The primary purpose of financial accounting is to provide investors (for example, shareholders) or creditors (for example, banks) information regarding company and management performance.
The financial data prepared for this purpose are governed by generally accepted accounting principles (GAAP) in the United States and international financial reporting standards (IFRS) in many other countries.
GAAP and IFRS ensure that accounting data utilised for reporting reasons is consistent from one company to the next. This requires that cost accounting data used to calculate the cost of goods sold, inventory values, and other financial accounting data used in external reporting be provided in compliance with GAAP or IFRS. While GAAP and IFRS are convergent, distinctions persist. These distinctions are irrelevant to our topic for the reasons mentioned in the following paragraph, but you should be aware of them.
Unlike cost data used for financial reporting to shareholders, cost data used for managerial purposes (that is, within the company) does not have to conform to GAAP or IFRS. Management is permitted to define cost information in its own way. Indeed, accounting data utilised for external reporting is frequently completely unsuitable for managerial decision-making.
For example, managerial decisions concern the future, and hence estimates of future costs are more helpful for decision making than externally reported historical and current expenses. Unless otherwise stated, we assume that the cost information is being created for internal use by managers and is therefore exempt from GAAP or IFRS compliance.
This does not mean there is no “right” or “wrong” way to account for costs. It does mean that the best, or correct, accounting for costs is the method that provides relevant information to the decision-maker so that he or she can make the best decision.