Finance/Management Accounting the Topic of Finance and Essay

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  • Subject: Economics
  • Type: Essay
  • Paper: #37607299

Excerpt from Essay :

Finance/Management Accounting

The topic of finance and managerial accounting inclusively, are broad and incorporate a critical skill set in the modern day business student. Finance involves corporate and investment finance and managerial accounting is complimentary as it involves cost accounting and essentially stresses cost management. Together, these topics provide a comprehensive financial analysis skill set yielding capability in solving the day's most critical business financial quandaries. The literature review will seek to narrow down the literature and funnel the topic into the main financial analysis area.

According to Musvoto, (2011), "Studies in accounting measurement indicate the absence of empirical relational structures that should form the basis for accounting measurement. This suggests the lack of objectivity of accounting information. Landmarks in the development of finance theory indicate the use of accounting measurement information as a basis for their development. This indicates that subjective accounting information is incorporated in finance theory. Landmarks in finance theory development reflect the use of accounting information as the basic building block. For example, the mathematical economic analysis by Modigliani and Miller (1959) of capital structure reflects the model's dependency on information that is determined by accounting models." (Musvoto, 2011)

Additionally, according to Musvoto (2011), "Other models such as portfolio theory of Markowitz (1952) the capital asset pricing model (CAPM) developed by Sharpe (1964), Lintaer, (1965) and Mossin, (1966) are based on the concept of return on investment. The return on an investment is arrived at after allowing for expenses on the income of the investment. Just like in determining taxation conventional accounting rules are used. This also carries over accounting judgments into these models." (Musvoto, 2011)

Musvoto's argument is financial theory as advanced as portfolio theory is a function of the underlying accounting theory that pins the fundamental value of the firm's operations to derive a financial valuation. The rather ubiquitous relationship that once existed between finance and accounting is now a bit clearer. Without strong accounting analysis, the financial theory behind corporate or investment analysis is likely to be flawed.

A more historic piece of research by Allen (1992) provides a background that point to the accounting model as the steward of the financial management model. According to Allen (1992), "Accounting is concerned with verifiable facts about the past. This leads to a focus on how much of the wealth created by an enterprise has been realized in the form of tangible assets. Financial management, on the other hand, is concerned with judgments about an uncertain future. Its focus is on the creation of wealth, and hence on profits as yet unrealized, and assets as yet untangible." (Allen, 1992)

David Allen (Allen, 1992) was chairman of the Financial and Management Accounting Committee at the time this research was published and hence was the head of the coordinating institute for global accountancy institutes, societies, and associations. The Institute of Management Accountants is also comprised within this group.

According to Allen (1992), "Accounting is governed by objectivity -- the characteristic of an outsider looking in. It is therefore rooted in costs, and oriented towards capital maintenance: "Profit is what you could afford to distribute and still be as well off as you were." Financial management, meanwhile, is essentially dynamic, paying due attention to the long-term continuum, and is based on cash flows and the time value of money (otherwise known as the cost of capital)." (Allen, 1992)

The accounting theory since Allen's declaration of its function in the early 1990s has centered around incorporating this view within accounting information systems. Additionally, the expensing of salaries and of asset sales via tax accounting theory (Allen, 1992) also played a role in defining the accounting role within the framework of financial management. Allen decided to use accounting as a mechanism to evaluate the valuation and undertaking of risk as is defined by the financial valuation.

According to Leauby & Wentzel (2006), "Finance provides a natural partnership with management accounting for several reasons. A survey of practitioners from IMA's (International Management Accountants) 1999 Practice Analysis shows that terminology used to describe the work of management accountants tend to include the term "finance." Furthermore, according to the 1996 Practice Analysis, management accountants are doing "less traditional accounting and more financial analysis and business partnering," suggesting that finance will "broaden its role to strategic partner. Rather than support only what happens in the division, management accountants will look at the marketplace and at what the competition is doing. They will need to be more strategic, be better visionaries, and be more proactive." Additionally, IMA refers to its members as accounting and finance professionals, thus demonstrating the importance of the linkage between the two disciplines and emphasizing how inseparable they have become in business practice." (Leauby, Wentzel, 2006)

The IMA has developed a strong cult following that has also pervaded the network of accounting and financial management in the corporate world. As a professional organization with a global reach that provides a market-based designation, the IMA's assertion to compound Allen's viewpoint of strengthening the nexus between finance and accounting including managerial accounting established the practice within industry.

However, only the best of breed financial manager understood the underlying accounting principles to effective financial management. Managers that held the designation of the IMA charter proved ability as an accounting and finance manager. Whether the underlying understanding of how accounting is a function of financial management remains an individual experience. China is an emerging market that provides an example of the modern interpretation of management accounting and finance.

According to Lawson (2009), "The economy of China has been growing at an explosive rate for the last two decades. This growth has been fueled largely by exports to the West, especially the United States, which is experiencing a growth trade imbalance with China. But despite this emergence of China as a major player in the world market, little is known about the management accounting techniques and costing methodologies that Chinese companies use to cost their products and manage their firms. Similarly, the role played by the finance and accounting function in these firms isn't well understood, although both areas can significantly impact operations and affect companies that work with or compete against these firms." (Lawson, 2009)

According to Black & Gallagher (1999), "The finance-economics view states that firms are economically constrained rather than physically constrained. It predicts that firms frequently have spare capacity, in contrast to the management accounting view that production at full capacity is the norm. Management seeking to maximize full value will not be employing a choice algorithm that results in the rejection of profitable sales. Finance-economics theory predicts that a firm's optimal capacity investment results in having sufficient capacity to enable the acceptance of all profitable sales. A situation where a physical capacity constraint forces a firm to choose between profitable products-with the most profitable products being produced and less profitable products being rejected-is suboptimal." (Black, Gallagher, 1999)

Black & Gallagher's research provides the real nexus between the managerial accounting and finance. In his research, we see how optimal capacity investment (Black, Gallagher, 1999) is an applied accounting-finance model used to maximize profitability under capacity constraints. Manufacturers often increase profits tremendously by forensic accounting practices sued to track costs back through the expense cycle. This ostensibly is the same function completed using a different modality.

According to Herbert (1996), "Since the late 1970s, observers of accounting and finance research have noted a growing gap between extant academic research and the needs of practitioners. A major view suggests that the methodological precepts of most extant accounting/finance research are constructed in abstruse mathematics based on hypothesis far removed from reality; in consequence, many practitioners have remained skeptical, unable to express an opinion and have withdrawn from the decision making process (Allen, 1992). (Herbert, 1996)

Additionally, according to Herbert (1996), "Accounting and Finance as a social science subject field suffers from certain intrinsic flaws which are not only pervasive to behavioural science in general, but may be sufficiently serious to warrant asking whether additional refinements or a complete reconstruction may not now be necessary. At least three major defects can be identified: a tendency towards managerialism, a failure to accommodate value-pluralism, and unremitting reliance on the scientific paradigm of enquiry." (Herbert, 1996)

Herbert's research does point to the once held belief of the mathematical advancement into accounting and finance convoluting the field and causing a chaotic managerial environment based on analysis and unjustifiably confusing decision-makers into producing sub-optimal results. Additionally, its application within the framework of the social science field was seen as in need of complete reconstruction. We have since seen such masters of finance as George Soros and others use behavioral finance as a means to model accounting and finance equations and have thus created the modern day field of behavioral finance.

According to Seigel (2010), "Practice Analysis of Management Accounting collected information from 800 U.S. practitioners who work in companies of various size and in a variety of industries. When asked which term they use to describe their work, 39% say finance,…

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