Management Accounting's Evolution and Ties with Other Functions in Company - Essay Example

?Evolution of Management Accounting Discipline and Its Relationship with Other Functions in Organisations Table of Contents Introduction 3 Evolution of Management Accounting 4 Importance of Understanding Management Accounting 6 Different Aspects of Management Accounting 6 Ethical Aspects 7 Performance Measurement 8 Cost Effective Analysis 11 Managerial Activities and Investment Aspects 11 Critical Evaluation 13 Future Outlook of Management Accounting 13 Conclusion 14 Reference 15 Introduction Globalization of trade and business is the major factor that helps to differentiate the modern and traditional business concept. The primary difference can be realized through the changing thought process of entrepreneurial and managerial perspectives. The increasing volume of trade and business activities raises the necessity of advanced business models and theories. The companies have realized the essence of cross-functional integration in achieving common organisational long term and short term goals. For example, business organisations are now more concerned with maximising the stakeholders’ value instead of profit maximisation. Besides, they have recognized their responsibilities towards society, community, corporate and environment. Now, they aim to develop their organisational structure and strategies that strive to meet these responsibilities. In this respect, different aspects of management accounting play very crucial role. It is one of the primary areas that help to meet objectives of corporate governance and strategic formulation process. This paper will attempt to present critical analysis of management accounting by pointing out its important aspects. At first, the evolution of management accounting will be analysed by figuring out its influencing factors. It will also discuss the historical background of the present management accounting system. Next, the importance of understating the management accounting for the present business world will be studied and explained. The next section will attempt to present the relationship between management accounting and other organisational aspects like ethics, strategy development, decision making etc. Critical evaluation of management accounting will present its major pros and cons followed by the future outlook of management accounting. This section will try to develop certain recommendations for bringing further development in modern management accounting. In order to support the critical analysis and discussions, proper evidences will be provided. Finally, the entire discussion, analysis and major outcomes will be summed up in conclusion. Evolution of Management Accounting Before presenting the evolution and historical development of managerial accounting, it is necessary to understand the term ‘management accounting’ because this term includes two major concepts of business organisational activities. Robert S, Kaplan identified two major areas of management accounting and these are cost accounting and management control (Kaplan, 1984). These two areas are very vital for organisational success. Management accounting process is helpful in executing cost accounting and management controlling activities. R. N. Anthony defined that “management accounting is concerned with accounting information that is useful to management” (Banjerjee, 2005, p.2). T. G. Rose elaborated that management accounting is meant to adopt and analyse the accounting information for better diagnosis and explanation for assisting managements in decision making process (Palanivelu, 2007, p.289). Many critics and scholar observes the cost accounting, financial accounting and management accounting as different areas of finance. However, this can be interpreted as the traditional concept of management accounting. This concept was in trend prior to 1980s before the modernisation of cost accounting and management control. Thomas Johnson traced that US corporations started to focus of management accounting during 1850-1925 as this field was very important for the growth and development of transportation, manufacturing and distributional process. However, during this period, the corporations did not stressed on bringing innovations in their management accounting system. Kaplan observed that after 1925, significant and interesting developments were made. The academic developments of management accounting were one of the major instances in this respect. This has led to influences the management accounting thought process. For example, Shillinglaw studied that during 1950s, corporations started to treat capital budgeting in new ways and they innovated new techniques for discounted cash flow methods and analysis (Kaplan, 1984). Management accounting is related with trade and business and hence, its importance kept rising with the increasing activities of trade and business. In this respect, the Industrial Revolution was the most crucial period for trade and business. Industrial Revolution was first experienced by the European countries and gradually its effects were spread in the rest of world. With the increasing necessity of trade and business and related activities, the scope of management accounting increased. In this respect, railroad and textile industries played very significant role in shaping management accounting techniques and practises. These two industries required a large amount of inputs like labours and raw materials. Hence, it became very necessary to track all records of inputs and output for making further decisions and for measuring the effectiveness of entire business activities (Caplan, n.d.). In the last fifty years, prominent developments in management accounting system can be traced. There are several factors that have brought these significant changes in this field. The technological, economical and business growth and developments have caused the modernisation of management accounting techniques. These three major developments have led to enhance product lines, service sectors and information revolutions. Modern business organisations have started to use innovative management techniques in management accounting systems. Some of major developments in management accounting techniques are activity based accounting, just-in-time, total quality managements, process costing, LIFO and FIFO etc. These techniques are very helpful the managerial decision making process (Caplan, n.d.). Importance of Understanding Management Accounting With time companies are realising importance of management accounting and thus the organisations are paying attention to incorporate different concepts of contemporary management accounting along with other traditional accounting practices. Traditionally people had a strong believe that the role of account department is to maintain daily transaction in a well organised manner so that at the end of the quarter or at the end of the year company can formulate its financial statement. However, these traditional accounting strategies failed to provide required in-depth information about financial performance of the company. Because of the narrow focus of traditional