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Unit - 1 MODULE - 1 Introduction to Management Accounting
• Introduction and Meaning of Management Accounting • Definition • Relation of Management Accounting with Cost Accounting and
Financial Accounting • Role of Management Accounting • Nature of Management Accounting • Scope of Management Accounting • Tools and Techniques • Difference between Management Accounting and Cost Accounting • Difference between Management Accounting and Financial
Accounting • Functions of Management Accounting • Concepts of Management Accounting • Limita
tions of Management Accounting
IInnttrroodduuccttiioonn && MMeeaanniinngg:: The term management accounting has its base in accounting for
managers, through which managers get necessary information on
executing their functions. In other words, it helps a manager in planning,
organizing, directing and controlling the business operations in an orderly
manner. Accounting, generally, is referred to as the process of recording
and classifying the monetary transactions of a business concern for the
purpose of analyzing and reporting the result to various parties. Financial
accounting does this work effectively. It meets the aims and objectives of
various persons, say, shareholders, creditors, bankers, etc, outside the
organization. Thus, it is the primary duty of an accountant to record and
analyze the transactions of the business and prepare the final accounts in
order to take certain decisions. Financial accounting does convey
meaningful information to the outsiders, but it at times fails to communicate
the valuable information to the management. Owing the rise of joint stock
companies and large scale enterprises, the complexities of operating a
business firm has also increased.
A manager requires organized information, not just raw data, so as to
take important decisions. Decision making in any business enterprise is a
primary function of management. Financial accounting does provide
various sets of accounts and statements to assess the working of a
concern, but it does not provide enough information and in appropriate form
which can help a manager to arrive at a particular decision. Financial
accounting gives an overall picture of an enterprise, while the mangers are
interested in minute details to correct the deviations. Again, managers
require information continuously. They cannot wait for a year to end and
then receive the final accounts. They must get information on a weekly or
monthly basis. These growing requirements have changed the picture of
the basic traditional accounting of recording in to a powerful tool of
forecasting, budgeting, budgetary control, etc. This has led to the formation
of the management accounting, whereby; an organization plans, organizes,
directs and controls the resources of the organization through above
mentioned tools. When accounting is considered in the form of functions of
management providing adequate and appropriate information for
management requirements, it is referred to as ‘Management Accounting’.
Meaning and Definitions: In simple terms, any accounting system which aids management in
carrying out its managerial functions effectively may be termed as
Management Accounting. It is generally referred to as Accounting for
Managers. It is an accounting system designed to provide adequate and
appropriate information/details to the management in order to carry out its
functions. It helps in the creation of various policies to conduct the day to
day activities. It is also known as “Management Oriented Accounting” or
“Accounting for Management”.
Management Accounting is the term used to describe the accounting
methods, systems and techniques which, coupled with special knowledge
and ability assist management in its task of maximizing profits or
minimizing losses.
- Rober N. Anthony
Management Accounting is accounting for effective management.
- Bose
Management Accounting is the application of appropriate techniques and
concepts in processing historical and projected economic data of an entity
to assist management in establishing plans for reasonable economic
objectives in the making of rational decisions with a view towards
achieving these objectives.
- American Accounting Association
The following definition is given by the Management Accounting Team of the Anglo-American Council of Productivity.
Management Accounting is the presentation of accounting information in
such a way as to assist management in the creation of policy and in the
day to day operations of an undertaking.
"Management Accounting is the term used to describe the accounting
methods, systems and techniques which, coupled with special knowledge
and ability, assist management in its task of maximizing profits or
minimizing losses."
- J. Batty
"Any form of accounting which enables a business to be conducted more
efficiently can be regarded as management accounting."
- Institute of Chartered Accountants of England and Wales
"Such of its techniques and procedures by which accounting mainly seeks
to aid the management collectively have come to be known as
management accounting."
- The Institute of Chartered Accountants of India
"Management Accounting is an integral part of management concerned
with identifying, presenting and interpreting information used for:
1. Formulating strategy
2. Planning and controlling activities
3. Decision making
4. Optimizing the use of resources
5. Disclosure to shareholders and other external to the entity
6. Disclosure to employees
7. Safeguarding assets”
- The CIMA (UK) Thus, the above mentioned definitions clearly state that management
accounting is concerned with accounting information which is useful to the
management. Management covers all rearrangements, combinations and
adjustment of the traditional accounting figures which may be required to
provide the managers with the information from which they can control the
business. It encompasses accounting methods, system and techniques
which are employed with knowledge, skills and ability, to aid management
in its task of maximizing profits of the concern.
