Organisational Context of Management Accounting - Essay Example

?Organisational Context of Management Accounting Table of Contents Table of Contents 2 Introduction 3 Issues in Management Control & Accountability 4Conceptual Analysis & Methodology 5 Agency Theory 5 Contingency Theory 7 Institutional Theory 8 Analysis, Discussion, and Synthesis 9 Conclusion 11 References 12 Bibliography 14 Introduction This essay addresses the problems of management control and accounting that was persistent at Ivy League University which lead it to introduce new ERP system. The problems have been analyzed from three perspectives i.e. agency theory, contingency theory and institutional theory and has addressed mainly the potential problems of principal-agent and the management accounting system in an organization. The governance framework of Ivy League University is decentralized where the various departments are separately administered and consolidated centrally for the purpose of financial reporting and regulatory requirements. The university receives research grant funds for which it has a fiduciary responsibility. The revenues from grants and contracts constitute 30% of the total operating budget of the University. The consolidated grant activity is reported other university funds because improper management of grant funds increases the risk position of Ivy. The grant activities are strictly assessed by the legal counsel and the internal as well as external auditor. The University’s Central leadership works towards decreasing inconsistencies in grant activities. Ivy has made an effort in business process redesign and system modernization within three functional areas i.e. financial management, administration of grants and contracts, and HR and payroll. Therefore, in order to create an integrated administrative system, Ivy had introduced ERP that was expected to decrease audit risk and increase fiduciary control. These efforts were driven by the fact that Ivy is a highly leveraged and highest graded financial institution in US and the bond-holders have trusted it with their money. However, the introduction of ERP has also brought along problems of adjustments to a more centralised management accounting system where it was more decentralised previously and followed the legacy commitment accounting. Issues in Management Control & Accountability Major issues that were related to the management control and accountability of Ivy League University are: High Audit Risk: As Ivy was involved with decentralized governance framework in which every department was administered separately in its grant funds and its uses. There was a gap between funds actually used and those reported. The inconsistencies in spending process were quite high. Despite this disadvantage, the commitment accounting was an essential part of the management accounting system at Ivy, removing which from the ERP system presented institutional risk. Management Control: In Ivy, FSS (Faculty and Support Staff) were responsible for the actual expenditure of Principal Investigators (PIs) and the decided budget. The funds that were asked by PIs for project activities are known as commitments (commitment accounting). The negotiation between PIs and administrators to allocate the funds was a result of many subjective factors such as individual temperaments, departmental norms, available time, professional relationships, nature and stage of research. Therefore, the management control over the variations in research expenditure was very low. The ERP financial management was introduced without the feature of commitment accounting which posed problems of faculty’s control over their finances. The problem was that the new management accounting system focussed more on providing information to the Central leadership than the faculty, as expressed by the academic manager. Accountability: The University is responsible for the grants it gets every year for research work. The grant providers have a right to know that their funds are utilized in an efficient manner. The problem of accountability has been associated with the variances in the expenditures of PIs for research commitment funds. They are accountable to the stakeholders who provide funds for the research work. These funds constitute almost 30% of total operating funds budget. Conceptual Analysis & Methodology Managers in an organization use accounting information to make informed decisions, which allows them to get equipped for managerial control within the organization. As per CIMA, management accounting is the science of value creation in the organizations through a combination of finance, accounting and management (CIMA, 2012). Recently, much importance has been given to the management accounting control systems within the organizations, although the issue of control always existed. These control systems are an integral part of organizations’ development. The MAC system is a process that involves identifying, measuring, accumulating, analyzing, interpreting and presenting the information that facilitates the executives in fulfilment of organizational objectives (Macintosh and Quattrone, 2009, p.5). The reasons for need of accounting controls are several such as the need to aggregate and express the financial results of all the activities through a common measure, the stakeholders’ need to monitor liquidity and profitability of the organizations, to enable the common decision rule as applied to all the managers while considering the various courses of action, and importance of measurement of financial results so as to provide freedom and autonomy to the managers in achievement of objectives (Drury, 2007, p.394). Agency Theory Agency theory was originated in 1960s where the problem with risk-sharing was addressed. The risk-sharing problem arises when the parties to the risk have different attitudes towards the risk. The agency theory addressed this attitude in the form of principal-agent problem where the principal and agent have different interests in an organization. The principal (owner) delegates the management of a firm to the agent (manager) through a contract. It has been often found that the interests of agents are in conflict with the interests of the principal and it becomes difficult for principal to verify if the agent