Accounting and its types

This short series tries to show that the concept of accounting is much broader than most people think. It briefly describes the basic branches of accounting, especially financial and managerial accounting.

This series is freely followed by series Cost accounting.

Branches of accounting

Term accounting is not the same as financial accounting. It is a broader term that includes a number of branches. The branches differ mainly in the information it supplies and for whom it is intended:

• Financial accounting - for example IFRS and US GAAP
• Management accounting
• Tax accounting
• Government accounting
• Project accounting etc.

Financial accounting

The purpose of financial accounting is to present true and fair information about financial position, financial performance and cash-flow of the entity for the external stakeholders such as shareholders, investors, creditors or government. Financial accounting looks mainly into the history and is (mostly) maintained mandatorily.

Financial accounting can be governed either by generally accepted accounting standards (GAAP such as IFRS or US GAAP) or national law. 

Management (managerial) accounting

Management accounting provides information for decision-making and as such it looks mainly into the future and is prepared for internal use, mainly for managers of the entity.  Management accounting uses data from financial accounting, but also from other internal and external sources. There is no requirement to keep management accounting records.  Management accounts do not necessarily be in the form of statement of financial position, financial performance and cash-flow. It may contain only a set of analyses e.g. of products, segments, geographic locations etc.

Organisation of financial and management accounting

Almost any company is required to maintain financial accounting records for the purpose of financial reporting. Management accounting is voluntary and depends on whether management requires it. If the entity maintains management accounts as well, the accounting system can be organized as:

• One ledger system - only the financial accounting is used for decision making or financial accounting shows more details to satisfy managers as well.

• Double (or more) ledger systems – two or more accounting systems are maintained separately. It is more difficult and the entity can have two (or more) sets of profit or balance sheet figures then. But multiple ledger systems provide better information for decision-making and it better fits the information needs of different users. It is advisable to prepare a regular reconciliation of the differences between the two (or more) ledgers. This can be fulfilled by having the systems linked by control accounts.

Cost accounting

Cost accounting is a set of management accounting methods, techniques and procedures used mainly to determine actual or planned costs of cost objects (cost center, product, cost unit, department, process, activity).

Cost accounting is not an exact discipline.  It involves a set of well tried-out methods or techniques, but very important in its application is also common sense.

Purpose of cost accounting

• Facilitate decision making
  • Analyze product profitability – help mainly determine which products are profitable and which are not.
  • Cost-plus pricing - setting appropriate price based on costs. It is one of the methods how to set up the selling price of the product. But this approach lacks commercial approach as the price based only on costs may not be competitive.

• Control over the costs
  • Cost analysis is the starting point for cost reductions and optimization programs
  • It is used in budget and forecast preparations and as the result, it can warn management about the costs spent above budget. 

• Valuation of the inventory and cost of goods sold – help determine:
  • which costs shall be included to the value of inventory (or costs of goods sold) and which shall be booked immediately to statement of profit and loss as period costs
  • to which cost objects shall the costs be allocated
  • the methodology for cost allocation and apportionment