Relation of Management Accounting with Cost Accounting and Financial Accounting: Three types of Accounting such as Financial Accounting, Cost Accounting
and Management Accounting are strongly interconnected. The
Management Accounting uses the principles and practices not only of cost
accounting but also of financial accounting. Cost accounting is a more
detailed application of financial accounting and management accounting
goes a step further. The following chart explains that relation of
Management Accounting with Cost Accounting and Financial Accounting.
Preparing Revenue statement and
Position Statement
Evaluating Cost for Control and optimum
competence
FIANANCIAL ACCOUNTING
COST ACCOUNTING
Help Management for Planning, Control and
Decision Making
MANAGEMENT ACCOUNTING
ROLE OF MANAGEMENT ACCOUNTING: Management Accounting, as a key input, provides valuable services
to management in all the functional areas. It plays a major role in various
managerial functions and thereby helping them to take effective decisions
which are discussed below:
1. Planning: Planning basically involves deciding future course of actions
based on the current status of the given resources. It involves
formulation of policies, setting up goals and objectives and deciding a
sequence of activities. Management accounting makes an important
contribution by supplying valuable information and data for analyzing
the problem and taking the accurate decision. Information is the
important factor required to plan anything.
2. Organizing: It basically involves grouping of activities in such a way that
they operate in a coordinated way in order to achieve the common
objective. It identifies the relation between authority and
responsibility. Management accounting contributes here by creating
various centres which carry various tasks to be performed in order to
obtain the pre-determined objective. This gives a sound organization
structure with a clear-cut distinction of authority and responsibility.
3. Coordinating: This includes interlinking of different divisions of the business
enterprise in a way so as to achieve the objectives of the organization
as a whole. There is a requirement of a kind of coordination between
various departments such as production, purchase, finance, human
resource, sales, etc. An effective way to achieve coordination
between the departments is to allot them respective budgets which
are inter-connected. Thus, management accounting is used in
designing budgets for an efficient allocation and coordination of
resources.
4. Controlling: Controlling means, establishing standards or standard
performance, measuring actual performance, comparing the actual
performance with the established standards and then at the end
taking corrective actions for the deviations. The techniques such as
budgetary control, standard costing and departmental operating
statements greatly help in performing this function. Thus, as a matter
of fact, the entire system of controlling is designed and operated by
the management accounting practices.
5. Motivating: Motivation means channelizing strong motives or urges of an
individual into action so as to obtain goal directed behavior. It
involves maintenance of a high degree of morale in the organization.
The supervisor should know whom to motivate, to what extent to
motivate, which tools to be used to motivate, etc. These burning
questions can only be answered if the decision making authority has
certain reports to find out the functionality of the resources. Periodical
departmental profit and loss accounts, budgets and reports go a long
way in achieving this objective.
6. Communicating: Communication involves transmission of ideas, symbols, facts,
information, etc from one person to another through a channel. The
orders of the supervisors should be communicated to the
subordinates while the results achieved by the subordinates should
be reported to the supervisors. Moreover, the management also owes
a responsibility to supply information to various other parties such as
creditors, bankers, investors, shareholders, etc. Management
Accounting helps the management in performance of this function by
developing a suitable system of reporting which emphasizes and
highlights the relevant facts.
TTOOOOLLSS aanndd TTEECCHHNNIIQQUUEESS:: 1. Financial planning:
Financial planning involves determining financial structure of an
enterprise. It includes determining financial objectives, both, long
term as well as short term, formulating various policies relating to
finance and developing various procedures to achieve the objectives.
Here, the concern is to take a decision about raising finance. That is,
the sources of finance should be precisely decided along with the
cost at which they are procured. The firm should minimize the cost of
the capital and should define the usage of the capital at a proper
place so as to generate the desired revenue. Thus, the financial
planning is a technique used by management accounting so as to
assist the management in taking important decisions.
2. Analysis of financial statements: The analysis part of financial statements and its interpretation
are one of the most important things that are made use of by
management accounting. Management accounting uses various
techniques such as ratio analysis, fund flow statement, trend
analysis, etc to analyze the statements and bring out conclusion so
as to take wise decision.