is acting in his/her self-interest or in the interest of the principal (Eisenhardt, 1989, p.58). The agency theory has been referred to explain a number of organizational phenomena such as diversification strategies and ownership structure (Denis, Denis and Sarin, 1999, p.1075). Jensen and Meckling (1976) defined the costs associated with agency problem and its relationship with the issue of separation and control and investigated the effect of debt and external equity on these costs. It has also been acknowledged that the focus of agency theory is also on the employment contracts that maximize the performance of organizational addressing the problems of information asymmetry and lack of motivation. Such problems are persistent in the decentralized firms where the decisions are made by the managers who have information advantage over the shareholders. In case of Ivy League University, the grants providers were at a disadvantage in information that was available to the administration and PIs. PIs had a habit of over-spending the commitment money and ensured that the once the funding is approved, it has to be spent entirely instead of returning. Certainly, their interests were in conflict with the interests of the external funds providers. The theory describes these information problems that may arise in intra and inter-firm relations and how to encourage managers not to misinterpret the relevant information. The behaviour of managers can be attributed to several factors: Managerial Incentives: Many a times, the incentives of managers are linked with the achievement of budgeted targets, which motivates the managers to provide biased information. Conflict of Interests: The interests of managers are usually different from those of the owners as the manager may not bother about the owner’s wealth maximization. Potential for Information Asymmetry: The owner has to depend on the agents to get the financial and operational information related to the organization. This may result into loss of control over the strategic matters of the organization. The managers usually have the incentives to take advantage of this situation. Contingency Theory In order to design an effective accounting control system, it has always been essential to consider the circumstances in which the system will be used. The management accounting control in organization is best described by the contingency theory. The main premise on which the contingency theory of management is based is that there is no universal accounting system that can be applied to all the organizations in every circumstance (Emmanuel, Otley and Merchant, 1990, p.57). The contingency theory identifies the aspects of accounting system associated with certain circumstances and matches them appropriately. The aspects of accounting control system have focussed on the inclusion of budgeting such as participation and achievement of budgets, performance evaluation such as timeliness and level of aggregation of information. Reid and Smith (2000) confirm the choice and adaptation of management accounting systems in small firms to be contingent upon environment, technology and organizational structure. Donaldson (2001) discusses the contingency theory in the form of three contingencies i.e. environment, strategy and organizational size. The environment contingency has an impact on mechanistic structure. The mechanistic structure refers to the effect of technological and market changes on the environment of the organization. The strategy contingency asserts that the organizational strategy should fit with the three contingencies size, strategy and environment. For example, an organization employing diversified strategy that wants to utilize the unfitting functional structure will eventually become ineffective because it is likely to have a top management lacking responsiveness to the markets. Institutional Theory Institutional theory has tried to explain how the structures and behaviours of the organizations are shaped by institutional environment. The concept of institution has been defined from various perspectives. Some are clearly defined while others are not explained well. So despite the similarity in approaches, there is no agreement on specifics. The sociological formulations with institutional focus can be explained as: Process of Development: Philip Selznick (1996) described the difference between an organization and an institution where if an organization is institutionalized, it attains a distinctive competence and special character. The leadership is responsible for monitoring the costs and benefits of institutionalization. Therefore, the institutional theory traces the development of processes, outlooks, strategies, distinctive forms, and competences from the organizational adaptation and interaction. Process of Creating Reality: Other versions of institutional theory have been largely contributed by Peter Berger in which the nature and origin of social order were addressed. Discrete Social Context: Here the concept of institution has been described as features of social life that lasts generations and survives social changes, which could have ended it. The social life here means the system of social practices and beliefs (Scott, 1987, p.499). Analysis, Discussion, and Synthesis In the last section, three theoretical perspectives have been discussed, which outline the case study and help in evaluation of the persistent problems at Ivy League University. The case of Ivy can well be explained by the perspectives of agency theory and contingency theory. Ivy certainly had issues with the management of grants and their uses by the faculties. Ivy League, just like a firm, depends on its credit ratings and relevant research being carried out every year for the funds in the form of grants. This makes the issue of governance in the academic institution all the more important. The grants management has historically been autonomous at Ivy and the management accounting system was based on commitment where the PIs were asked to commit the grants at the starting of each budget. This was commitment accounting which was based on the 'sociomaterial' configuration. However, the central leadership (similar to board of governors in firms) was responsible to oversee the variances in the research