Evolution of Performance Measurement Models in Management Accounting Name Grade course Tutor’s name 2nd October 2010 Abstract Changes in management accounting have gone by unnoticed in the recent years. This article tries to explain by how much management accounting has altered through the years, since the 1950s to date, and the reasons that led to the changes. This work also focuses on various performance evaluation models, their applications and their effectiveness. Introduction
There was little advancement in accounting in the 1950s, as much of the effort was made towards finance and stock valuation. However, there have been material changes in the business environment over the past six decades, coupled with advancements in information technology that have warranted the transformation of management accounting. Although management control measures have altered significantly, there have been little changes in design and actions in most procedures. Literature review Scholars and business people alike have contributed to the advancement of management accounting.
Bhattacharya (2009, 11) says that except for those who work in research, many people do not realize the role in management accounting changed from cost collection and analysis to a proactive part in development and implementation of strategy. Bhattacharya gives two reasons for this; first being that there is no culture to capture the evolution of accounting and a lack of innovativeness on the part of accounting bodies. Secondly, most businesses do not fully utilize management accounting systems, implying that the average accountant would not experience the whole scope of his or her profession.
The Institute of Management Accountants (IMA) of the USA captures the evolution of management accounting by giving it a new definition: “Management accounting is a profession that involves partnering in management decision making, devising planning and performance management systems, and providing expertise in financial reporting and control to assist management in the formulation and implementation of an organization’s strategy” (Berliner and Larcker 1988, 19). This portrays the role that management accounting is expected to play by boosting competitiveness of companies in the future.
In the 1950s, management accounting was preserved for lower level management, but presently, IMA says the same position is reserved for top management for the same company. Horngren (1989, 52) observes that cost accounting classes in the 1950s laid emphasis on inventory valuation and income determination models. He goes on to say that focus in the discipline has shifted over the last sixty years. Horngren (1989, 112) notes “between 1960 and 1970, 46 percent of the material in textbooks covered inventory valuation while 33 percent focused on management accounting, compared with 73 percent and 6 percent respectively in the 1950.
Interest in management accounting has been increasing over the decades mainly due to the changing dynamics in the business environment. ” In the period between 1950s and 1960s, accounts were handled by a single person and focused on a single period, which all changed in the 1970s as accounts came to be handled by multiple people and focused on multiple periods. There was easy access to information in 1950 to 1960, relative certainty and hence zero cost of information.
On the contrary, uncertainty and asymmetric information across individuals led to costly information in the 1970s and 80s. Company objectives also contributed to the shape up of management accounting, as Horngren (1989, 107) puts it. Profit maximization was the major goal for companies in the 1950s, leading to practices such as variable costing. However, the objectives changed in 1980s as companies sought to utilize their resources, while considering important areas such as marketing, training, motivation, innovation and quality.
Managers nowadays choose methods that will provide the greatest benefits, rather than making decisions based on the cost of each. Furthermore, management accounting in the 1950’s focused on cost determination and financial control and therefore the models developed were based on budgeting and cost accounting systems. Through 1960s, focus shifted to providing information needed for management control of the business processes. In the framework, planning and control systems are composed of management control, strategic planning and technical control.
In the 1970s, management accounting laid emphasis on planning and control, where the contingency theory influenced choice of accounting and control procedures depending on the circumstances surrounding the organization at the time (Ittner and Larcker 2001, 379). In the past, the traditional cost accounting model was developed for the mass manufacture of standardized goods. Ittner and Larcker (2001, 379) notes “need to improve the system arose that led new operating concepts such as just-in-time, zero defects and computer-integrated manufacturing could be supported. The Japanese Management model focuses on just-in-time production, where suppliers make daily deliveries and finished products are immediately transferred to warehouses or shipped to customers. This could be the main reason behind Japan’s manufacturing’s success and competitiveness (Warren 2008, 87). Focus in management accounting then shifted to the reduction of waste in the mid 1980s, leading to the development of activity based costing (ABC) and activity based management (ABM).
Warren (2008, 117)notes “the ABC model assigns the cost of each activity to all the products or services provided to a company’s customers, according to the resources used up in the process of production. ” This model gives the company an actual picture of the cost of each item that it offers to the market, allowing management to eliminate products that are the least profitable. However, the major challenge of the ABC model was that two different sets of costs on one product which caused uncertainty and raised a lot of arguments (Needles, Powers and Crosson 2007, 273).
During the 1990’s, managers were forced to concentrate on creating and enhancing firm value, a result of the agency theory. The agency theory outlined the contractual relationship between managers (agents) and shareholders (principals), where agents are to take actions that maximize the interests of principals. This saw the dawn of management accounting systems. Kaplan (1984, 257) define management accounting systems (MAS) as “systems which support managerial planning, evaluation, and control activity and, in a broader sense, facilitate strategic choice”.
Contingency theory implies that companies are part of an environment made up of external factors and thus should employ strategy based on internal factors, so as to ensure their survival and competitiveness. MAS can thus was used as a measure of strategy’s performance since it emphasizes on the ability of the organization to adapt to change (Burns and Scapens 2002, 18). Later Cost management systems (CMS) were developed. CMS for computer integrated manufacturing (CIM) IS more comprehensive than cost accounting since it allows managers to be proactive in planning, managing and cost reduction.
CMS approach to measuring performance includes four levels of management; market level, business, factory and shop floor level. Cost management systems help in reducing costs since it aims at predicting costs before they are incurred, as opposed to relying on reported figures as is the case with cost accounting (Berliner and Brimson 1988). It’s advantageous in that continual improvement is possible by elimination on non-value added costs, that is, costs which don’t add value to the end user of the product.
Through the use of CMS, accountants place more emphasis on a product’s development stages in its life cycle and also target costing. The action-profit linkage model (APL), suggested in the early 2000s enables managers to “identify and measure key drivers of business success and profit, develop causal links among them and estimate the impact of actions taken to bring them about” (Warren, Reeve and Duchac 2008, 149). It denotes that a strategy is a set of activities that a company selects to indulge in.
Proposed actions may originate from a variety of the company’s departments such as finance and accounting, human resources, marketing or operations. The actions in effect will impact on a product or service offered by the company, which will in turn influence a customer’s behavior towards the said product or service. The customer’s attitude will in turn be reflected in the company’s revenues, thus indicating the cost of undertaking the chosen strategic action and ultimately linking actions to profits in decision making.
The down side of this model is that managers who use it tend to limit investments to only profitable areas. Conclusion Management accounting has undergone decades of challenges and progress. The traditional cost accounting models laid more emphasis on cost, while the modern models focus on cost, quality, timing, functionality, accuracy and reliability, and overall strategies that will help the organization to meet both its short term and long term objectives.