3. Historical cost accounting: Entering the actual costs after they have incurred is called
historical cost accounting. Although, management accounting does
not use past data, but in case of standard costing though, these data
prove to be very useful and hence it is useful to management
accounting.
4. Standard costing: Standard costing is a crucial tool to control cost which is the
basic aim of management accounting. This basically involves
preparation of standard costs of various activities, measuring the
actual performance, comparing it with standard costs and correcting
the deviations, if any found.
5. Budgetary control Budgetary control is an instrument used for planning and
controlling the operations of the business enterprise. This activity
basically calls for comparing the actual performance with the set
standards and thus, correcting deviation. The major aim of budgetary
control is to ensure that the funds are utilized optimally, and thus, a
firm can produce goods at the minimum cost and sell them at a price
which will help them achieve a desired level of profit. Thus it is used
under management accounting.
6. Marginal costing: This method helps the management to measure changes in the
costs with the changes in the output level or volume of production.
This is one of the costing methods which is used to measure costs
and profitability of a concerned product at different lines of
production.
7. Decision accounting: More often than not, management encounters problems related
to various alternative solutions. From the available solutions, the
purpose is to select the best decision which proves beneficial for the
company. Decisions are generally made after studying the data of
costs, prices and submitted by management accounting and then the
best one is chosen for implementation.
8. Revaluation accounting: Revaluation accounting is basically meant for replacement of
fixed assets in the times of rising prices. It ensures the maintenance
and preservation of the capital for the purpose of replacing the fixed
asset after its life gets over.
9. Ratio accounting: Ratio analysis is basically a technique through which a firm’s
performance is analyzed and interpreted by means of accounting
ratios so as to take certain decisions. It helps the management to get
a clear picture of firm’s performance at various levels and time
periods and also allows the management to have a comparative
analysis. Based on these, the firm can take a proper decision.
10. Internal auditing: Auditing is an independent appraisal system designed within
the organization in order to review the performance of accounting,
finance and other operations as a basis for protective and
constructive service to the management. It primarily deals with the
matters relating to accounts and brings about effectiveness in the
organization by putting a mandatory regular check on the activities.
11. Management information system: Today’s world is an informative world. No firm could survive
without adequate information. Management accounting with this
regard provides adequate and appropriate information to the
management so as to take various decisions. It provides necessary
information to all the levels of management according as their
requirements.
12. Statistical techniques: Management accounting, in order to operate more effectively,
also calls for certain statistical tools such as time series, regression
analysis, sampling, correlation, etc which are highly useful for
planning and forecasting. Through these tools, one can prepare
graphs, charts, diagrams, etc. to make the information look more
impressive and comprehensive.
NNaattuurree ooff MMaannaaggeemmeenntt AAccccoouunnttiinngg::
As discussed earlier that management accounting is essentially
accounting information which facilitates the management in making
important decisions that would generate maximum profits out of the
business activities. On the basis of the previous discussion and various
definitions, following are few characteristics of management accounting:
1. Forecasting: Management accounting is basically concerned with the future.
It is not restricted only to the collection and analysis of historical data
or facts but also attempts to emphasize on what should have been
done. Thus, it is more focused on activities that are going to take
place in the future, for decisions that a manager takes is always for
the future course of action and not for the past. All the tools and
techniques used under management accounting is future oriented.
2. Disseminate information: Management accounting, through its techniques, generates
data or information which it provides to the management. It does not
help in making decision or providing an opinion on it. The task of
arriving at a decision remains with the management. Management
accounting, however, only supplies information necessary to take any
important decision.
3. Increase in efficiency: Management accounting provides information that helps
generate various alternatives for the management. Out of various
alternatives, the management chooses the best one which gives
maximum profit and incurs minimum cost. Thus, by providing efficient
and effective data to the management, it helps the management to
make an effective decision and thereby helps in increasing efficiency
of the firm.
4. Usage of techniques and concepts: Information, when available randomly, does not help in making
effective decisions. It has to be so organized as to interpret the same.
Management accounting through various techniques and concepts
makes accounting data more useful. The techniques usually
employed include marginal costing, standard costing, break-even
analysis, and budgetary control among others.
