The very objective of accounting is to provide accurate, reliable and timely financial information to the various stakeholders of the business.The intent is to enable the users of accounting information to interpret the results of business operations, ascertain its financial position, solvency and undertake rational decision making.
Before going any further, it is essential to know who these entities are and why do they need accounting information of the business?[/vc_column_text]
Users of of Accounting
The financial information of the company is required by its various stakeholders which include:
- internal users – such as accounting managers, owners and employees
- external users – such as creditors and lenders, investors, suppliers, government agencies, tax authorities etc.
Owners use financial statements to understand the overall performance of their business. They are keen on ascertaining the profitability, the amount of risk involved and understanding the impact of the changing economic factors on their business.
Likewise, managers need accounting information to strategize, control and take informed decisions for their respective divisions . They need to project sales and expenses to come with projections for the future periods and thus ensure that the available resources are allocated appropriately via budgeting.
Similarly, creditors and lenders are keen on understanding the credibility and financial soundness of the company they are lending to. They are interested to know if the company would be able to pay back the credit by evaluating its liquidity and overall profitability. On the other hand, investors require financial information to evaluate their decision of investing in the business.
Thus, considering the variety of purposes for which accounting information is needed by various entities, there exist different branches of accounting.
This article talks in detail about the various branches or types of accounting and their significance.
Branches of Accounting
1. Financial Accounting
Financial accounting is a branch of accounting that deals with the process of recording, summarizing and reporting of the entity’s financial transactions. The objective is to record, prepare and present financial information systematically to be able to ascertain the financial results of the entity for a given accounting period.
Thus, financial accounting involves the reporting of accurate, reliable and timely information of the entity’s operating profit and financial position to its various stakeholders.
Further, these financial reports or statements are prepared as per the standard format and accounting principles specific to the region or country in which the entity is located. The accounting principles that an entity adheres to while preparing its financial statements depends upon the regulatory and reporting requirements of the area/country or the target market it deals with.
This is to bring uniformity across the financial statements of entities of the specific region/country and undertake inter company comparisons easily.
For instance, companies in India follow Indian Accounting standards. Whereas companies in the US adhere to Generally Accepted Accounting Principles (GAAP).
Financial Statements Prepared in Financial Accounting
As mentioned above, financial information is reported to the users of accounting information with the help of financial statements. These majorly include:
- income statement – highlights the results of your entity’s operations and reasons for its profitability or losses
- balance sheet – depicts the financial position of the entity, that is, what it owns and owes to third parties on a specified date
- cash flow statement – shows cash inflows and outflows of an entity at a specific date
shareholder’s equity – depicts the changes in the value of the shareholder’s equity
Also, these financial statements depict five major facets of the financial information of a business entity. These include:
2. Cost Accounting
Cost accounting is a branch of accounting that deals with:
- the process of accounting for costs and classifying expenses to ascertain total cost of a product/service with accuracy
- and presenting such data for managerial decision making
It involves the use of various costing techniques, principles and standards that help business entities to develop budget to control costs and be cost effective.
Commonly used cost accounting techniques include:
A costing technique where costs are categorized as fixed and variable cost. Furthermore, the cost of producing additional outputs is calculated and the impact of changes in volume or type of such additional output on profit is analysed.
It involves preparing budgets and comparing actual performance with budgetary performance to achieve the targets.
It involves setting standard costs and comparing them with the actual cost. Furthermore, the differences between the standard and actual costs are analysed which involves finding the underlying causes and their impact.
It involves using the same costing principles and methods by a number of businesses under the common management. The idea is to allow for greater comparability between the costs ascertained by various businesses.
As mentioned above, the Cost Accounting Standards Board (CASB) have formulated certain cost accounting standards to be adopted by organizations so as to bring uniformity in cost measurement, classification and assignment.
Further, cost accounting involves classifying costs associated with the production of goods or services. This is undertaken based on various factors such as nature of expenses, its relation to a cost unit or cost centre, different functions of the business entity, cost behavior etc.
Accordingly, these can be classified based on the:
- nature of expenses – material, labour and overhead costs
- relation to cost centre or unit – direct and indirect costs
- functions of the business entity – production, administration, research and development, selling and distribution
- cost behavior – fixed and variable cost
- costs needed for managerial decision – opportunity cost, marginal cost, differential cost, sunk cost etc
- nature of production or process – process cost, batch cost, operating cost etc
time – historical cost etc
3. Management Accounting
Management accounting came into existence subsequent to financial and cost accounting. As the name suggests, it is a branch of accounting that associates management of an organization with accounting.
Thus, any information that is necessary for managerial decision-making forms part of management accounting. This information is ultimately provided to the management by the other two branches – financial and cost accounting.
In other words, management accounting gathers financial and cost accounting information and provides the same to people at various levels in managerial hierarchy. This further enables the managers in undertaking managerial functions like planning, controlling, decision making etc and evaluating the performance of each these managerial functions.
Thus, management accounting can be defined as the use of relevant techniques and concepts:
- for processing historical and projected economic data of a business entity by the management
- using such analysis to set reasonable objectives and
- take rational decisions to achieve such objectives
Needless to say, management accounting is, therefore, undertaken to:
- plan and set objectives
- analyse the available financial information
- help people at managerial level to undertake effective decision making
- exercise control with the help of various management accounting tools like budgetary control
Furthermore, management accountants use various techniques to undertake management accounting effectively. These include:
Financial Statement Analysis
This is a technique that helps in evaluating the financial data provided by the financial statements of the company. Various tools of financial statements include common size statement analysis, comparative statement analysis, ratio and cash flow analysis etc.
This involves deciding beforehand the financial engagements necessary for a company to achieve its goals. Therefore, it requires the management to formulate policies in respect of working capital needs, sources of funds, utilization of funds etc.
Tools like budgetary control and standard costing are used to confirm that planned performance translates into actual performance.