The Role and Operation of Management Accounting in Organizational Control - Essay Example

This paper is of two parts, with the second part building on the first. We begin by briefly describing our key items, namely: management accounting, organizational control, systems approach and Simon’s Levers of Control. Then, we cap our discussion by attempting to understand the role and operation of management accounting in organizational control from the perspectives of systems approach and Simons’ levers of control. Management Accounting Management accounting, as defined by the Chartered Institute of Management Accountants (CIMA), is “the process of identification, measurement, accumulation, analysis, preparation, interpretation, and communication of information used by management to plan, evaluate, and control within an entity and to assure appropriate use of and accountability for its resources” (CIMA Official Terminology). As such, management accounting is focused on business strategy and strategic decision making. With value creation as its objective (in contradistinction to financial accounting’s mere measurement of the organization’s worth or value), it is tasked to do the assessment about the competitiveness of (business) environment and the ascertainment of whether the competitive advantage (of the environment) is sustainable. Understandably, thus, management accounting is essentially forward looking by providing real-world strategic direction, business management and leadership (in comparison to financial accounting which -- as it does financial reporting, auditing, among others – is doing an after-the-fact verification). Control System Plainly said, control (system) is any scheme or design to manage, command, direct or regulate the behavior of entities (within an organization). In the context of organizational management, it is a system that gathers and utilizes information to evaluate and influence the performance of different resources – such as human, physical, financial, and what not – of an organization with the organizational strategies as the backdrop. It is a management function to monitor and, thus, to ensure that all the processes of an organization is geared towards its defined goals and strategies. Organizational control system is as old as organizations. It is an activity that essentially facilitates in the fulfillment of goals of organizations. Required by coordination of activities, motivation of behavior and the need to address the uncertainty and turbulence that organizations are facing, it is “any process in which a person or group of persons or organization of persons determines (or intentionally effects) the behavior of another person, group or organization” (Samuelson 1999, 1-2). Systems Theory Organizations and management of organizations may be understood through the prism of physical- and engineering-models-drawn systems approach or theory. The word “system” describes any set of interacting elements over time (see Vincent 2002), as in the bodily system of any living organism or the physical set up of computers and telecommunications. Systems theory, then, is a framework from which one tries to analyze and/or grasp the nature of and the very interaction among objects in concert in order to come up with some result. With the managerial, procurement, production, marketing, accounting – among others – as subsystems, organizations are systems (Hahn 2007, 305) -- of physical, social and technological nature. “As applied to organizations, (systems theory is focused) on the entire organization and considers the primary system objective to be sustainability of existence… through adaptation brought about by constant interaction with its environment” (Hahn 2007, 308). As system, organizations then are open (in opposition to closed system that is described as not in whatever form of relation with its environment). Their contact with the environment is necessitated by their basic survival. For this reason, organizations and their subsystems are of boundaries that make possible their exchanges with and adaptation to their environments, as these “systems… acquire information relating to either the environment or an organization’s transformation”… which is then “used to change strategic direction or modify internal processes” (Hahn 2007). These boundaries are made concrete by an open system’s four distinct functions, namely input, processing or transformation, output, and monitoring. The inputs consist of resources such as people, (raw) materials, equipment, money/finance, information and recruits from the outside of the organization. These are essential to construct and develop system operations. Said to be the heart of an organization, the processing, or transformation, function is when value is added by converting – through technology and human resources -- the inputs into product or service useful to society. The outputs are representing the consumption of goods/products and/or services, or the payment of wages and dividends. Then, finally, from outside and inside a system, monitoring mechanisms serve to gather critical information so as to more fully understand how an organization performs in terms of efficiency of operations and effectiveness of social interaction. Simons’ Levers of Control Aiming to introduce a paradigm through which the everyday management tension between value creation and control is dealt with, Robert Simons (Levers of Control: