Management accounting - financial reporting - Essay Example

Introduction Recent literature suggests that the environment that supports management accounting practices have changed considerably with advances in information technology, mounting competition among companies, globalization of businesses, economic recession, new management strategies and the shift of focus to customer services and improved quality. To support such changes, companies have altered their management accounting practices to adapt to the ever changing environment. There is sufficient research done by the authors discussed in this work, to support such a statement. The authors have also identified the factors that led the companies to implement such changes in their respective subject groups. To remain competitive in such a globally advanced environment, developing countries have introduced new cost and management accounting systems such as activity-based costing (ABC), activity-based management (ABM), target costing, product life cycle costing, quality cost management, customer accounting and the balanced score card (BSC) approach to performance measures. The difference in the systems used by the developed and developing nations can be attributed to the difference in cultural values between them. The systems in practice in the developed nations need not suit the developing nations as the environments surrounding the two are significantly diverse. A study of the South African firms by Waweru et al (2004) revealed that on average 63 percent of the management accounting changes were implemented in the last decade. Due to liberalization, increased competition and technology changes, the South African firms felt the need to be more competitive and hence adapted their management accounting techniques to suit these needs. Quality and customer service were identified as the immediate competitive strengths and therefore changes were implemented to support these factors. The second study discussed here by Joshi (2001) caters to management accounting techniques adopted by Indian firms and a comparison of the same with a study conducted on a developed market, Australia. Owing to differences in cultural values and the risk averse nature of Indian companies, adoption rates is relatively higher for traditional management accounting techniques in India and lower for newly developed techniques. The study reveals that Australian companies are early adopters while Indian companies are late adopters. The final study discussed by Damant (2003) in this work deals with a specific aspect of financial accounting, the income statement. The author of the study supports the view that a proposed change is needed to the traditional profit and loss account to promote better understanding and transparency in reporting. Although it is evident from the study that financial accounting requires a standardized format across companies and industries to enable comparisons and benchmarking, the author is of the opinion that implementing the new matrix would clear away many past and present difficulties in financial reporting. Theoretical insights by the authors According to Waweru et al (2004), all organizations are subject to their external environment and are dependant on them for their inputs and their output. "A company has to maintain a consistent relationship with the environment for its success." The changes in the external environment cause a rippling effect that causes alterations in the management accounting principles adopted by a company. The authors concur with the statement and conducts further research to identify the factors that induce and hinder the companies to alter their management accounting principles. Studies have proved that the political, social, economic and cultural aspects that surround a company influence its management accounting practices. Bearing in mind the diverse conditions under which companies operate, developing countries are cautioned against adopting principles practiced by the developed countries. Joshi (2001) also supports previous studies conducted concerning management accounting practices that proves that changes have to be made to these practices to adapt to the changes in competition and production environment, changes in cost structures, and the rapid development of technology. It is argued that the dominance of Japanese companies in global competitiveness is attributable to the country's transformation through automation, cost discipline, continuous improvement and collective decision-making. Previous studies on budget planning and standard costing, target costing, ABC and other developed management accounting practices in various countries, show evidence of its adoption across the US European countries, Australia and finally, Asia. These new techniques have been suggested as means of linking operations to company strategies and objectives. Studies report that more than half the companies in the US practice the developed management accounting techniques with a lot of success rates. Evidence from Europe proves that even though the adoption rate is slow, they are catching on and implementing the changes. The same stands for Australia as well, while India shows poor rates of adoption and implementation. The study conducted by Waweru et al (2004) has been supported by several previous researches; research conducted by Vally in 1998 that suggested a significant relationship between the size of the company and the transfer pricing methods used by South African firms; research by Taylor et al. in 2001 that established Australian executives to be more tuned in to financial measures whereas those in Mauritius, a developing country, to rely more on non-financial measures. The authors also make reference to changes adopted in management accounting practices by developed countries in the last decade that suggested a 31 percent change in Canada within the last 3 years and significant changes in the UK as well during the last decade. The arguments in support of this claimed changes in the way management accounting is used rather than in the introduction of new techniques. Waweru et al (2004) makes a reference to contingency theory and supports their study with the aid of this theory. "The contingency theory of management accounting is based on the premise that there is no universally appropriate accounting system applicable to all organizations in all circumstances." On the other hand, the theory identifies the reasons for such changes and the authors propose the following four factors as the influence in organizations in developing nations: Economic constraints Deregulation/ global competition Technological advancement and Size and type of organizations The third article discussed here by Damant (2003) deals with a specific aspect of financial accounting, investment analysis and the income statement, and the changes recommended to be made to the