. The IFRS tend to be principle-based and pursue the goal of providing useful information, eventually leaving companies with larger room for the interpretation and implementation of those standards in business practice.
C. Tax Accounting
Contrary to financial accounting, the purpose of tax accounting is based on taxes rather than on presenting the entire financial position of the company to its stakeholders.
While financial accounting seeks conformity with issued accounting principles like GAAP, which aim to represent the company’s financial situation properly, tax accounting is largely based on the laws enacted through a politico-legislative procedure. It’s not absolutely abnormal for tax rules to differ from generally accepted accounting principles. For example, while simultaneously preparing the tax payables and the financial statement, the relevant balance sheet items can be accounted for variously.
Financial accounting usually takes a closer look at all the financial transactions of the accounting year. Instead, tax accounting only comprises the transactions that are relevant to the proper calculation of the organization’s tax burden and the conforming preparation of the tax documents.
Due to the great complexity the task often involves, the duties of tax calculation in larger companies—with the goals of minimizing tax payments, optimizing tax cash flows, and acting in conformity with the law—are often performed by specialized tax accountants and not the financial accounting department.
D. Management Accounting
As an essential contrast to financial accounting, management accounting does not focus on external information recipients but on “internal customers,” i.e. within the enterprise. It is aimed at supporting internal specialists and executive staff in decision-making, eventually leading to an achievement of the organization’s goals—or to budget and perform better in general.
To provide useful information or data to the management, it might be necessary for a management accountant to pass through several process stages: identifying information, measuring and analyzing it, interpreting it, and eventually, communicating it.
Management accountants might not simply assist decision-makers. Because of the widely-shaped field of tasks, he/she can also be seen as a risk, liquidity and investment manager, a budgeter, a cost accountant, a performance analyst, a business process designer, a controller, planner, and strategist.
Read on: The article “What is management accounting?” defines management accounting in more detail and gives greater insight into the typical tasks of a management accountant.
What Is Management Accounting & Why Do You Need It?
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Must-read blog posts about management accounting and financial control—classical topics, as well as modern subjects, latest trends, and current challenges in the management accounting discipline. Aimed to inform, inspire, and entertain management accountants and anyone with a deeper interest in management accounting.