accounting, it failed to assist the management in making strategic decision. For the managers it is quite difficult to analyse the crude data accumulated by the account department. This specific need of the managers has been fulfilled by the management accounting. Management accounting use the crude data generated by the account department to filter it with help of different accounting tools and then to develop specific reports which can be used by the managers in analysing performance of different functional department. Managerial accounting gave a new edge to the traditional concept of accounting because the managers can use these reports to plan, execute and control different strategies in a more effective manner. Different Aspects of Management Accounting The above sections have described and explained the reasons behind the increasing demand of modern and advanced managerial accounting systems and processes. The scope of management accounting includes cost accounting, management accounting, budgetary control, taxation, auditing, capital budgeting, operational research and statistical methods etc (Thukaram, 2007, p.6). These areas are very important for meeting the different aspects of a business organisation. These aspects of business organisations include several areas like business ethics, performance evaluation, cost benefit analysis, managerial decision making process etc. Therefore, the primary aim of management accounting is to meet these aspects that ultimately helps to develop a growth oriented organisational culture and management process. In this process, the management must implement modern financial management tools and models in management accounting techniques. The following sections will discuss different aspects of management accounting using different theories and models. Ethical Aspects The ethical aspect is one of the vital issues to be taken care by the account department. Generally, the account people face a unique dilemma because companies are always under pressure to meet the sales target and profit margin. Market image of the company depends on factors like increase in turnover and profitability of the company. Therefore, several companies introduced creative accounting policies to camouflage its financial information. There are several examples of financial frauds in past where well renowned companies like Xerox, Enron and WorldCom tampered their financial data in an unethical manner. April 11, 2002 the Securities and Exchange Commission (SEC) filed a case of allegation on Xerox because through last five years the company had manipulated vital financial information regarding the total revenue and net profit earned by it. The company later agreed to pay $10 million as penalty and it restated the financial information from 1997 to 2002. KPMG, the auditing firm of Xerox was equally responsible for such unethical conduct of $3 billion hike in revenue and gap of $1.4 billion in EBT. In 2005 the audit firm also had to pay fine of $22.48 million to Securities and Exchange Commission (SEC) (Kay, 2002). Like Xerox, Enron was also got caught in a case of financial scandal. The finance department of the company used accounting loopholes along with special purpose entities to hide debts of billions of dollars. Even the Chief Financial Officer of Enron misleads the board members and provoked them to be part of such unethical conduct. Because of such misconduct, the shareholders of the company lost approximately $11 billion (Tran, 2002). Similarly, WorldCom did the largest fraud in the history of US. The accountancy scandal was of $11-billion in April 2002 which resulted in collapse of the company (CBC News, 2005). After these cases of major frauds the government along with the authorised accounting bodies introduced several changes in the accounting and auditing standards so that degree of transparency can be enhanced and such cases of fraud can be prevented. However, just standards alone cannot prevent unethical accounting fraud until the management of the company incorporate ethical aspect in the management accounting practice. Performance Measurement The role of management accounting is not confined only within account department; rather managers use it for performance measurement. To measure the performance of the entire company, account department in assistance with other departments has developed several control tools which analyse whether all the strategically important departments are performing as per the predetermined standard or not. One of such commonly used tool is Balance Scorecard (BSC) that is used as an effective management accounting tools. Bob Kaplan and Eric Norton in 1992 developed the concept of Balance Scorecard. They argued that performance of the company should not be monitored only through financial perspective; rather other factors like customer, internal business processes and innovation & learning along with financial performance should be taken into consideration. Figure 1: Balance Scorecard (BSC) (Source: California State University, Long Beach, n.d.) Each of these factors introduced in Balance Scorecard are quite essential for total performance of the organisation. As for example the financial aspect takes into account “how the company look at its shareholders”. Therefore, the company set the targets in terms of return on investment (ROI), return on capital employed (ROCE), net profit margin, price-earnings ratio and so on. Internal business processes deals with “what must we excel at?”. Generally, the company analyse the market competitiveness and the strategy followed by the rivals. Later on it searches for its core competency which can be used to acquire a better market position in the industry. To sustain in the contemporary business environment, it is quite essential that the company should go on updating itself in terms of technology and product quality. As for example a company which produces consumer durables should go on updating the features of its product range to match with the changing life style of the customers. This is equally true for the service sector. For example a company which offers tour package should analyse the changing market condition to remodel the service offers. Innovation and learning aspect of BSC is use to realise “can we continue to improve and create value?”