How Managers Use Innovative Control Systems to Drive Strategic Renewal, 1995) pointed out four “formal information-based routine or procedure that may be employed by the management to either preserve or alter patterns in organizational behavior” (159ff). In addition to the traditional internal controls, these control levers are, diagnostic control systems, belief systems, boundary systems, and interactive control systems. Internal controls are the usual safeguards – e.g., structural, staff, and systemic checks and balances -- by any company in order to protect its assets and make certain reliable record-keeping. The diagnostic control systems are instituted so that companies can optimize their outcomes as they get things done. Heavily relying on quantitative data, statistical analyses, and variance analyses, examples of these systems are output measurement, valuation standards, and incentives and compensation systems. With the use of these and other numerical comparisons, managers can scan for anything unusual that might indicate a potential problem. Belief systems are put in place by organizations to control their personnel’s commitment to their vision, mission, core values, and the like. This control lever communicates the tenets of the culture of the organization to its every member. Usually thought of as “minimum standards,” boundary systems enable the organizations to stake out the territory for each of their members. Among these systems are codes of conduct, pre-defined strategic planning methods, asset acquisition regulations and operational guidelines. Interactive control systems are employed by smart organizations for tracking of new ideas, triggering new learning, and for properly positioning the organization for the future. A hint is provided by the word “interactive;” it is a system that tries to maintain regular and face-to-face contact between the supervisors and the subordinates. Among these systems are the practices of incorporating process data into management interaction, face-to-face meeting with employees, and challenging data, assumptions, and action plans of subordinates (cf. Simons, Control in an Age of Empowerment, 1995; Kaplan & Norton 2001, 349). Concisely put, internal control ensures check and balance; diagnostic control system relieves the organizational block in the form of lack of focus or of resources by building and supporting clear targets; the belief systems take care of uncertainty of purpose by clear communication of values and mission; the boundary systems allays pressure or temptation by specifying and enforcing the “rules of the game”; and the interactive control systems reduces lack of opportunity or fear of risk by opening organizational dialogue to encourage learning. With the use of these levers, Simons believed that managers can actually unleash the creative potential of their subordinates without losing control of their teams and theirs objectives. Management Accounting as Control System From the CIMA definition, we can infer that management accounting is expectedly responsible to be of assistance in ensuring an effective managerial control system (within an organization). Management accounting is meant for strategic direction (Tu 2008). It is a tool to effectively determine and keep abreast of the internal and external environments of any organization. As such, then, management accounting provides – at least, to the minimum – the backdrop against which the control process is done, i.e., the organizational strategies. Further, at the same time, management accounting provides the basis for any call for change of behavior in the organization. As a process, it is monitoring the developments within and without the organization. It tells whether the organization is still keeping on its track, or tells about the adjustments that organizations and their members need to do in order not to veer away from their pre-determined route. Laughlin (2007) reminds everyone that accounting as a control system is regulated by, among others, societal values as it does its controlling over the development within an organization. Controlling the System and its Sub-Systems Thus far, we raise the question: how is management accounting going to serve as control system in systems theory? In systems theory, what is the key is the relationship between and among the subsystems – which “must be coordinated in a way that results in purposeful action as each subsystem contributes to the transformation process. At the same time, subsystems must adapt to both internal and external environmental agitation” (Hahn, 310). There is then a need for organizations to have a decider subsystem that does maintain operational order by monitoring and coordinating the activities of each system components. This role is usually assigned to the executive management, which treats accounting’s information as an important font of institutional memory useful to system members who are responsible to and who actually do the planning and control (Hahn, 310-311). However, Kurunmaeki (2004) writes about the experience of medical professionals in Finland in the 1980’s and 1990’s, where management accounting as a tool was equally effectively acquired by those in the medical field (328). Emanating from the systems theory is the well-known Harvard school of organizational control, or the classical organizational control system (see Anthony, R. 1965). According to this school, there are