Strategic Management Accounting - Literature review Example

Strategic Management Accounting Introduction Criticisms on the inadequacies of traditional accounting and budgetary control began surfacing in 1980s leading to what is known as strategic management accounting (SMA) of today though its development and implementation are still incomplete. (Tomkins and Carr, 1996) An important purpose of SMA is to furnish management of an organisation with information for formulation of organisational strategy and advise how it should be implemented. And as a means to realise the ends of the strategy, the concept of performance measurement methods has been developed. As such strategic management accounting and performance measurement have become integral parts of organisation strategy. Definitions According to Coad (1996), strategic management accounting is still an evolving discipline with no boundaries set so far and the literature so far developed on the subject is “both disparate and disjointed”. Innes(1998) states that it is the means of providing information for making strategic decisions in organisations for long term purposes both internal as well as external. This definition alludes to information such as activity based costing for the product mix, introduction of new products and discontinuance of existing products involving long term decisions. Cooper and Kaplan (1988) has stated similar views that strategic accounting techniques are designed to support the overall competitive strategy of the organisation through the use of information and technology for more refined products and services. Target based costing, life-cycle costing and activity based management are said to fall within this domain of SMA as stated by other writers. The term strategic management accounting was introduced by Simmonds (1981, 1982) who mainly meant it to be externally focussed by analysing and comparing the management accounting data of a business and its competitors. His postulation is that profits are earned not out of efficiencies but competitive positions in the market. The Chartered Institute of Management Accountants (CIMA) of UK defines it as “A form of management accounting in which emphasis is placed on information which relates to factors external to the firm as well as non-financial information and internally generated information. (CIMA Official Technology, 2000:50) However in view of the divergent views, Lord (1996) arrived at the following conclusion after a detailed literature review. 1) SMA is an extension of traditional management accounting’s internal orientation to external outlook on competitors. 2) It is the system of management accounting designed in accordance with the firm’s chosen strategic position. 3)And as a means of obtaining competitive advantage by making product differentiation and reducing costs through exploitation of linkages in the value chain and optimizing cost drivers. Competitors’ information (external) Simmonds (1981, 1982 and 1986) states that management accounting of a firm should collect information of the rest of the industry to which it belongs, such as data on costs, prices, sales turnover, market shares, cash flows from published sources such as company annual reports, press releases, data from official institutions and also informal sources such as sales personnel, analysis of competitors products, reports of industry specialists and consultants. He also stresses that forecasts could be made on the competitors’ cost reductions and selling price reductions by the use of learning curve as a means for gaining competitive advantage over the competitors. The learning curve effect that is capable increasing the sales volumes and market share, is a fool proof method to stay ahead of the competitors that make them always lagging and force them to exit the industry. Simmonds also says that the tool of cost-volume-profit relationship of the competitors can help predict their pricing reactions. (Simmonds, 1982; 207) Competitive advantage In order to obtain the above said value chain linkages, Porter (1985) proposed value chain analysis for achieving competitive advantage. The linkages can be within the firm, between the firm and its suppliers and customers. The primary linkages are inbound logistics, operations, outbound logistics, marketing and sales and services. The support or secondary ones are firm infrastructure, human resource management, technology and procurement. Cost and assets are assigned each linkage i.e activity. The cost drivers are responsible for the cost behaviour pattern in each activity since the drivers behave interactively and success in containing the cost depends on the firm’s ability to cope with them. This process called strategic cost analysis also attempts at identifying value chain and behaviour pattern of cost drivers of competitors which information should enable the firm to improve or reconfigure it own value chain. Porter says that this should be done continually in order have sustained competitive advantage. To illustrate a real life example of how an American automobile firm did not use the method of exploiting value chain linkages and ultimately failed to improve profitability although it had generated substantial internal cost savings by applying just in time (JIT) manufacturing techniques. It happened because price increases by suppliers more than offset the savings generated internally since 50% of the costs in the value chain related to purchase of parts form suppliers. Besides the automobile company had reduced the level of buffer stocks without corresponding timely supplies by the suppliers. Thus manufacturing costs increased eating into the savings generated internally. (Drury, 2004) Strategic