same. In a research presented by Richard Barker, Research Fellow at the IASB, he argues that the traditional profit and loss account be supplemented with a statement of comprehensive income in the form of a matrix. The theory to support this states that everything that happens to a company has some significance to its future and hence a distinction between items in the profit and loss and reserves is a delusion in principle and practice. Even though financial accounting practices require a standardized means of reporting across different industries, changes have been recommended to improve the format of reporting to make it more transparent. How the balance sheet, the income statement and the cash-flow statement articulate one with another over time and over an economic cycle are at the heart of what a financial analyst does. It is the author's opinion that the financial statements of a company should reflect the timing, size and certainty of the future cash flows generated by the company and this acts a basis for making economic decisions. Study Liberalization of the Indian economy since 1991 has brought Indian companies to a global platform as well as opened doors for global companies to enter the Indian market. This increased pressure for international competition has changed the Indian economy and led Indian companies to adopt various traditional as well as recently developed management accounting practices. The study conducted by Joshi (2001) examines the extent to which these companies have adopted such practices, the benefits received from them and the priority that will be given to these practices by the Indian companies in the future. The study was conducted on a sample of 60 large and medium sized manufacturing companies in India and the results obtained were then compared to the results of a similar study done in Australia. Waweru et al (2004) on the other hand, studied the South African firms and related his work to all developing nations. The study conducted by the authors entailed a multiple case study approach, revolving around 4 companies, ACB, XYZ, MNO and OLA, based in South Africa. It has been intended to study whether differing environmental conditions create the need for different types of management accounting systems. The focus is on the management accounting systems prevalent in the companies, how much has altered in the last decade and the factors that supported and hindered such changes. Twenty seven management accounting and controlling techniques, divided into five main types - planning, controlling, costing, directing and decision-making - have been discussed in the study. While both the above mentioned authors studied management accounting and the extent of change accounted in its practices by different countries, Damant (2003) on the other hand, discusses a set of proposals to alter the format of the income statement to one that accounts for the true picture of performance of a company. For example, the author argues that extraordinary or exceptional profit in a statement should be foregone and instead a comprehensive statement should be introduced that display performance in total and in the clearest form possible. The author attributes the resistance to this theory to unfamiliarity and limited publications but states with ample confidence that the proposals will soon be accepted. Findings As a response to the initial subject of the existent management accounting practices put forth by Waweru et al (2004), the respondents identified those that were currently practiced within their companies out of the 27 listed. Although they all operated under a formal budgeting system, flexible budgets were introduced only in their recent past when it was recognized that fixed budgets did not suit their working environment. Developing countries, due to their unstable economies, are more suited to flexible budgets as opposed to developed economies. Three out of the four companies prepared their budgets using the less costly and less time consuming incremental budgeting method. Sales forecasting was mostly done by studying past sales trends and the final incremental figure was left to the judgment of the top executives. The culture of decentralization and encouraging participation from employees was an impending trend in the developing countries. Due to lack of adequate faculties, statistical methods were not used by these companies to forecast sales. Waweru et al (2004) also noted that the companies were united in their use of discounted cash flow methods for capital appraisal. Although these methods were not used in isolation, their prominence in the developing countries is attributed to the instability prevailing in their economies. It was also noted that the culture of developing countries promoted collective and team based performances rather than individual performances. This is in part due to the widespread poverty in these countries and therefore, the financial as well as non financial performance measures adopted by these companies were reportedly team-based. It should be pointed out that although financial measures have existed in these companies for years, non financial measures were relatively new and in their early stages of introduction. Joshi (2001) is of the opinion that India appears to be hesitant in adopting new measures due to cultural values, lack of infrastructure, availability of material on the techniques and lack of promotion by consultants. A study on the impact of culture on management accounting techniques in different countries showed that national culture had a huge impact on certain aspects of management accounting practices. The author explains that the term culture inculcates elements such as attitudes, beliefs, norms, and values and in the context of this study, these elements relate to the management's perspective of change. While comparing the cultural aspects between India and Australia, the author seems to concur with the previous study of Waweru, Hoque and Uliana that India, being an emerging market, gives emphasis on collective rather than individualistic terms and as a consequence there exists hierarchy within the companies in India. Indians are also risk averse and the companies tend to be more centralized and autocratic. Indian societies believe in long term orientation and the cultural richness and heritage delays the process of adoption of new techniques. In view of these, it is evident from the study that Indians are late adopters when compared to Australian companies. Owing to cheap and abundant labor in the developing countries, traditional cost allocation bases such as direct labor were implemented for computing indirect costs for product costing, noted Wawaeru et al (2004). Joshi (2001) in his study revealed that the adoption rate in India for traditional management accounting practices was higher than for the recently developed techniques as most of