three subsystems of control, namely: the strategic planning, the management control, and operational control. Subsequent to its being made known to wider public, this theory was eventually criticized for several grounds. Prominent of the critique against the system-theory-inspired-control system is the being intertwined – thus, impossible to simplistically divide in such as suggested fashion. Besides systems theory is based on basic assumption that the environment is stable and the task is routine. Thus, in more unpredictable environments and with un-programmed tasks, systems theory does not seem to hold (Samuelson, 4). General system theory is considered “too general for purposes of developing (management) accounting standards,”… (and) as regards the applicability of system theory viz. the role of accounting in organizations, it is believe that using “an open or closed classification was not useful in accounting discussions” insofar as organizational scope, structure and political attributes are concerned; for, accounting distinctly plays a role “in the development and presentation of information to decision makers striving to sustain operating activities” (Hahn, 309). Over-all, a view on system theory is that it is quite restrictive and too peripheral as inherent in it are a number of shortcomings in the face of different situations (Samuelson, 4-5). Likewise, we can indicate here the discussion by Thrane (2007) as regards the role and practice of accounting in dynamic and complex business networks. As systems, organizations change on account of various perturbations from the (external) environment or the (internal) installation of management accounting. These processes result to bifurcation (or the branching out of new inter-organizational configurations) or oscillation (or destabilization). For this reason, Thrane holds that management accounting is actually a source of instability rather than stability, a source of emergent, unintended order rather than planned or institutionalized change in systems. Between Control and Value Creation: Simons’ Levers of Control Simons’ Levers of Control were conceptualized to serve organizations that cannot revert to the machine-like bureaucracies of the 1950’s and 1960’s just to strike the balance between maintaining control, efficiency and productivity on one hand and giving employees the elbow room to be creative, innovative and flexible. For in the modern world of corporations, managers would love to encourage the employees to think for themselves and to create new processes and methods of doing their stuff, while still reserving to themselves sufficient control so as to be ascertained that employees’ initiatives would ultimately serve and improve the organization. Simons maintain that traditional hierarchical command and control systems are archaic, given his – and other management theorists and writers’ – observation that such were tying the hands of the managers and were neither strategically responsive and adaptive nor were maximizers of any given strategy’s performance. In place of what he calls outmoded control system, Simons brings forward a management control system that are formal, information-based routines and procedures that managers may use to monitor and change behavior in an attempt to bring about desired results (see D’Acierno 1996). Practically, what Simons has offered is a novel set of terms for defining and classifying the entire range of familiar management tools. In the process, he shows his deeper comprehension of the utility, organization and structure of the mechanisms of management – which were already on hand. Such redefinition of the former terms results to extension of the control of the management over results and the broadening of the notion of what is possible (cf. D’Acierno). The whole idea is concerned about how hard the business organizations are trying to define their strategies and the organization leaders are personally and seriously intervening to make sure that every movement of and in the organization runs along the line of the defined strategy. Hence, the prerequisite of the system, according to Simons, is that managers have and very well understand their strategies. Once they have their strategies, the Simons’ levers of control expect them to be embedded into every management system and process. And that step goes a long way in terms of aligning the whole organization around its real aims (D’Acierno). Conclusion While management control systems’ fundamentals are never changing, there is always a need to develop and refine their details to keep them relevant as the control needs of the changing environment are changing too (for details, see Nixon and Burns 2005; Quattrone & Hopper 2005 did a study on organizational control within the context of the centralization-decentralization debate). Hence, for the 21st century that is characterized by intellectual capital as the key feature, there is said to be a need for a new framework. The preceding can qualify as an attempt precisely along this concern.   References: Anthony R. 1965. Planning and Control Systems: A Framework for Analysis. Boston: Harvard University Press. CIMA. 2005. Management Accounting: Official Terminology of CIMA. London: CIMA Publishing. D’Acierno, L. 1996. Levers of control: How managers use innovative control systems to drive strategic renewal. Strategy + Business. 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