Evolution of Management Accounting - Term Paper Example

Evolution of Management Accounting discipline and its relationship with other functions in organizations Introduction According to Bhimani (63), management accounting discipline is widely used in running of organizations and has enabled managers to simplify the operations of the organizations and has increased efficiency of running the business towards attaining managerial objectives. In Kaplan (390), the development of managerial accounting was rapid between 1850 and 1920 due to rapid expansion of business especially in the transport and textile industry. The pioneers of management accounting wanted o simplify the operations of the business and achieve a greater efficiency and profitability. They sought for strategies that would apply better in their situations and this became acceptable in every other organization especially in United States and Europe (Kaplan, 391). The desires was mainly driven by the need for efficiency of utilization of scarce factors of production especially labour and find a way of motivating managers in order to achieve the goals of business owners (Riahi-Belkaoui, 67). This study helps students and business people to understand how different cost accounting started and the basis in which they came into existence. It will also help assist to with criterion to develop new strategies for making different accounting options specific to their situations. According to Kaplan (391), most of the managerial accounting approaches in use at present came into existence long before 1925. Most of the advancements in cost accounting came into existence between 1850 and 1915. These changes were mainly imposed by railroad construction and establishment of a steel industry coupled with the outcome of the scientific management interest groups. Key institutions involved in pioneering innovations in administration of businesses include the DuPont Corporation in 1903 and General Motors in 1920 through the establishment of Return on investment strategy to examine the business performance, motivations and control of business resources through use of budget (Kaplan, 397). However, the modern advances in accounting include discounted cash flow breakdown and management science as well as group decision theory representations. Since then, there has been gradual development and implementation of changes in managerial approaches to match the new business requirements (Riahi-Belkaoui, 54). However, the business environment has been undergoing tremendous developments both in nature and scope over the last six decades (Bhimani, 76). This is due to emerging innovations and increase in operations as a result of globalization. Therefore, each business should be aware of its goals and develop strategies for accounting to achieve its goals of production more effectively and efficiently. As a result of 1980s innovations, there is an increase in competition for the businesses which requires a change in the way businesses use to make their financial reports and regulate their operations (Kaplan, 399). Due to poor stock market performances of 1920s, business directors started focusing on creating financial report as a financial reporting requirement at that time hence limiting the growth of management accounting strategies. As a result of emerging competitions among the world nations, Automobile manufactures of Japan forced Americans and European nations to establish broader view of business performance based on value and service as opposed to assessment based on efficiency of output (Kaplan, 394). The business performance has been undergoing a lot of changes aimed at improving their operations and increasing the managerial efficiency. The ancient strategies are inadequate to match the modern requirement for effective business operations (Riahi-Belkaoui123). This is because in the modern period business are focusing on cost reduction and profit maximization through technology and advancement. There is no room for errors in the current period since a slight defect could make the business to loss its entire operations to the competitors (Bhimani, 82). Furthermore, businesses are focusing on minimization of the expenses through reduction of inventory held at any given time to decrease in storage space. Therefore, businesses have to develop production strategies to ensure they meet daily client’s needs without surplus or deficit as a result of deficiency of inputs. After the establishment of enormous industries in United States which resulted to development of textile mills and railroads as a result of scientific management strategies (Bhimani, 99). This resulted to need for knowhow about application of cost and management skills to run the rapidly expanding businesses in the area of shipping, manufacturing and supply in the period between 1850 and 1925 (Kaplan, 396). This was influenced by desire to establish a mechanism of coordinating internal activities such as processing of raw materials in the textile industries as well as in shipping of cargo and passengers through use of railways (Sabrina & Julien, 39). This approach offered economic incentives of performing various practices for ordinary tasks from one location instead of having such tasks performed in different locations, a practice which was quite expensive and laborious. For example the establishment of cost accounting processes of Layman Mills (England) in 1855 assisted managers to examine effectiveness with which the mill was able to transform the raw materials into final products (Kaplan, 401). The strategy used double-entry book of account offered a trail regarding the efficiency of labour, production expenses of the end products, effect of different organization structure and regulation of the use of unprocessed materials. Finally, the strategy assisted the railway to handle huge chunks of money that any other business by providing a summary of financial operations of the corporation (Bhimani, 104). Furthermore the corporation was able to form a method of processing financial report involving various department located in different parts and account for expenses incurred and income generated by various subdivisions of the railway corporation (Kaplan, 395). However, during that period, the business managers used this approach to establish the expenses incurred directly by particular factor hence this did not take into account invariable expenditure or cost incurred during a specific period. According to Kaplan (402), the Du Pont Powder Company was established