. To retain competency in present market, a company has to be learning organisation. Therefore, companies should incorporate targets in terms of training and development of the employees in the Balance Scorecard. As customers are one of the most vital factors for any business; hence the customer component was introduced to analyse “how do the customers see us?” (Stewart & Carpenter-Hubin, 2001, p.39-40). To measure customer satisfaction, company should try to verify the degree of customer satisfaction, growth in market share, loyalty and longevity of the customers. Each year the company revive the targets to be achieved in each of the four sectors. For better analysis, the management set measures, objective and the action to be taken. At the end of the predetermined time frame, the management verify how far the objectives have been achieved. They also use the information collected through BSC to find out the core reasons because of which the company failed to achieve the target. Therefore, BSC is an effective tool of management account to measure performance of the organisation as whole. Cost Effective Analysis As discussed earlier, the traditional accounting practices used by a company fail to provide in-depth information about cost incurred at different point within the organisation. If the management can understand the point where cost is being incurred in the process of production, it becomes easy to manage the operational cost. This is possible if the management incorporates the concept of activity based accounting (ABC). As per this technique the economic benefit gained by an activity is converted in terms of cost. If the management find that the amount of cost incurred in conducting the activity is greater than the benefit derived, they may decide to discard such activity or replace it with some other economical one (Cinquini & Mitchell, 2005, p.67-68). ABC provide information that can be used by the managers while developing policies and making decision (Cinquini & Mitchell, 2005, p.72). Even in the service sector such as a health organisation can use ABM as a part of its total quality management process. This may assist in introducing “best practices” for high quality service offered to the customers (Aird, 1996, p.18-19). Managerial Activities and Investment Aspects The role of management accounting in managerial decision making and investment making processes are other major functional areas. In this respect, it is inevitable to understand the basic of managerial process. There are two major functions of management i.e. planning and controlling. In this process, the managerial accounting helps managers by providing relevant and valid information which are necessary for planning and controlling. For example, in case of controlling the resources, the budgetary planning is very effective. Budgetary planning is helpful for coordination, communication and motivation purposes. The management is responsible for maintaining a proper coordination within the organisation. While considering budgets, it is very important to allocate proper amount of resources to each department. In order to develop a product or services, an organisation needs to incur expenses for marketing, R&D, manufacturing expenses. Therefore, management accounting must be incorporated with other organisational activities. This helps managers to take decisions for planning and controlling the entire organisation (University of North Florida, 2007). The information disclosed by management accounting is the primary tool for managers to understand and analyse the internal condition of business organisations. Based on the financial performance of business, managers take decisions for bringing future development. However, the information revealed by management accounting must be incorporated with other information disclosed by other department like marketing and R&D for better managerial decisions (Walden University, 2011). The management accounting system also deals with the financial reporting standard that includes the disclosure of financial statements of financial performance. These financial statements are very important for the internal and external users like investors and stakeholders for making investment related decisions. The internal management teams use financial statements for making capital budgeting decisions. Besides, the potential investors’ groups analyse the financial statements of companies from making investment decisions (Kuppapally, 2008, p.168). In this respect, accounting standards and techniques used by management for disclosing financial statements is prominent for attracting potential investors. However, management teams should not practise unethical behaviours in financial reporting to misguide investors. Critical Evaluation With time companies are realising importance of management accounting to have a better managerial control. However, certain managers are doubtful because they say the time and cost incurred in conducting managerial analysis and developing different managerial reports is too much as compared to the benefit derived. Several small companies do not possess the required capital to incorporate different management accounting tools like BSC and ABC. Again, the lack of trained human force to conduct the analysis is also a major barrier for SMEs. The large organisations face the problem in using the management accounting tools because the efficiency of these tools depends on the quality of the data collected. There is a high possibility that if the quality of data is not much reliable, the report may not reflect true picture. If the management uses such distorted report they may derive a wrong conclusion about performance of the organisation. Future Outlook of Management Accounting The discussions on management accounting, its importance and its various aspects have provided enough evidences of its increasing necessity for organisational success and corporate responsibilities. The misuse of management accounting techniques causes fatal consequences for industry and for economy. The economic downturn of 2007-2008 was an example of such misuse of management accounting techniques. The US lending institutions increased the use ‘repo-105’ to reduce financial risk unnaturally and when the market crashed, the entire world economy suffered. After such bitter experience, the international organisations, and other government regulators are working for bringing further development in management accounting to such consequences. The Association of Chartered Certified Accountants (ACCA) is a global body responsible for bringing constant development in management accounting standards. This organisation conducts research to understand the future demand and trend of management accounting to implement future management accounting standards (Association of Chartered Certified Accountants, 2010). After the global downturn of 2007-2008, the primary concerned for management accounting is to diminish the financial and credit related risks. Other organisations like IFRS foundations, The American Institute of Certified Public Accountants, OECD etc are also major governing bodies and they are working for improving management accounting standards as per the requirement of business world. Conclusion No doubt managerial accounting is gaining popularity day by day in contemporary business environment. Managers prefer to use this as a parallel tool in analysing performance of different departments. Traditional accounting mainly deals with day to day transactions, maintenance of financial records and formulation of final reports. However, it is not effective enough to provide required information to the managers while they make strategic decisions. This loophole of traditional accounting has been covered by managerial accounting as it provides in-depth information regarding performance of different functional areas. Therefore, management accounting should be used parallel with traditional accounting for effective management. 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