5. No fixed model: Management does not have strict rules and system which has
to be followed as it is in the case of double entry system. The usage
of data differs from organization to organization. It is purely a
subjective matter when it comes to development and usage of the
bits of information produced through management accounting.
6. Aids management: As discussed earlier, it assists management in carrying out its
functions effectively. It provides various customized data which helps
in planning, organizing and controlling the activities at various levels
and time periods. It provides accurate information and at the right
time to the management so as to enable them to make a right
decision.
7. Cause and effect analysis: The most distinguishing feature of management accounting is
that it portrays cause and effect relation between the variables. If the
firm had earned profit, then it displays the reasons for the same and if
the firm had incurred loss then, it gives reason for loss as well. Thus,
on this ground, management is also at times called as science.
8. Helps in achieving objectives: The ultimate aim of any business concern is to earn profit. All
other plans and strategy prepared are directed towards earning a
handsome profit. Management accounting, by providing information
and assisting management, tries to do the same. It aids management
so that managers can take effective decisions which are directed
towards the achievement of certain objectives. Thus, management
accounting, directly or indirectly, helps in achieving objectives of the
concern.
SSccooppee ooff MMaannaaggeemmeenntt AAccccoouunnttiinngg:: The management accounting is very wide and broad in its scope. It
embraces a variety of aspects of business operations. The ultimate
objective of management accounting is to aid management in effective
functioning of planning, organizing and controlling. The following are some
of the areas included within the scope of management accounting:
1. Financial accounting: It is a general accounting practice which includes recording of
transaction taken place in the business, posting it into respective
ledger account, balancing them and preparing a trial balance. On the
basis of the trail balance, the entry is made in trading, profit and loss
and balance sheet. These accounts and statements in turn show the
real position of where the business stands. On the basis of these
accounts and statement, management can take effective decisions.
These accounts and statements help the management to analyze the
situation and interpret the data for some meaningful usage to the
operations. Management accounting, thus, is incomplete without the
availability of data on financial accounting.
2. Cost accounting: Cost accounting is one of the branches of accounting. Cost
accounting is basically a process or technique to ascertain costs. It
provides valuable data for planning, organizing and controlling
business operations through various tools, viz. standard costing,
marginal costing, budgetary control, etc.
3. Budgeting and forecasting: Budgetary control is an instrument used for planning and
controlling the operations of the business enterprise. This activity
basically calls for comparing the actual performance with the set
standards and thus correcting deviation. The major aim of budgetary
control is to ensure that the funds are utilized optimally, and thus, a
firm can produce goods at minimum cost and sell them at a price
which will help them achieve a desired level of profit. Forecasting, on
the other hand, is a prediction made of what is going to happen in
future as a result of a given situation.
4. Statistics: Management accounting, in order to operate more effectively,
also calls for certain statistical tools such as time series, regression
analysis, sampling, correlation, etc. which are highly useful for
planning and forecasting. Through these tools, one can prepare
graphs, charts, diagrams, etc to make the information look more
impressive and comprehensive.
5. Inventory control: Management accounting also embraces inventory control as it
involves major portion of the total cost. The management should
determine accurate levels of different stockpiles, such as minimum
stock level, maximum stock level, re-ordering level for stock control.
The study of inventory management helps the managers in taking
wise decisions.
6. Analysis and interpretation of data: Analyzing the financial data is very important and interpreting
them in a correct way is equally significant. Financial accounting
provides valuable data which can be used for a comparative study
over the years so as to analyze the situation of the company and
differences in financial statements, and then, take appropriate
actions.
7. Reporting: Once the data has been analyzed and interpreted, the next task
before the management is to communicate those valuable data to the
interested parties, both inside and outside the organization. For that,
the management needs to prepare various reports which make the
data presentable in a proper form from the core numerical form.
These reports can be sent monthly, quarterly or yearly to the
interested parties in order to arrive at a decision.
8. Methods and procedures: Management accounting also hold in its arms maintenance of
proper data processing and other office management services,
reporting on the best use of mechanical and electronic devices. It
defines various methods and techniques on how to do a particular
work.