in 1903 and by 1910 they had utilized all different management accounting strategies. This resulted to centralization of various organizations processes in a single business as opposed to previous methods of contracting separate business units to carry out various business operations (Bhimani, 112). This increased business efficiency and profitability of the Du Pont Powder Company and this lured other large business corporations to apply the same approach in their operations (Sabrina & Julien, 41) This strategy enable businesses to make investment decisions by employing their resources in the most profitable ventures and raising additional capital required for expanding business operations. Management accounting capital costing activity: During this period, business invested heavily without knowledge on how to trace the amount of capital that was input in business or how much expenses incurred (Kaplan, 398). However, Carnegie came up with an idea of tracing the amount of resources invested in the business and the amount of earning the business was obtaining. As a result, he targeted on lowering the amount of variable expenses sustained by the business and this enabled him to set the prices his products lower than his competitors while at the same time he was able to realize huge profit to continue expanding the business. This enabled his business to continue surviving even during period of economic meltdown as opposed to his rivals who went underground. Therefore, without knowledge in management accounting managers could not have been able to estimate the value of resources they invested in business against the returns of those resources (Sabrina & Julien, 54). One of the most significant uses of management accounting in making investment decisions of the inadequate resources is the development of discounting method of estimating earnings from the ventures. It is obvious that the value of money continues to decline over time hence managers should be able to compare returns from various ventures over a certain period of time (Bhimani, 123). This is based on the fact that the longer it takes the business to generate income the higher the discounting rate hence the lower the value of money earned in several year in the future than the same amount at present. Management accounting and human resourcing activities in the organizations: Another move in scientific management was developed by engineers who were able to carry out thorough job breakdown to establish the number of people required to perform specific tasks for specific time in order to achieve a certain target (Kaplan, 392). This formed basis for working out wages for various workers based on their efficiency and number of hours they have worked (Sabrina & Julien, 72). This approach became essential particularly in use due to inadequate labour supply since business managers could motivate the workers by paying them according to the amount of work they have done hence workers committed themselves to working overtime in order to increase their earnings while the business owners maximized production. Management accounting and performance or efficiency estimation: By 1918, managers started using standard costing approach in which they started taking into consideration the value lost as a result of unused capacity of the machines or the idle time of the workers (Kaplan, 393). However, before this period, managers used to value their earnings as just the excess of income over the cost incurred without including the invariable expenses. The business managers were not also recognizing the loss of value of their assets over time due to tear, obsoleteness and so on (Sabrina & Julien, 67. Through establishment of standard costing, the business managers came to realize that the expenses incurred in production varied with amount of output (Bhimani, 135). Therefore, as more units were produced, the amounts of expenses incurred per units produced continue to decline. This technique of allocating costs per units of output also assisted in determining the minimum amount of products that were necessary to cover the invariable cost before the business could be able to start realizing some profits (Jean & Robert, 36). Similarly, the managers could use this technique to estimate the amount of profit they can make from their production activities. This technique of allotting both variable and invariable expenses on the total units of outputs became practical in United States in the year 1904. The next advancement involved separating expenses on the based on the efficiency of machines used (Bhimani, 143). Traditionally, managers used to allocate cost based on the mean of all machines. The new development revealed that all machines did not perform at the same rate hence expenses must be different. This was a very essential discovery since it could assist managers to make use of most efficient machines to maximize their income. Management accounting and departmentalization: Increase in complexity of business structures and desire for increased business efficiency resulted to separation of managerial activities into different departments (Jean & Robert, 39). With each department being ended by different personnel, this resulted to business efficiency as different personnel strived to achieve the best approach that would increase the efficiency of department they were in charge of. In order to provide incentives to the department personnel, Du Pont Company came up with Return on Investment (ROI) strategy to estimate the efficiency of operation of specific department and that of entire Company (Kaplan, 403). Du Pont considered this strategy better than the previous approach of calculating profitability of the business as a proportion of sales or expenditure, but failed to give the earnings as a proportion of the resource invested in business (Bhimani, 147). The use of ROI enabled managers to choose the best venture to allocate scarce capital based on expected proportion of income from the resources allocated. The mangers also took into consideration the additional expenses resulting from loss of value of the assets over the period they are in use (Jean & Robert, 42). The use of ROI enabled managers to separate capital budget and operating budget. Management accounting and managerial roles: During the First World War, managers in different departments faced conflicts of interest as top mangers discarded their duties and started monitoring the activities of their junior managers (Kaplan, 405). After the war, a period of economic meltdown