Monday, August 20, 2007

Accounting - Three Major Areas

There are three major functional areas in accounting, which need to be considered in modern day accounting for any business. The three are financial, cost and management accounting.

The first area, namely financial accounting, is primarily useful for ascertaining the results of the business on a periodical basis; for example, one year. This will help to determine the future course of action in the long term. In economical terms, financial accounting treats money as a factor of production.

Cost and management accounting are tools to enable management to take decisions on a day-to-day basis. Cost and management accounting are not useful for their own sake. These two functions assist management in the conduct of the business along with other key factors involved in running of the business. Key factors could be demand, supply, competition, availability of raw material, logistics etc.

The second area, namely cost accounting, seeks to ascertain the value of direct costs and indirect costs involved in production . From this value, management can make an informed decision regarding the improvement of production performance. In economic terms, cost accounting is a measure of economic performance. This information gives management a clear indication of economic performance of the production resources of the business.

Costing also helps the sales manager in setting prices. But since costing is a measure of economic performance, it cannot be considered as an absolutely accurate basis for setting prices. This is because selling prices are more of an economic decision. It would not be amiss to mention here that prices depend basically on market factors. Prices depend more on demand, supply and competition and less on costs. For example, high demand coupled with lack of competition would mean that business could charge higher prices for its products, well above the costs.

The third area, namely management accounting, is closely interrelated with costing accounting. Although it has evolved from cost accounting, management accounting has a broader role to play in management decisions. It measures economic performance of the business enterprise as a whole, vis-a-vis the economic environment in which the business operates. This function of accounting seeks to combine the financial and cost information in a broader aspect.

Finally, management accounting is instrumental in assisting and advising management in making important business decisions. It makes management aware of the economic implications and consequences of their decisions. In economic terms, it implies a close study of money as an economic resource, while simultaneously treating it as a measure of economic performance. This enables management to measure it as an economic factor of production, e.g. the rate of return on capital employed.

It is thus seen that accounting has a distinct role to play in three different areas, which are equally vital. With the advent of computerised accounting, it has become very easy for management to monitor the accounting information on the tips of its fingers. Financial accounting programs enable financial statements and various cost and MIS statements to be produced almost instantly at push of a button. Now, only the laborious part of accounting is data entry. Financial managers must ensure that meaningful data is input into the system to produce meaningful information. Proper categorisation must be done, and keying errors avoided at all costs, ensuring providing accurate financial information to management.

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