Evolution of Management Accounting - Research Paper Example

Evolution of Management Accounting The 1958 Committee on Management Accounting defines Management Accounting as "the application of appropriate techniques and concepts in processing the historical and projected economic data of an entity to assist management in establishing a plan for reasonable economic objectives, and in the making of rational decisions with a view towards achieving these objectives." (Riahi-Belkaoui, 1992) Similarly the emergent conceptual framework of management accounting started by the National Association of Accountants defines management accounting as: "The process of identification, measurement, accumulation, analysis, preparation, interpretation and communication of financial information used by management to plan, evaluate, and control within an organization and to assure appropriate use of and accountability for its resources. Management accounting also comprises the preparation of financial reports for non-management groups such as shareholders, creditors, regulatory agencies, and tax authorities." (Riahi-Belkaoui, 1992) It was against a backdrop of an increase in industrial production in the 19th century and throughout the middle of the 20th century that managers saw the importance of cost accounting following a tremendous increase in investment in factories, natural resources and equipment. (Freitas, 2002). During this era managerial accounting and cost accounting had no clear distinction as managerial accounting was often taken to mean the same thing as cost accounting. (Freitas, 2002). Managerial accounting began shifting focus from cost accounting sometime around the 1960s as a result of the growth of the service industry and the rapid growth of financial institutions, which brought about a change in the accounting environment. (Freitas, 2002). In addition, this era also saw the emergence of the idea of human resource accounting as well as a significant change in the area of managerial accounting research. The usefulness of mathematical models made managerial accounting more quantitative in the 1960s and 1970s. (Freitas, 2002). Increase recognition of the importance of human assets in economics, psychology, and personnel management led to the development of human resource accounting, which refers to the accounting for people as organisational resources. (Freitas, 2002). There were however difficulties with this accounting as it were difficult to decide how to provide a value to the human resources. (Freitas, 2002). Firstly, they needed a method to account for human resources; secondly there was the need for a model and concepts for measuring the costs and value of people as organisational resources. Thirdly, there was the need for experiments to apply the approach in an actual organisation; this was difficult as organisations were not willing to serve as sites for the experiments. (Freitas, 2002). And the fourth and last stage was to test empirically, human resource accounting information in a behavioural context. And the 5th stage like the 3rd one needed additional experiments to apply human resource accounting technologies to a variety of managerial problems. (Freitas, 2002). Most of what is known today as Management accounting such as standard costs, overhead rates, opportunity cost and profit centres were referred to as costs accounting and not management accounting. Also Management Accounting was not included in the School Curriculum of many schools. (Cunha, 2002). Introduction of management accounting as a course highlighted two important differences from cost accounting. Firstly, management accounting took into consideration the fact that the end numbers were used by people for decision-making and therefore took into consideration how such information could influence their behaviour and thus the idea of behavioural accounting. (Cunha, 2002). Secondly cost accounting was too much concerned with full costing (finding the true cost) while management accounting considered a wide range of topics. (Cunha, 2002). Management accounting has gained a lot of recognition as a distinct course from cost accounting as evidenced by a series of developments such as the dropping of "Cost" from their name by the National Association of Cost Accountants, changing the NAA magazine title to Management Accounting, and establishment of a Certificate of Management Accounting which mirrors the CPA exam. Another important development is the formation of the Committee of Cost Concepts and Standards by the American Accounting Association (AAA) in 1954. This committee classifies cost information into three different classes including "full cost", "differential cost", and "responsibility cost". (Cunha, 2002). Full cost constructions are used to arrive "normal" or "selling" price which is the sum of the its direct costs including a fair allocation of indirect costs. (Cunha, 2002). This method of cost allocation has undergone a great refinement for the past 30 years. Managers have been able to make more realistic measurements of full cost through the use of techniques such as the conversion of indirect costs to direct cost, installation of meters on machines, refinement of standard cost and other techniques to refine cost. (Cunha, 2002). Manufacturing was also the most widely used case study of full cost accounting until the 1960s. (Cunha, 2002). However, full cost accounting has been extended to other industries such as retail and services and has been found to be very helpful. For example law firms and Accounting firms now keep track of salary cost of those working on a set customer so they can bill more realistically for the time and level of experience used. (Cunha, 2002). Full cost accounting considered profit maximisation as the main goal of all companies whereas the microeconomic view was that where marginal revenue and marginal cost meet is where a company should produce to maximise profit. (Cunha, 2002).By assuming that companies never know what their demand curve is, nor what price customers are willing to pay, and that satisfactory profits were rather than maximum profits were a more realistic goal for a company, full cost accounting was considered a more valid approach to costing. (Cunha, 2002). Differential costs considered the use of present value in calculating costs. For example, in a Supreme Court case