followed which made business to suffer due to insufficient long-term plans. This led to the establishment of multi-divisional firm by Du Pont and General Motors companies (Jean & Robert, 41). The accounting approach taken by General Motors enabled the company to improve its operations in a number of ways (Bhimani, 149). One them is that it assisted the managers in predicting the business performance at the end of financial year. Then, it enabled the business to estimate the annual expenditures and earnings and predict any possible variations from the estimates. This also included suggestion to the department managers regarding a possible course of action to enable them achieves their targets in accordance to the budget (Kaplan, 391). Finally, his approach empowered department managers to utilize available resources and managerial skills to achieve their targets in line with the organizational goal. Management accounting and ethical issues in the organizations: The General Motors introduced a procedure for motivating business through profit sharing in a contract agreement where the contracted party was supposed to earn a constant amount irrespective of the proceeds of the contract (Jean & Robert, 46). However, this resulted to unfairness since some department managers could engage in a contract that benefit individual department to regardless of detrimental effects to the rest of the organization. In order to ensure fairness in the entire company, the General Motors introduced a different method for motivating the partners who were involved in a business agreement (Kaplan, 414). This involved introduction of bonus plan instead of divisional profits in which the benefits realized from the business performance was shared by all those works who contributed to the earnings of the business. Management accounting and procurement operations: There was a challenge in estimating the cost of production of various products in an organization especially where one department traded with another department in the same organization (Kaplan, 405). Since some expenses were shared among the departments, it was difficult to estimate the earning obtained from some products in a situation where some finished products of one department were transferred to another department as its raw material before it sold to the market (Jean & Robert, 53). This was also a challenge because the manager could not be able to make decision on whether it was cheaper to manufacture some products on their own or whether to source them from the outside market in a situation where some processed products were required as raw materials for a different department in the same organization (Sabrina, & Julien, 45) To solve this problem, General Motors applied a method of working out the entire cost associated with finished products from one division which was required in another division as its raw material (Kaplan, 413). The approach involved adding some estimated profit from the final product in manufacturing division before transferring it the another department as it raw material . According to Jean & Robert (54), the aim of this approach was to enable each division to work out its expenses and earnings independently and establish the efficiency of its processes. This became the basis for working out opportunity cost where there are different options to choose from. According to Kaplan, (408), until 1925, businesses relied on ROI and payback period in making investment choices. After 1925, managers started investing their resources in research and technique to ensure efficiency in production and increase potential for predicting the best investment options based on anticipated returns from the capital invested. One of the major developments was discounting of cash flows realized from capital investment over a period of time (Jean & Robert, 62). Quantitative estimation of the business performance has enabled managers to decide on the best investment options. However, the emergence of agency theory has assisted in maximizing the gains realized by both the investors and the managers of the business as well as the other stakeholders (Bhimani, 165). However, this required the investors to specify their objectives provide financial incentives to the mangers in order to enable them pursue investor’s goals. The issue of transaction cost has also been dealt with during this period whereby the organization bears the burden of the transaction cost in order to maintain it as low as possible and increase organizations efficiency (Kaplan, 411). Use of short term goal to estimate earnings could result for ineffective utilization of resources because investors could fail to invest resources in long term project with greater returns in future in comparison to the short term projects. In conclusion, the development of management accounting techniques was critical for management different operations of the business due to rapid increase in size and complexity of processes. Management accounting techniques have played great role in designing business activities such as deciding the number of workforce required, working out profitability of different ventures for investment decisions, pricing of output, procurement of input, motivating workers and estimating the efficiency of operations of the business activities. Consequently, business managers are able to reward workers according to their productivity in business hence resulting to fairness in business practices. However, different organizations can utilize different strategies to achieve different level of performance hence it vital for the managers to find out which strategies can best fit their situation. Also, business should strive to develop new strategies in case they feel that none of the existing management accounting strategies can fit in their case effectively. Works Cited Bhimani, Alnoor, Management Accounting in the Digital Economy, Oxford University Press, Oxford, 2003, pp. 43-189 Jean, Heck, L. & Robert, Jensen, E., An Analysis of the Evolution of Research Contributions by the Accounting Review, 1926-2005: Accounting Historians Journal, Vol. 34(2), 2007, pp. 32-65 Kaplan, Robert, S., The Evolution of Management Accounting; The Accounting Review, Vol. 59(3), 1984, pp. 390-418. Riahi-Belkaoui, Ahmed, Behavioral Management Accounting, Quorum Books, Westport, CT, 2002. Pp. 21-213 Sabrina, Bellanca, & Julien, Vandernoot, Belgian Public Accounting: Evolution and Compliance with IPSAS; International Advances in Economic Research, Vol. 19(1), 2013, pp. 21-87 Read More