By Bob Schneider
Accounting can be divided into several areas of activity. These can certainly overlap and they are often closely intertwined. But it's still useful to distinguish them, not least because accounting professionals tend to organize themselves around these various specialties.
Financial accounting is the periodic reporting of a company's financial position and the results of operations to external parties through financial statements, which ordinarily include the balance sheet (statement of financial condition), income statement (the profit and loss statement, or P&L), and statement of cash flows. A statement of changes in owners' equity is also often prepared. Financial statements are relied upon by suppliers of capital - e.g., shareholders, bondholders and banks - as well as customers, suppliers, government agencies and policymakers. (To learn more on this read, What You Need To Know About Financial Statements.)
There's little use in issuing financial statements if each company makes up its own rules about what and how to report. When preparing statements, American companies use U.S. Generally Accepted Accounting Principles, or U.S. GAAP. The primary source of GAAP is the rules published by the FASB and its predecessors; but GAAP also derives from the work done by the SEC and the AICPA, as well standard industry practices. (For more on this see, What is the difference between the IAS and GAAP?)
Where financial accounting focuses on external users, management accounting emphasizes the preparation and analysis of accounting information within the organization. According to the Institute of Management Accountants, it includes "…designing and evaluating business processes, budgeting and forecasting, implementing and monitoring internal controls, and analyzing, synthesizing and aggregating information…to help drive economic value."
A primary concern of management accounting is the allocation of costs; indeed, much of what now is considered management accounting used to be called cost accounting. Although a seemingly mundane pursuit, how to measure cost is critical, difficult and controversial. In recent years, management accountants have developed new approaches like activity-based costing (ABC) and target costing, but they continue to debate how best to provide and use cost information for management decision-making.
Auditing is the examination and verification of company accounts and the firm's system of internal control. There is both external and internal auditing. External auditors are independent firms that inspect the accounts of an entity and render an opinion on whether its statements conform to GAAP and present fairly the financial position of the company and the results of operations. In the U.S., four huge firms known as the Big Four - PricewaterhouseCoopers, Deloitte Touche Tomatsu, Ernst & Young, and KPMG - dominate the auditing of large corporations and institutions. The group was traditionally known as the Big Eight, contracted to a Big Five through mergers and was reduced to its present number in 2002 with the meltdown of Arthur Andersen in the wake of the Enron scandals. (For further information see, An Inside Look At Internal Auditors.)
The external auditor's primary obligation is to users of financial statements outside the organization. The internal auditor's primary responsibility is to company management. According to the Institute of Internal Auditors (IIA), the internal auditor evaluates the risks the organization faces with respect to governance, operations and information systems. Its mandate is to ensure (a) effective and efficient operations; (b) the reliability and integrity of financial and operational information; (c) safeguarding of assets; and (d) compliance with laws, regulations and contracts.
Financial accounting is determined by rules that seek to best portray the financial position and results of an entity. Tax accounting, in contrast, is based on laws enacted through a highly political legislative process. In the U.S., tax accounting involves the application of Internal Revenue Service rules at the Federal level and state and city law for the payment of taxes at the local level. Tax accountants help entities minimize their tax payments. Within the corporation, they will also assist financial accountants with determining the accounting for income taxes for financial reporting purposes.
Fund accountingis used for nonprofit entities, including governments and not-for-profit corporations. Rather than seek to make a profit, governments and nonprofits deploy resources to achieve objectives. It is standard practice to distinguish between a general fund and special purpose funds. The general fund is used for day-to-day operations, like paying employees or buying supplies. Special funds are established for specific activities, like building a new wing of a hospital.
Segregating resources this way helps the nonprofit maintain control of its resources and measure its success in achieving its various missions.
The accounting rules for federal agencies are determined by the Federal Accounting Standards Advisory Board, while at the state and local level the Governmental Accounting Standards Board (GASB) has authority.
Finally, forensic accounting is the use of accounting in legal matters, including litigation support, investigation and dispute resolution. There are many kinds of forensic accounting engagements: bankruptcy, matrimonial divorce, falsifications and manipulations of accounts or inventories, and so forth. Forensic accountants give investigate and analyze financial evidence, give expert testimony in court and quantify damages.
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