Financial accounting

Financial accounting is the field of accountancy concerned with the preparation of financial statements for decision makers, such as stockholders, suppliers, owners and other stakeholders. The fundamental need for financial accounting is to reduce principal-agent problem by measuring and monitoring agents’ performance and reporting the outcome to interested end-users. Financial accountancy is used to prepare accountancy data for people outside the organisation or for those, who are not involved in the mundane administration of the company. Meanwhile, it generates some key documents, which includes profit and loss account, patterning the method of business traded for a specific period and the balance sheet that provides a statement, showing mode of trade in business for a specific period. It records financial transactions showing both the inflows and outflows of money from sales, wages etc.

Financial accounting empowers the managers and aids them in managing more efficiently by preparing standard financial information, which includes monthly management report tracing the costs and profits against budgets, sales and investigations of the cost. It could be the only type of accounting that managers need. Because the role of financial accounting is provide legal information to managers such as financial accounts in the form of trading, profit and loss account and balance sheet. The paramount importance function is record serve a dual purpose as evidence in the event of any dispute regarding ownership title of any property or assets of the business, which protects and safeguards business assets. It also helps prevent unwarranted and unjustified use. However, there are some limitations of financial accounting have led to the development of cost accounting:

1. Weakness not spotted out by collective results: Financial accounting discloses only the net result of the collective activities of a business as a whole. It does not indicate profit or loss of each department, job, process or contract. It does not disclose the exact cause of inefficiency i.e. it does not tell where the weakness is because it discloses the net profit of all the activities of a business as a whole. Say, for instance, it can be compared with a reading on a thermometer. A reading of more than 98.4° or less than 98.4° discloses that something is wrong with the human body but the exact disease is not disclosed. Similarly, loss or less profit disclosed by the profit and loss account is a signal of bad performance of the business in whole, but the exact cause of such performance is not identified.

2. Not helpful in price fixation: In financial accounting, costs are not available as an aid in determining prices of the products, services, production order and lines of products.

3. Provides only historical information: Financial accounting is mainly historical and tells you about the cost already incurred. As financial data is summarised at the end of the accounting period it does not provide day-to-day cost information for making effective plans for the coming year and the period after that.

4. No analysis of losses: It fails to provide complete analysis of losses due to defective material, idle time, idle plant and equipment. In other words, no distinction is made between avoidable and unavoidable wastage.

5. No data for comparison and decision-making: It will not provide you with useful data for comparison with a previous period. It also does not facilitate taking various financial decisions like introduction of new products, replacement of labour by machines, price in normal or special circumstances, producing a part in the factory or sourcing it from the market, production of a product to be continued or given up, priority accorded to different products and whether investment should be made in new products etc.

Overall, financial accounting plays an essential role in running a company, but not means it must be the only type of accounting that managers need. Because the limitations displayed above states that well-running a company not only the financial accounting but also need another type of accounting which has an important function to make decisions for managers in a company. It is management accounting. Management accounting is provides the appropriate information for managers. This information is used in decision making of business, planning and controlling of the company. Management accounting usually consists of confidential data of a certain company which is only accessed by managers, thus making it secure and reliable. In this method no accounting standards are used, instead internal controls make most of the key decisions for managers. So that management accounting is the type of accounting which should also compulsory for companies.