the practices adopted related to traditional budgeting and performance evaluation methods. The future emphasis also lay in traditional practices rather than newly developed systems. Significant differences were found between the Australian and Indian practices, the biggest difference lying in the varied cultural values of both countries. Indian management is comparatively more risk averse, conservative, less innovative in adopting new techniques and give strong emphasis to societal values and practices. According to Waweru et al (2004) another notable trend in these companies is the overt contribution of top management in the decision making processes. Monetary as well as non-monetary methods were used to motivate employees and in the recent years, decentralization and encouragement of participation of front line staff in core processes also gained prominence. By encouraging employees to invest in the company shares, they motivated them to better overall performance. While discussing motivation, it is desirable to note the study of financial accounting in relation to the same. According to Damant (2003), a friendlier means of financial reporting that can be read by layman, which includes company employees and shareholders, can go a long way in promotion and motivation. An aspect of the new matrix that poses a definite advantage is the solution to the problem of complexity in reflecting changes in fair value in the traditional profit and loss account. This problem is tackled by the proposed matrix by using the remeasurement column that clearly defines the true value of change and the nature of the change in value concerned. Further, the central column of the matrix strikes a familiarity with the historic cost profit and loss account with more rigorous principles and maintaining its part share in the performance reporting of the company. The new matrix also makes another important distinction - a distinction between different types of performance outcomes. The value of a company is assessed by discounting the future cash flows and revaluating the assets and liabilities over time. Thus, a financial analyst, in forecasting the future cash flows will have to deal separately with those assets and liabilities which are already valued on future cash flows. The new matrix, with the help of the remeasurement column, helps in assessing the real success or failure of a company by the valuation of the assets and by their changes reflected in that column. Technology and introduction of fast computers also had a major share in the alteration of management accounting techniques used according to Waweru et al (2004). Reports were prepared more frequently and reported to a larger audience as information became readily available. Graphs and charts were introduced which simplified the reports and could be understood by laymen and this increased participation from front line staff. This encouraged problem solving at the point where they occurred to save time and effort at the top management level. Political and social considerations carried a lot of influence in the capital budgeting decisions on these companies and most often were replaced, with successful outcome, by management judgment. Joshi (2001) supports this view through his study. The results of the study indicate that the pace of automation in Indian manufacturing companies have been significant, no drastic changes have been adopted in the cost structure and multiple rates are used in allocating overheads irrespective of the size of the companies. The author, while discussing the adoption rates of traditional as well as newly developed management accounting practices, reveal that Indian manufacturing companies show high adoption rates as far as traditional techniques are concerned and relatively low adoption rates for newly developed techniques. When compared to Australian companies, a similar trend was noticed with regard to management accounting techniques except for high priority given to formal strategic and long range planning by Australian companies as opposed to low adoption of the same in Indian companies. Waweru et al (2004) noted that although JIT was implemented in staff scheduling and reducing wastage, owing to poor infrastructure facilities and poor supply chain management, the technique could not be practiced for the purpose of managing inventory. Decision making without proper research and proper knowledge of the entire workforce were discouraged and proper capital appraisal methods were introduced on account of increasing competition. On the same note, Joshi (2001) claims that even though it is argued that ROI leads managers to place excessive emphasis on short-term profitability, Indian as well as Australian companies rely heavily on ROI and budget based variance analysis for organizational and divisional performance. An interesting point noted in the study is that those companies in India that have adopted new techniques has done the same by way of an integrated process, and owing to the slow abandonment of traditional techniques that are to be supplemented by the new techniques, Indian companies are still heavily dominated by the traditional systems. Another point of study is that large size companies in India showed better rates of adoption of new techniques than small size companies. While evaluating the benefits derived from the adoption of management techniques, Joshi (2001) found that Indian companies derived high benefits from traditional techniques and even higher benefits from two new techniques, target costing and ABC, which even had low adoption rates. Target costing was also ranked second for future emphasis owing to the realization by Indian companies on managing costs at planning and development levels rather than after full-scale production. The individualism-collectivism dimension influences the time horizon for performance evaluation and hence, there are significant differences in the performance evaluation techniques adopted by Indian and Australian companies. The study by Joshi (2001) has also conducted a comparison between Australian and Indian firms and found three major differences between the emerging and developed countries. Firstly, the annual growth rate for the last three years was an average of 6 percent in India and between and 9 and 10 percent in Australia. Compared to the highly sophisticated and structured capital markets in developing countries, India's stock markets were neither structured nor sophisticated. And finally, the number of qualified accountants is much lower in India when compared to Australia. Besides the above, there are identifiable differences in business environments, ownership structure, legal requirements, poor infrastructure, and the cultural background and value orientation of people, among these two nations. Australian companies give high emphasis on the newly developed practices and are usually early