What is the Management and financial accounting?

it is clear that accounting information has a number of different purposes, governed by the needs of those using it. This brings us to consider different types of accounting, namely financial accounting and management accounting, as the purposes fulfilled by accounting information generally fall under one or the other heading. It is important to note that this does not mean that any different types of books or records need to be kept. It is just that the information produced from the books and records organises, classifies, summarises and communicates information according to the perspectives and needs of the users, as Table 1 below shows. Table 1 Differences between financial and management accounting Financial accounting Management accounting Chief purpose Production of summarised income statements and balance sheets by managers as a formal report on the stewardship of resources entrusted to them but should also, in the case of public companies, help interested parties (such as investors) make decisions. Depending on the type of the business entity, documents may be publicly available. Production of detailed and up to date information used by managers to plan activities and control them. This information is not publicly available, but is internal to the entity producing it. When information is prepared Annually, at the end of an accounting period, but, depending on the type of business entity, may be every three or six months as well. Normally prepared on a monthly basis. Governed by Legal requirements and often mandatory accounting regulations* and/or conventions which may also dictate a required format (though this depends on the legal form of an entity). Management needs only – with no legal requirement to produce anything in any format, or anything at all. Information is produced in the format management deems most useful, e.g., by operating unit or product line, to record and monitor sales (by product, region, etc.), costs of production methods or products. Perspective Gives information about past performance, and might in practice be outdated by the time summarised documents are produced. Comparative and up to date. While a given month’s results are provided, these are usually accompanied by a total for all months to date and comparative figures for a prior year (as well as for planned activities in the month and period to date). The main elements of accounting information- you that results of all business transactions over a period of time need to be summarised, presented and interpreted in order to assess a business’s performance and its financial position at a given date, in the form of an income statement and balance sheet. It was emphasised in Section 3 that the presentation of financial accounting information is governed by a combination of legal requirements and accounting regulations and conventions. Different types of business entities are governed by different requirements. However, one of the rationales underlying the preparation of income statements and balance sheets is to turn raw financial data into useful information, and this is achieved in part by organising, classifying and presenting data in particular ways to make them meaningful. Here we shall look at some conventional ways of doing this. Income and expenses-
An income statement is a summarised financial statement which shows how well or badly a business is faring. An example of an income statement is shown in Figure 3. This is an income statement for a hypothetical sole trader (here called Mr Schmidt).Sales 40,000 Less: Cost of goods sold Opening inventory 14,000 Purchases Total22,000 36,000 Less: Closing inventory Total(12,000) Total(24,000) Gross profit 16,000 Less: Expenses Rent 3,000 Lighting and heating expenses 2,800 General expenses Total800 Total(6,600) Net profit Total9,400 Figure 3 Example of an income statement As its name suggests, an ‘income statement’ includes all the income generated by a business in its accounting period. This is usually derived from the sales of its products and services, which are first listed from individual accounts on to the trial balance and then added up together. Income derived from sales may be referred to by a number of different terms, such as turnover or sales (sometimes sales turnover ), sales revenue or just revenue . However, income may be derived from other sources, and the source may be denoted in the terminology used to describe it. If a business derives income from a bank account in the form of bank interest, for example, this too will be included in the income statement. It will be shown separately from income arising from sales and will be called ‘bank interest receivable’ or something similar. However, perhaps rather unhelpfully for persons learning about accounting for the first time, ‘revenue’ can also be used as a general term to mean any sort of income, and if so used, could include ‘bank interest’ as well. There is no hard and fast rule about how the terms ‘income’ or ‘revenue’ are used. They are both very common terms, and you will see both used in this course. In acquiring or making products for sale, or delivering services to customers, however, a business will have laid out some of its own resources (most commonly, money). For example, if a business makes a product, it will need to buy in raw materials, pay wages to employees making the product, and pay for electricity (for example) used in the manufacturing process. Likewise all such items are listed from individual accounts on to the trial balance and then added up together, with like items grouped together. For example, raw materials will be added together, as will energy items, wages, etc. The term costs or expenses is often used here to denote these types of items. Some accounting textbooks differentiate between these terms, but you will find them used interchangeably without distinction of meaning, and we do not differentiate between them in this course. Often terms used in accounting are also used in every day life with no reference to their financial meanings and this contributes to the overall lack of precision. For example, it is common to speak of someone ‘paying the price’ for something, such as committing a misdemeanour. An income statement shows the total costs subtracted/deducted from total income. If there is an excess of total income over total costs, this is referred to as a profit (sometimes called a surplus , if the entity, like a charity, does not have a profit motive). If total costs exceed total income, then a loss or deficit (the latter is often used by non-profit-making entities) is said to arise – hence the alternative name for an income statement of ‘profit and loss account’. By organising, classifying and presenting income and expenses in this way, the income statement makes them into meaningful information because by calculating a profit or loss it becomes possible to determine how well or poorly a business is performing. You will see that Mr Schmidt has separated his costs into those that relate to items that he has sold and the rest, and it shows two different kinds of profit. You will learn all about this later in this course, so do not worry if there are things here that you do not understand. Note also that the accounting convention used here puts figures to be deducted in round brackets. This is widely used, especially in the UK, but you should be aware that not every country uses it.