DDiiffffeerreennccee bbeettwweeeenn MMaannaaggeemmeenntt AAccccoouunnttiinngg aanndd
FFiinnaanncciiaall AAccccoouunnttiinngg:: Financial and management accounting are closely interrelated since
management accounting, to a large extent, is just a mere extension of
financial accounting. Most of the data for exercising management
accounting comes from financial accounting only. In spite of such a close
relation between the two, there are certain fundamental differences
between them, which are discussed below:
Objectives: The main aim behind practicing financial accounting is to supply
data or information in the form of profit and loss account and balance
sheet to external parties like shareholders, bankers, investors,
government, etc. This information is provided at some definite period
of time where the internal management does not share any interest.
Management accounting, on the other hand, is mainly responsible for
the data for the internal management team so as to operate
effectively. Thus, the former is basically meant for external reporting
while the latter is for internal reporting process.
Performance: Financial accounting measures an overall performance of the
business concern by portraying the information through profit and
loss account and balance sheet. It displays the financial position of
the firm at a particular date. In case of management accounting, it
provides the data of all relative departments and their function
performed in the business. Thus, it measures the performance of
each individual activity rather than giving the overall picture. Thus,
financial accounting cannot reveal what part of the business is going
wrong and why. While management accounting provide a detailed
analysis of the adverse impacts generated by individual section of a
business.
Data usage: Financial accounting is historical in nature and thus uses past
data to record the transaction and thereby displays the result. It
analyzes the past data and then provides the report in the present.
Management accounting, on the other hand, is based on future and
therefore supplies the data for present and future duly analyzed and
in a detailed structure.
Monetary management: Under financial accounting, those transactions which involve
monetary effect are taken into consideration. Non-monetary
transactions are not taken into account in financial accounting
practices. However, in case of management accounting, non-
monetary events also find their way to enter into the books. For
example: new technology, human resource, etc. These all affect the
business to a large extent and thus cannot be avoided.
Reporting: The period of reporting, in case of financial accounting, is
longer than management accounting. Usually, profit and loss account
and balance sheet are prepared at the end of the financial year or
probably half-yearly. This goes well as the data is to be provided to
the outside parties generally. But the management needs a
continuous availability of the data and report in order to improve on
the current lines of conducting business. This is fulfilled by
management accounting. Management accounting provides
information at frequent intervals which financial accounting fails to
provide.
Nature: Financial accounting has been said to be more objective than
management accounting. Financial accounting is generally counted
as a positive science while management accounting is subjective in
nature as it is highly based on judgments rather than measurements.
Legality: With reference to legality of the concept, financial accounting is
more or less a mandatory practice for every business unit while
management accounting, on the other hand, is voluntary. There is no
compulsion as to whether or not a firm should practice management.
Coverage: Financial accounting is broad in nature covering all the aspects
of the concern while management accounting is limited in this case
focusing mainly on the needs of the management. It covers those
aspects which are important from the managerial perspective of
decision making.
Publication and audit: Financial accounts like Profit and loss account and balance
sheet are to be published for the use of general public and are also
subject to audit by a chartered accountant. In case of management
accounting, there are no such provisions made. All the details and
reports are generally meant for the internal use for the management
only.
Methodology: Financial accounting and management accounting also differ in
respect of their methodology. In financial accounting, the information
is recorded or maintained in the form of various accounts and
statements while in case of management accounting, costs and
revenues are mostly reported by various responsibility centres.
Difference between Management Accounting and Cost Accounting:
Basis Management Accounting Cost Accounting Objective The purpose of management
accounting is to provide information to the management for planning and coordinating the activities of the business
The objective of cost accounting is to record the cost of producing a product or providing a service. The cost is recorded product-wise or unit-wise
Scope The scope of management accounting is very wide. It includes financial accounting, cost accounting, budgeting, tax planning, reporting to the management, interpretation of financial data, etc.
Cost accounting deals primarily with cost ascertainment
Nature Management accounting is generally concerned with the projection of figures for future
Cost accounting uses both past and present figures
Data used Management accounting uses both quantitative and qualitative information
Only quantitative aspects are used in cost accounting
Development The management accounting has been developed only in the last 30 years
The development of cost accounting is related to industrial revolution. Cost accounting was able to provide information not only about cost structure but also for planning and decision-making
Principle Followed
No specific rules and procedures are followed in reporting management accounting
Certain principles and procedures are followed for recording costs of different products. The same rules are applicable at different times too.
