Emergence of management accounting

Emergence of management accounting Introduction Management Accounting deals with providing information for internal users, mainly the managers. Since they are the section of people who directs and controls the operations of the firm, the information that Management Accounting provides is very useful. Some of the basic management activities are: Planning: Considering various alternatives and choosing the best among them. Control: Ensure that the chosen plan is being followed and whether there are in line with the objectives of the firm. Directing and Motivating: Activities need to be monitored and employees need to be motivated and encouraged to ensure smooth and effective functioning of the organization (Seal, W et al., 2006). Emergence of Management Accounting The concept of Management Accounting evolved during the Industrial revolution of the 19th century. During that period, most of the companies were controlled and owned by a few managers. Elaborate financial reports were not demanded as there were no external shareholders. The 20th century saw a lot of changes in the economy; companies were required to submit detailed financial reports in order to satisfy the capital markets, taxation purposes and creditors (Seal, W et al., 2006). Earlier, production technology was simple, with products passing through a series of distinct phases of production. So, it was easier to identify the associated material and labor costs, thus direct labor was used as the basis for assigning indirect costs to products (Ashton, D et al., 1995). Role of Modern Management Accounting Organizations are under pressure to not only make decisions on a day to day basis but also to chalk out a plan that will help them to survive and grow in the ever changing market place, considering the fact that they will be faced with uncertain circumstances. The main role of modern management accounting is to provide the various levels of management with information that is relevant to make sound decisions and to add value to the company. It is slightly different from traditional accounting because they provide managers with essential information in time to set targets, minimize the cost, develop standards, monitor performances and compute variances, thereby improving the quality of the products with reduced wastage. Apart from these, Management accounting aids in improving the flexibility and innovative capacity of the organization, thus making continuous changes to improve its financial and non financial performance to stay on track with the rapidly changing economy (Atkinson, An thony A et al., 1997) (Prit, 2009). Shaping an organization Management Accounting can help shape an organization in the following ways: Provides accurate and timely information to help cut costs, measure and improve the productivity. Information on product costs helps in the introduction of new products in the market, pricing decisions and, if required, abandonment of obsolete products. For large and decentralized organizations, it is essential to motivate employees using appropriate incentives and benefits. This decision is based on the results provided by the management accounting system. Acts as a communication tool which the upper management uses to communicate with the middle and lower management and vice versa. Information about the organizational goals and strategy is passed on to the operational divisions and feedback is communicated back to the upper management (Kaplan, Robert S., 1987). Binds the operational and strategic goals together in order to ensure that the performances of the operational divisions are aligned with the organizational goals (Ashton, D et al., 1995). Management Accounting shaped by organization An organization can also have an impact on this accounting system in the following ways: In order to successfully grow in the rapidly advancing market, customer satisfaction has become the prime focus. This affects the kind of information required by the organization and demands sophisticated form of management accounting system. Since organizations are divided into sub units, the interdependence among them would be very high. As a result the dynamics of the information needed has changed. Due to increased coordination among organizations, the gap between suppliers and employees are getting narrow. This has led to changes in the way that organizations collect and use management accounting information (Atkinson, Anthony A et al., 1997). A major computer revolution has brought about a significant reduction in the information collection and processing costs and has eased the work of accountants (Kaplan, Robert S., 1987). Management Accounting a Global phenomenon The challenge faced by companies today is; the alignment of local business processes with the global objectives and strategies. Since the organizations are widely dispersed and decentralized, integration of the sub units and its operations has become vital in order to compete in the global market. This requires management of various organizational relationships, internal, external, vertical, hierarchical, horizontal and lateral ties. In the growing global economy, management accounting is required to: Manage the flow of vertical and lateral information within organizations. Integrate and coordinate activities of units located in various locations (Scapens, R et al., 2007) (Ashton, D et al., 1995). Reduction in tariffs, ease in worldwide transportation and removal of other trade barriers has increased competition as more and more companies are entering the market, thus, the need for management accounting is increasing too. For example: Since business is expanding widely, outsourcing has become a great deal and countries like India and China are leading the way in this area and have a competitive edge over other firms (Seal, W et al., 2006). Impact of globalization Management accounting is shaped by various changes in the global environment, such as: Rapidly changing business climate has increased the research opportunities in the area of management accounting. Many of the countries in the world are re-structuring themselves. Countries like Taiwan, India and parts of Eastern Europe are slowly moving into large scale privatization. This has the altered the global competition scene. Shaping global organization Management Accounting plays a major role in shaping the global: Aids in stabilizing transfer of currency and the transfer of goods and knowledge between companies located in different countries. Manages the fluctuations in currency by the purchase of financial instruments like futures and options. Enables coordination and integration among the various activities of a globally dispersed organization. Helps to monitor and evaluate the performance of its subsidiaries (Ashton, D et al., 1995). Helps in building stronger political relationships between the firm and the government of the country where it has its operations. These ties can have positive impact in the form of tax breaks, subsidies etc. 3 Recent developments in Management Accounting Techniques a) Balanced Score card This technique consists of an integrated set of performance measures that are derived from and also helps the companys strategy. It develops a strategy for the company to further it objectives successfully (Seal, W et al., 2006). The characteristics of this technique: Helps the management to clearly state the vision and strategy in a tangible form. Helps in communicating the objectives and strategy to the employees and encourages them to set individual