There are three types of accounting and each has different characteristics. Some accounting software packages can handle all three types of accounting through the use of multiple or hyper-focused categories for each transaction. Accountants will often specialise in one of the three types of accounting.
Tax Accounting – for Government Tax Authorities
In this type of accounting, entries or reports are created based on the rules set by the relevant government tax authorities.
An example in Australia is asset purchases. If the asset cost and related installation/setup costs are over a certain threshold, the asset must be deducted across more than one year. The Australian Taxation Office (ATO) sets the threshold and methods to calculate the deduction for each year. The effect on the accounting reports is that the cash profit for the year will be different to the tax accounting profit.
In small businesses, the external tax accountant prepares the accounting records this way, as it is easier to transfer the information to the tax return. In larger businesses, an in-house team of tax accountants prepares tax accounting reports, tax returns, and provides tax advice to other areas of the business.
Financial Accounting – for Investors, Lenders, and Government Agencies
In this type of accounting, entries or reports are created based on Accounting Standards set by government-related and international accounting bodies. For example, the Australian Accounting Standards are set by the Australian Accounting Standards Board and closely modelled on the International Financial Reporting Standards.
Having one method of preparing accounts makes it easier to compare companies of different sizes and industries. Most governments and stock exchanges demand the use of Standards to ensure transparency and an efficient marketplace for capital. Top-level management are often given large bonuses based on the results in Standards-based reports.
An example benefit of Accounting Standards is that there are additional disclosure rules in the notes to the financial statements, such as outlining the remuneration of key management personnel.
Small businesses are usually below the threshold where governments insist on Standards-based reporting. Larger businesses have an in-house team of financial accountants, or a separate team for each division/country, that prepare the reports.
Management Accounting – for Internal Management
This type of accounting is focused on preparing reports that help management make decisions about the business. There are no external rules or Standards to follow, but there are standard methods taught to accounting students.
Example management accounting reports include cash flow projections, budgets, variance reports, product costings, and business acquisition analysis reports. They can also include Standards statements, such as profit and loss, balance sheets and cash flow statements, that have been prepared in a way that is more meaningful to management decision making.
Small businesses may only perform a cash projection in their head, if at all. New or proposed small businesses may do a rough calculation to map their path to millions. Larger business, particularly manufacturers, make extensive use of management accounting reports, and may work with an external Virtual CFO or have dedicated staff in each business unit, region or site.
All businesses can benefit from management accounting reports and I highly recommend investing in them. All businesses must prepare tax accounting records for their taxes, and larger businesses must prepare standards-based financial reports for external stakeholders.