Question

One theme from the the first two weeks is that there are some important similarities between managerial and financial accounting. While managerial and financial accounting are designed to provide information to different types of users, the tools that are used are often the same. This is because, ultimately, external users would like to know as much about an organization as possible to better inform their decisions. So, some of the information that managers use to run the organization is passed on to external users for decision making purposes.

This raises an interesting point: Why do we bother with preparing different types of accounting information for internal and external users? External and internal users have different motives, so they require different types of information. However, assuming that external users of information are competent, it seems reasonable that they could make more informed decisions if given free access to an organization's internal accounting information (as opposed to the summary data contained in external financial reports). Thus, there must be some reason why companies choose to keep their accounting details hidden from the public.

We will only really scratch the surface of the principal-agent problem, but I do want to touch on a few issues. First, what is one reason that company managers (i.e. "agents") would want to avoid disclosing private accounting information of the company? Second, as an owner (i.e. "principal"), would you be concerned that there might be important information about the company that the managers are not disclosing in the financial statements. Finally, what might be a way that owners can ensure that managers are faithfully representing the financial position of the company without forcing them to disclose private company information?

Answer 1

Let us first discuss what are the similarities between managerial and financial accounting as follows

1. Both are the parts of total accounting information system.

2. Economic events are dealt in the both system of accounts.

3. The economic events are qualified only in monetary terms

4. Both are concerned with financial statements, revenues, expenses, assets, liabilities and cash flows.

5. Both the system of accounts are accumulating and classifying the accounting information for the preparation of financial statements.

6. Some database is used for preparing financial statements and reports under both system of accounts.

7. Both are determining and measurement of costs for different accounting periods and even for different departments and sections.

8. The same accounting principles and concepts are used in both system of accounts for the purpose of cost accumulation and cost allocation.

Now, Coming to the questions, why do we bother with preparing different types of accounting information for internal and external users

1) The inormation or data required by internal and external users vary significantly. The Information sought by internal users are predominantly for decision making with reagrd to future running of business whereas external users are more interested in making investment decisions

2) Accounting supplies managers and owners with significant financial data that is useful for decision making. This type of accounting in generally referred to as managerial accounting.

Some of the ways internal users employ accounting information include the following:

• Assessing how management has discharged its responsibility for protecting and managing the company’s resources
• Shaping decisions about when to borrow or invest company resources
• Shaping decisions about expansion or downsizing

3)  The record of a business’ financial history for use by external entities is used for many purposes. The external users of accounting information fall into six groups; each has different interests in the company and wants answers to unique questions. The groups and some of their possible questions are:

• Owners and prospective owners. Has the company earned satisfactory income on its total investment? Should an investment be made in this company? Should the present investment be increased, decreased, or retained at the same level? Can the company install costly pollution control equipment and still be profitable?
• Creditors and lenders. Should a loan be granted to the company? Will the company be able to pay its debts as they become due?
• Employees and their unions. Does the company have the ability to pay increased wages? Is the company financially able to provide long-term employment for its workforce?
• Customers. Does the company offer useful products at fair prices? Will the company survive long enough to honor its product warranties?
• Governmental units. Is the company, such as a local public utility, charging a fair rate for its services?
• General public. Is the company providing useful products and gainful employment for citizens without causing serious environmental problems?

Some of the ways external users employ accounting information include the following:

• Stockholders have the right to know how a company is managing its investments
• Federal and State Governments require tax returns and other documents often prepared by accountants
• Banks or lending institutions may use accounting information to guide decisions such as whether to lend or how much to lend a business
• Investors will also use accounting information to guide investment decisions

A company usually gives two sets of reports. One is for interanl purpose that improves day to day operation of the business. That is solely for the use of Management'

Another set of report can be prepared for the purpose circulating to general public which can be used by the external users as given above for various uses.

Its not appropriate to disclose all the information about a companys operation in public domain which would ultimately destruct the companys operation

There are certain info which could be used by the competitors against the establishment