FFuunnccttiioonnss ooff MMaannaaggeemmeenntt AAccccoouunnttiinngg:: The basic function of management accounting is to assist the management in performing its functions effectively. The basic functions of manager/management are planning, organizing, directing and controlling. The management accounting assists in the performance of each of these functions in the ways mentioned below:
1. Provides data: Management accounting serves as an important source of data
for the planning of management. The accounting information and documents are a repository of a vast quantity of data about the past progress of the enterprise which are a must for making forecasts for the future.
2. Modifies data:
In order to facilitate managerial decision making and making it more effective and accurate, accounting data must have to be properly compiled and classified. Thus, modification of data is an important function as it processes the data so as to derive some meaningful conclusion.
3. Analyses and interprets data:
The data obtained from the accounting area is analyzed meaningfully for effective planning and decision-making. For this purpose, the data so collected is offered in a comparative form. Ratios are also calculated and likely trends are projected as well.
4. Serves as a means of communicating: The management accounting practices provide means for
communicating management plans upward, downward and outward through the organization. At an initial stage, it helps in identifying the viability or feasibility of various segments of plans. Later on, it helps all parties to inform about the plans that have been agreed upon and their roles in the given plans.
5. Facilitates control:
Management accounting assists in transforming given objectives and tactics into specified goals for attainment by a specified time and secures effective accomplishment of these goals in an efficient manner. All this is made possible through budgets and budgetary control and standard costing which are integral parts of management accounting.
6. Use of qualitative information: The quantitative information does have its vital importance in
the case of decision making by a management. Management accounting does not limit itself to accounting data for assisting the management in decision making but also uses such information which may not be capable of being measured in monetary terms. Such information may be collected from special field/in house surveys, statistical accumulation, engineering records, etc.
CONCEPT OF MANAGEMENT ACCOUNTING: Concept refers to the rule of the game of Management Accounting that helps and guides an accountant in presenting his responsibility. It is a science but not an exact science. Many of the conclusions drawn on the basis of it depend to a greater extent upon the intelligent interpretation of data and because of which it may be given direction only under exceptional situations. The general practices, which have been adopted by the Management Accountants to deal with an exceptional situation from time to time, have now taken the form of conventions. These concepts may be taken as directions while using management accounting and are listed as follows:
1. At the time of recording transactions, accounting should be made limited to business transactions only.
2. Cost and revenues ought to be matched as far as possible. 3. The methods, procedures and principles should be reliable and
consistent. 4. All anticipated profits should be credited on realization basis while
losses should be granted in advance. 5. All the accounting revelations whether relating to past, present or
future should be intended to meet the special needs of the business. 6. Capital employed should be kept intact at present price. 7. Management accounting information should be integrated and must
be futuristic. 8. Direct cost should be allocated to cost centres and it should be
recovered from products.
9. Reports and statements should not be utilized as a substitute for personal contact with the persons at higher levels of authority.
10. The object of control at source accounting should be followed.
Limitation of Management Accounting: Although management accounting is helpful in providing guidelines for planning, directing and controlling functions, its effectiveness is still limited by a number of reasons. Unless these limitations are taken into account, while using the management accounting system, the so called benefits of management accounting cannot be availed. The limitations of management accounting are as follows:
• Based on accounting records: Management accounting is mainly concerned with the re-arrangement or modification of a data. The data used for making the future decisions is historical. The correctness of the managerial decisions will depend upon the quality of data. If the financial data collected is incorrect, then management accounting fails to provide the right direction.
• Constant efforts: The conclusions and decisions drawn by the management accountant are not executed automatically. Thus, there is need for continuous and coordinated efforts of each management level to execute these decisions.
• Widespread Knowledge: It requires the knowledge of a number of related subjects. Management should have a thorough knowledge of the accounting
principles, statistics, economics, principles of management etc., to have an effective management accounting.
• Expensive System: It is very expensive. The installation of management accounting system requires a very complicated organization and several rules and regulations. This results in a huge investment which only large scale entities can afford.
• Resistance: Setting up of management accounting system requires basic changes in the organizational set up. New rules and regulations are also necessitated to be framed which affect a number of workforce and hence there is a possibility of resistance from some quarters or the others.
• Incommensurability : Management is only in the progressive phase; the techniques and tools used by this system give fluctuating results. Its conventions are not as accurate and established as of other branches of accounting. The conclusions taken from analysis and the interpretations are not the similar.