adopters of these practices. To tackle the question of changes implemented in the last decade, Waweru et al (2004) in their study, reported that on an average 63 percent of the management accounting systems changed in the last decade. In this study, performance reporting recorded the highest change (34 percent), followed by control (29 percent), planning (18 per cent), directing (11 per cent), while costing ranked last with only (8 per cent). The authors gained adequate evidence through the study to support their view that management accounting systems had undergone ample changes to suit the environment conditions. The authors reported that quality of customer service has been recognized as the competitive edge in the global environment by ACB Company and hence they have supplemented management accounting practices to be more competitive and make timely and quality decisions to meet customer needs. Companies ACB and XYZ believe that change is a continuous process and should be made according to what the situation demands. The most common factors identified as the motivators of changes in management accounting systems are increasing competition, technological advancements and increased access to the same, liberalization of the South African economy and poor financial performances. On the other hand, fear of accepting change, lack of adequate funds to finance change, lack of adequate accounting and computing skills, communication barriers and management inertia were considered as factors that hindered change in these companies. An investigation into the future priorities given by Indian companies by Joshi (2001) discovered that even though some new techniques such as target costing, ABC and benchmarking were given higher emphasis, traditional techniques will maintain its importance in the future as well. The study also provided that although Indian companies will continue to focus on traditional techniques, they will also refine and adopt new techniques over the next three years. According to Damant (2003), another important aspect of the proposed matrix is its treatment of earnings - it proposes to leave the theory of calculating earnings to the user of the statements. This would mean that the definition of earnings would vary from company to company, industry to industry or from one economic cycle to another. This is in contrast to the general theory that standardized definition is necessary to compare and contrast between different companies and industries. This is especially true in our present environment of advanced information systems. Thus the theory faces an apparent contradiction on this subject. While the theory supports that there can be no one figure that can represent the performance of a company, the world supports a standard figure across companies and industries. The concept of headline earnings, which reflects the operating or trading aspects of performance as opposed to changes in the capital aspects of a company's structure, is reported to be the practical solution for the above problem introduced in London and Johannesburg. The author states that this concept is very similar to the concept of separating remeasurement and other income in the new matrix. Results The study by Waweru et al (2004) supported the view that internal and external environmental factors surrounding a company effect changes in its management accounting systems. The study identified the contingent factors responsible for causing change in companies in developing countries as stated above. Global competition and technological advancements, along with economical uncertainties and resource scarcity experienced by the developing nations, were recognized as the core aspects of change in the management accounting systems. On the same line, the study by Joshi (2001) also supports the view that management accounting techniques are evolving with the environment that surrounds the business. As cultural values hold a considerable influence over the techniques adopted, there are significant differences in the practices between Indian and Australian companies. The conservative attitudes of Indian management towards new changes and challenges, high expenses in adopting new techniques, lack of training and expertise, and most importantly, the negative mindset of Indians towards foreign ideas, resources and goods have left Indian companies with a lower adoption rate to new techniques than their Australian counterparts. Meanwhile, on the financial reporting front, Damant (2003) reveals his support for the new matrix by encouraging the acceptance of the same by the regulators, the companies, the press, the markets as well as the investors and analysts. "The matrix is correct in principle, extremely valuable in practice, and deals with one of the great trends in financial reporting - the move to fair values - in a way which is obviously correct and understandable". Conclusion To conclude, this work has provided sufficient evidence to reveal that the authors discussed support the view that management accounting practices vary across organizations and industries. There is also adequate evidence to prove that different environmental aspects support different management accounting techniques. While the first two research articles discussed above deal with the various reasons for change in management accounting techniques across countries, the final study deals with financial reporting and the proposals to alter existing standards. The techniques adopted in developing countries are significantly different from those adopted by developing countries. This is mainly due to the unstable economies, political and social considerations and poor infrastructure and training facilities prevalent in the developing nations. The major motivators of change in developing countries such as South Africa and India have been identified as poor financial performances, liberalization and globalization, increasing competition and advancements in technology. The study on South African forms revealed the changes in management accounting techniques adopted by them to remain competitive as well as provide emphasis on customer services and improved quality. The second study conducted on Indian firms revealed that owing to the cultural values and norms that these companies adhere to, there is a considerably low adoption rate in relation to newly developed management accounting techniques as opposed to higher rates in relation to traditional techniques. Finally, the third study conducted by Damant supported the view that although standardization is necessary when dealing with financial reporting, a new format that promotes better understanding and transparency is called for. This new matrix supported by the author is expected to simplify the accounting calculations while maintaining the need for a standardized performance figure that promotes comparisons across companies. Read More