goals and align them to the organizational objectives. Develops measures to evaluate the performance. Four perspectives of a Balanced score card: Financial- concerned with profitability. Customer- concerned with customer satisfaction, retention of previous customers and acquiring new ones. Internal Business process- concerned with the internal processes that will help in attracting and retaining customers. Learning and growth- concerned with the long term growth and development of the organization. The balanced score card is used in both the manufacturing and service sectors. An example of a company in a service sector that uses this technique is the National Insurance Company. It is the property division of one of the major US insurance companies. In the year 1993 they launched the score card technique with revenue of $4 billion dollars. Unfortunately this never worked for the company and ended up making huge losses, until a management team was brought in to make repairs. They moved the company from a generalist strategy to a specialized one, thus, helping National Insurance to regain the profitable position in the economy. The balanced score card technique has its advantages and disadvantages. Advantages: Helps in providing periodic and systematic feedback. Helps in quantifying the vision and objectives of the organization. Helps to set individual goals and aligns them with the organizational objectives, thus, uplifting the morale of the workforce. It focuses on both, financial and non financial factors (Kaplan, R.S Norton, D. P,1996) (â€Å"Balanced Scorecard for Corus Group PLC†). Disadvantages Balanced score card is all about developing a strategy and if the management devises an ill-defined and unclear one, it will lead to a futile and confusing score card. Sometimes looked upon as a purely top down approach, where the strategy is created at the top and imposed upon the employees (â€Å"Balanced Scorecard: Panacea or poisoned chalice?†). The implementation of this technique can be time consuming and difficult and may not include the interests of the shareholders, suppliers and employees (â€Å"Balanced Scorecard for Corus Group PLC†) (Kaplan, R.S Norton, D. P, 1996). b) Just in time This management technique was first developed in Japan by Taiichi Ohno in the 1970s. Toyota Motors Corporation was the first one to adopt Just in Time technique as part of its production system. In this technique raw materials go into production as soon as they are received, the manufactured parts are completed just in time to go into the assembling process and they are shipped to the customers as soon as they are completed. The main features are, materials would be purchased only for the day to day requirement and there would be no goods in process at the end of the day as they are all delivered to the customers immediately (Seal, W et al., 2006). The Just in Time technique is most commonly used by the manufacturing and merchandising sectors. An example of a manufacturing firm using this technique: In the year 1992, the sales of one of the leading car manufacturers, Porsche declined to less than 15,000 and had a loss of about $133 million. The timely appointment of two Japanese experts identified the problem as wasteful inventory in the shelves. A quality control program was introduced to reduce the number of defective parts. Ever since, their earnings have jumped to about $55 million and huge sales of about 34,000. It would be appropriate to mention about a service sector using the Just in Time technique. McDonalds adopted this technique to compete with their competitor Burger King and Wendys. They had to carefully study the system and spend approximately $25,000 in each of its outlets. This was implemented to ensure that the customers would be served with the freshest food within 90 seconds of ordering and also to cut stock costs, which would ultimately lead to staff savings (Garrison and Noreen, 2003). The benefits and disadvantages of Just in Time technique are: Advantages: Reduction in warehousing and ordering cost. Can make use of the extra floor space which would otherwise be occupied by inventory, thus, avoiding any planned expansion that could result in extra expense (Kaplan, Robert S., 1987). Throughput time is reduced; as a result, the companies can give quicker responses to customers. The rates of defective units are reduced, therefore, less wastage and cost effective production. Disadvantages: If any parts are found defective, the whole production process would be held up. Companies are fully dependant on their suppliers, since they have to be able to provide defect free goods. Implementation can be slightly difficult as the workers required to operate under this system needs to be multi skilled and flexible (Garrison and Noreen, 2003). c) Activity Based Costing Towards the end of 1980, Activity Based Costing became a popular form of costing among the organizations. This provides managers with cost information to make strategic decisions. Under this system, overhead cost pools are allocated to the products and other costing objects using a measure of activity. The indirect costs are also allocated to different cost pools, based on the activity. The costs are all attached to each product on the basis of the cost drivers associated (Garrison and Noreen, 2003) (Ashton, D et al., 1995). A large number of organizations have adopted Activity Based Costing. One example of a company in the service sector, in a developing nation, that is successfully using this technique is Tata Consultancy Services; one of Indias largest consulting organization. They used this method to identify issues in their software business. With the help of Activity Based Costing, Tata Consultancy was able to find out that the quality assurance, testing and correction costs were having a negative impact on their profitability. This costing technique provided the required cost information to help the managers set appropriate priorities and monitor the detection costs (Garrison and Noreen, 2003). Activity Based Costing has its own advantages and disadvantages. Advantages: Simple to operate and can be easily understood. Focus is mainly on what causes the costs to increase. Absorption rates are closely linked to causes of overheads. Disadvantages: Implementation and maintenance is expensive. The changes may not be accepted easily by the employees, they may resist. Managers sometimes insist on including sustenance costs and idle capacity costs, this may result in overstated costs. Activity Based costing reports does not conform to the Generally Accepted Accounting Principles. This may require the companies to have two cost systems which can be an expensive affair (Garrison and Noreen, 2003). Bibliography Seal, W., Garrison, Ray H. Noreen, Eric W., 2006. Management Accounting. 2nd ed. Berkshire: McGraw Hill Education, 1:2-12, 17: 763-765, 19: 840-844. Garrison, Ray H. Noreen, Eric W., 2003. Management Accounting. 10th ed. New York: McGraw Hill/ Irwin, 1:13-17, 8:316-320, 338-339, 10:445-454. Ashton, D., Hopper T. Scapens, Robert W., 1995. Issues in Management Accounting. 2nd ed. England: Pearson Education Limited, 1:3-5, 3:46-47, 6:115-116, 14:300. Hopper T., Scapens, Robert W. Northcott, D., 2007, Issues in Management Accounting. [e-book] England: Pearson Education Limited, 4:65-69. Available at: Google e-books http://books.google.co.uk/books?id=k3La7WnBBGICprintsec=frontcoverdq=issues+in+management+accountingcd=1#v=onepageq=f=false. [Accessed 16 January 2010]. 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