expenditure of each department that worked as decentralized unit. This decentralization posed the problems of control by the Central leadership. This was a case of Principal-Agent problem at Ivy. In order to make the governance practices more effective a centralized information system was being installed. This was a way for the directors to ensure the grant providers that their money has been put to good use. The second theoretical perspective in the case came from contingency theory that relates more to the introduction of ERP system at Ivy and the post implementation problems faced by the faculties and support staff. The management accounting feature of ERP was a different one from the one being used earlier i.e. legacy accounting system. As the contingency theory asserts that there is not standard accounting system that can be implemented in all the organizations as the system is being contingent upon many other factors such as structure, environment and technology. In an analysis of two firms implementing the ERP system, each one adopted different configuration, usages and implementations mainly based upon their existent systems, organizational structures and the strategies they used. The customized system had a profound impact on the management control practices in these two firms. Most importantly, ERP wasn’t introduced to bring revolutionary changes in terms of accounting control rather it was to improve the prevailing practices (Quattrone and Hopper, 2005, pp.735-760). This shows that the introduction of such systems need due consideration on the specific needs and structure of the organizations. These contingent factors in the case of Ivy League were the information dissemination structure at the university, management structure, and the nature of grants accounting. The grant accounting process depended on a lot of factors such as departmental norms, individual temperaments, locally negotiated outcome, professional working relationships, and the nature of research. The new system left this part of accounting and provided a design with the faculties in which they could achieve their goals without any thinking on the detailed financial information. This approach was time-phased budgeting. Consideration to the contingent factors was not given importance until the faculties along with support staff started complaining about the system, which made their working inflexible. This was also a result of the lack of faculty involvement at the configuration stage. At last, ERP system was modified to include the legacy accounting in addition to time-phased accounting and two administrative support centres were set up to solve faculty problems. From the third perspective i.e. institutional theory, the Central leadership was responsible for the costs and benefits of the Institution. The institution had a set of cultural norms, outlooks, strategies and competences, which enabled it to establish itself as one of the most prestigious educational institutions. Conclusion An evaluation of management accounting theories have been done through this essay referring to the problems of management control and accounting that was persistent at Ivy League University. In order to combat the issues of decentralized information processing and accountability towards grant funds providers, Ivy introduced a new ERP system. The problems have been analyzed from three perspectives i.e. agency theory, contingency theory and institutional theory, addressing the potential problems of principal-agent, the management accounting system in an organization and institutional framework, respectively. Therefore, it has been found that Ivy League has had the potential for agency problem resulting into substantial agency costs. The Central Leadership has taken measures to address the problems and assure the grants providers the effective use of funds entrusted upon their institution. Moreover, the relevance of contingency theory has also been observed while the University tried to install a standard ERP system to take care of the management control problems and accountability and improve upon the information dissemination. There were several problems as the accounting system had to be modified to suit the needs of its users. References CIMA, 2012. What is CIMA's definition of management accounting? [Online] Available at: http://www.cimaglobal.com/Thought-leadership/Newsletters/Insight-e-magazine/Insight-2009/Insight-June-2009/What-is-CIMAs-definition-of-management-accounting/ [Accessed 15 March 2012]. Denis, D.J., Denis, D.K. and Sarin, A., 1999. Agency Theory and the Influence of Equity Ownership Structure on Corporate Diversification Strategies, Strategic Management Journal, 20, 1071-1076. [Pdf] Available at: http://lsb.scu.edu/asarin/PublishedPapers/Agency.pdf [Accessed 15 March 2012]. Donaldson, L., 2001. The contingency theory of organizations. USA: SAGE. Drury, C., 2007. Management and Cost Accounting. 7th ed. London: Cengage Learning EMEA. Eisenhardt, K.M., 1989. Agency Theory: An Assessment and Review. Academy of Management Review, 1989, 14 (1), 57-74. [Pdf] Available at: http://classwebs.spea.indiana.edu/kenricha/Oxford/Archives/Oxford%202006/Courses/Governance/Articles/Eisenhardt%20-%20Agency%20Theory.pdf [Accessed 15 March 2012]. Emmanuel, C.R., Otley, D.T. and Merchant, K.A., 1990. Accounting for management control. 2nd ed. London: Thomson Learning. Jensen, M.C. and Meckling, W.H., 1976. Theory of the firm: Managerial Behavior, Agency Costs and Ownership Structure, Journal of Financial Economics, 3 (4), pp.305-360. [Pdf] Available at: http://tolstenko.net/blog/dados/Unicamp/2010.2/ce738/03_SSRN-id94043.pdf [Accessed 15 March 2012]. Macintosh, N.B. and Quattrone, P., 2009. Management Accounting and Control Systems: An Organizational and Sociological Approach. 2nd ed. United Kingdom: John Wiley and Sons. Quattrone, P. and Hopper, T., 2005. A ‘time-space odyssey’: management control systems in two multinational organizations, Accounting, Organizations and Society, 30, 735-764. [Pdf] Available at: http://citeseerx.ist.psu.edu/viewdoc/download?doi=10.1.1.121.5155&rep=rep1&type=pdf [Accessed 17 March 2012]. Reid, G.C. and Smith, J.A., 2000. The impact of Contingencies on Information System Development. 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