involving the United Shoe Machinery Company, present value calculations were used to arrive at a fair price following the Supreme Court's ruling that the company must offer for sale machines that it had only offered as leases before. (Cunha, 2002). Increase use of present value calculations brought about the development of present value tables to avoid complex logarithmic calculations. Another important development was the required rate of return or cost of capital. After a careful thought it was discovered that it was impracticable to calculate an accurate cost of capital, and thus Anthony recommended that companies should use a rate above the cost of capital or 10% when in doubt. (Cunha, 2002). The last area considered for differential cost accounting was the idea of Net Present Value (NPV) and Internal Rate of Return (IRR). Anthony showed that the IRR often leads to two different solutions both of which are Mathematically correct. However, because NPV did not posses such problems, it became prevalent over IRR in most capital budgeting decisions. (Cunha, 2002). Last but not the least type of cost accounting was Responsibility Accounting discussed by Anthony Norton. Using the report "Tentative Statement of Cost Concepts Underlying Reports for Management Purposes", subjects such as responsibility centers, profit centers, transfer pricing, planning and control frameworks and extensions in other industries were discussed. While ideas such as responsibility centers and transfer pricing are fairly new, areas such as profit centers were simply restatement of old ideas that were used as far back as the 1800s by railroads and other large companies. (Cunha, 2002). The last area discussed by Anthony was the shift of Management Accounting from mostly manufacturing companies into areas such as retail and services industries. Anthony discussed new ideas such as zero-based budgeting and planning, programing, budgeting systems that were used widely by governmnet in the late 60s and most of the 70s. (Cunha, 2002). Though Anthony considered using sophisticated models as cumbersome, he credits them for helping to build progressive thinking and innovation. Anthony considers human resource accounting, inflation accounting and manufacturing cost accounting as potential areas that need much more research and inquiry. He considers a broader use of computers in future management accounting as a means through which management accounting can gain more timely information. He also considered automation of some of the more simple management decisions. he later considered the need for new measurement and appraisal techniques for both management and information they use as well as the need for continued research in the area of management accounting while hoping that potential users or government will be capable of funding the high cost of such research. (Cunha, 2002). However, managerial accounting has made little progress in achieving its intended goals since the 1960s to present date. (Freitas, 2002) According to the American Accounting Association: "The objective of the accounting function is the measurement and communication of data revealing past, present and perspective socio-economic activities. This purpose is to improve control methods and decision making at all levels of socio-economic activities." (Freitas, 2002) The above definition is challenged on the grounds that management accounting has not been able to play its role in decision making in the organisation as it has failed to achieve the objective and purpose of improving control methods and decision making at all socio-economic activities. It has also been unable to play a decisive role in the management of organisations as well as not being central to the operations of many businesses. The relevance lost on management accounting as a useful managerial tool is placed on Academic Accountants. (Freitas, 2002) In those days when manufacturing and other production processes where characterised by labour, the traditional cost accounting techniques and later on management accounting techniques were able to provide managers and other decision makers with information for decision making. (Blocher et al, 2005). However, today, manufacturing processes have become automated and there is also great competition in almost all industries. As a result the traditional management accounting practices are no longer capable of providing relevant and reliable information for decision-making. 'Traditional management accounting information driven by the procedures and cycle of the organisation's financial reporting system is too late, too aggregated and too internally focused to be relevant for managers' planning and control decisions.' Mintzberg 1975:Quoted by Johnson and Kaplan in Relevance lost: the rise and fall of management accounting 1987 "The present business environment has also become characterised by the importance of the investor and the drive for shareholder value." "The new manufacturing environment is characterised by more flexibility, a readiness to meet customers' requirements, smaller batches, continuous improvements and an emphasis on quality. In such circumstances, information produced by traditional management accounting systems is, at best, irrelevant and, at worst, misleading.' CIMA 1992" Following from the above three quotes, one can clearly see that although relevance has not been lost completely in management accounting, it has to some extent been lost as a result of the failure of traditional management accounting to provide the much needed information for the present day internal decision-making. New management Accounting should be able to provide management with reliable and relevant information in a timely fashion for decision making. Traditional management Accounting has failed in this domain and there is need for improvement. Also, the importance of the investor and the drive for shareholder value needs to be taken into account in new management accounting because it is the investor or shareholder who contribute capital for the running of the business, therefore whatever is done internally in the organisation should be focused on maximising value for the investor and shareholder. Managers need to be able to gain information concerning customers, employees, cycle time, product defect, machine efficiency, labour productivity competitors and other relevant external data so as to make concrete decisions. Traditional management accounting has been unable to provide such information and thus accounting for the lost of relevance in such management accounting. The new business environment needs to make use of strategic management accounting, which is a management accounting system organized so that it is capable of providing the information needed for long-term strategic decision making, as opposed to the more traditional approach of providing short-term costs. (Law, 2006). Strategic management accounting, for example, provides information that will assist in the pricing strategy for new products and decisions relating to the expansion of capacity. (Law, 2006). There is a current debate on whether to maximise shareholder value or customer value. One would be tempted to say that shareholder value should be maximised and not customer value as maximising customer value can be regarded as working against the interest of the shareholder. (Libby et al, 2002). However, it turns out that a policy that maximises customer value in effect maximises shareholder value. (Libby et al, 2002). Moles and Terry (1997) define shareholder value as a precept of corporate governance and a criterion of financial management that decisions should be made with a view to maximizing shareholder value. That is, capital budgeting and other corporate decisions should aim to increase the value of the stake held by shareholders in the firm by making, for instance, positive net present value investments. Customer value refers to an assessment of the overall capacity of a product or service to satisfy his/her needs while the customer value chain delivery system is the system made up of a company and its suppliers, distributors, and ultimately its customers, who work together to deliver value to customers. (Law, 2006). Strategic management accounting can be enhanced through the use of new cost and management accounting tools such as Activity-Based Costing and Performance Measurement tools such as the Balanced Scorecard. Management accounting can only be useful in the modern manufacturing today if it encompasses the new management accounting techniques listed above. An activity based costing (ABC) is a cost accounting system that recognizes the fact that costs are incurred by each activity that takes place within the organization and that products (or customers) should bear costs in proportion to their demand for activities. (Owe and Law, 1999). ABC was proposed by Professor Johnson and Kaplan in their book "Relevance Lost: The Rise and Fall of Management Accounting (1987)". (Owe and Law, 1999). Using ABC cost drivers are identified alongside activity cost pools and these cost pools are used as the basis for allocating costs to products. (Owe and Law, 1999). Supporters of ABC assert that ABC provides accurate cause-and-effect allocations that cannot be achieved by using volume based costing systems. (Owe and Law, 1999). ABC considers the fact that products consume activities and activities consume resources, which in turn consume money. Therefore it assigns costs to products based on the products demand for activities and thus resources, which are costly to acquire. (Blocher et al, 2005; Cooper and Kaplan, 1992). By using activity based costing, it is possible for the company to separate low value-added activities from high-value added activities and thus make efforts to phase out the low value-added activities. (Blocher et al, 2005, Cooper and Kaplan, 1992). According to Law (2005), the balanced scorecard approach is an approach to management that integrates both financial and non-financial Performance measurement in a framework proposed by Professors Kaplan and Norton. It is one of the most significant developments in Management Accounting by Professors Kaplan and Norton and was first reported in the Harvard Business Review in 1992. (Law, 2005). In a nutshell, by applying ABC the firm can eliminate non-value added activities, identify activities that add value to customers and thereby increase customer satisfaction. By so doing it will increase its market share and thus its revenues which will in turn increase margins. Increasing margins increases operating income which in turn increases net income and finally shareholder value. By applying the balance scorecard, the firm can focus its attention on how to measure performance by applying both financial and non-financial performance measures. BIBLIOGRAPHY Blocher E., Chen Kung., Gary Cokins., Lin T. (2005). Cost Management A Strategic Emphasis 3rd Edition Mc Graw-Hill. Cooper R., Kaplan R. S. (1992). Activity-Based Systems: Measuring the Costs of Resource Usage. Accounting Horizons. Vol. 6(3), Pp 1-12. Cunha A. M. (2002) Summary of Anthony, R. N. 1989. Reminiscences about management accounting. Journal of Management Accounting Research (1): 1- 20. Master of Accountancy. University of Florida. Freitas Z. D. (2002). Summary of Flamholtz, E. G. 1992. Relevance regained: Management accounting - Past, present and future. Advances in Management Accounting (1): 21-34. Master of Accountancy. University of Florida. Kaplan R. S., Norton D. P. (2005). The High Performance Organisation. Harvard Business Review. Pp 172-180 Law. E. J. (2006). Balanced ScorecardA Dictionary of Business and Management.. Oxford University Press, 2006. Oxford Reference Online.. http://www.oxfordreference.com/views/ENTRY.htmlsubview=Main&entry=t18.e511 Law E. J. (2006). Customer value delivery system A Dictionary of Business and Management. Oxford University Press, Oxford Reference Online. http://www.oxfordreference.com/views/ENTRY.htmlsubview=Main&entry=t18.e6184 Law E. J. (2006). Strategic management accounting"A Dictionary of Business and Management. Oxford University Press, Oxford Reference Online. http://www.oxfordreference.com/views/ENTRY.htmlsubview=Main&entry=t18.e6184 Libby, Theresa, Salterio, Steven E. and Webb, Alan (2002). "The Balanced Scorecard: The Effects of Assurance and Process Accountability on Managerial Judgment" Available at SSRN: http://ssrn.com/abstract=317486 or DOI:10.2139/ssrn.317486 Moles P., Terry N. (1997). Shareholder valueThe Handbook of International Financial Terms. Oxford University Press. Oxford Reference Online. Riahi-Belkaoui A. (1992). The New Foundations of Management Accounting. Quorum Books. New York. Publication Read More