Management Accounting practices A survey by Guilding et al (2000) on SMA practices covering 63 firms from U.K., 127 from the U.S.A., and 124 from New Zealand identified twelve strategic management practices. They are quality costing (cost of quality reports), life-cycle costing, target costing, competitive position monitoring, strategic pricing, competitor performance appraisal based on published financial statements, competitor cost assessment, value chain costing, brand value monitoring, strategic costing, attribute costing and brand value budgeting. (Guilding et al 2000) 1) Quality costing Quality of product or service is a source of competitive advantage. The quality costs are classified as prevention, appraisal and failure costs. An increased preventive expenditure will minimise or stop altogether returns, rework, scrapping and lost sales thus resulting in considerable savings and competitive advantage. (Heagy, 1991) 2) Life cycle costing The five stages in a product’s life cycle are design, introduction, growth, maturity and decline. A time-frame is pre-determined for each of these stages and the cost of the design is spread over the entire life cycle so that the management is not tempted to pre-mature introduction of the product looking at the per annum loss accumulating during the design phase. This philosophy of life-cycle costing entails cost appraisal on the basis of life time of the product rather than on annual basis. (Wilson, 1995) 3) Target costing It refers to special costing incurred to satisfy a particular customer need during the design and development phase. Closely associated with this Japanese Kaizen costing which goes even beyond the design and development stage i.e during the manufacturing phase so as make further savings in cost.(Sakurai,1989) In fact this was earlier adopted by Henry Ford (1932) This kind of external focus leads to market-led costing instead of cost-led pricing.(Guilding et al,2000) 4) Competitive position monitoring As already seen, this involves assessing and monitoring trends in the sales, market share, volume, unit cost and return on sales of competitors within the industry. This facilitates assessment of market strategies of competitors. (Drury, 2004) 5) Strategic pricing The strategic factors that go into pricing are competitor price reaction, price elasticity, market growth, economies of scale and experience. (Drury, 2004) 6) Competitor performance appraisal This is concerned with numerical analysis of competitor’s published financial statements which have the potential of giving information regarding competitor’s sources of competitive advantage. (Drury, 2004) 7) Competitor cost Assessment This is an arrangement by which competitor’s cost is updated by appraisal of facilities, technology and economies of scale through sources of direct observation, mutual suppliers, mutual customers and ex-employers. (Drury, 2004) 8) Value-Chain costing Value chain consist of activities such as designing, procurement, production, marketing, distribution and after sales service each of which allocated a cost based on activity based costing. (Drury, 2004) 9) Brand value monitoring Brand value is measured by product’s leadership in the market, stability, market for the product, international awareness, trend, support and protection along with historical brand profits. Sum of these values is brand value that is continuously monitored as one of the strategic management accounting methods. . (Drury, 2004) 10) Strategic costing This is the method of costing by using strategic and marketing information to arrive at superior strategies that will help sustain the competitive advantage. (Drury, 2004) 11) Attribute costing Lancaster (1966) has said that products are known by their attributes with unique appeal to consumers. Bromwich (1990) builds upon this notion of attributes as cost objectives. Thus operating performance variables, reliability and warranty arrangements, the extent of finish and trimness and also service factors such as supply assurance and after sales services are the examples of attributes which help product differentiation. 12) Brand value budgeting When the above said brand value is used for making decisions for allocation of resources to maintain and enhance the brand value is known as brand value budgeting. (Drury, 2004) Performance measurement-Balanced Score Card (BSC) BSC is a performance measurement tool developed by Kaplan and Norton (1992). It is used in all types of organisations such as business, industry, government and non-profit institutions. As a performance measurement framework, it incorporates non-financial performance indicators into financial metrics so as to give managers a more balanced view of the performance of an organisation. It has its origin in performance measurement reporting in 1950s by the General Electric which used it as a single performance measurement frame work. This is what has now developed into a full strategic planning and management system with the potential of transforming an organisation’s passive document into commands on a daily basis. The framework it provides not helps performance measurement but also helps managers what should be done and measured. The authors of the BSC give a clear cut way of measurement to balance the financial perspective. If fully implemented, BSC is capable of turning the strategic planning as the nerve centre of an organisation. The picture below of a template of a BSC would show how it integrates vision and strategy. It shows that an organisation is seen in four perspectives in order to develop metrics, collect data and analyse it in respect of each of these perspectives namely learning and growth perspective, business process perspective, customer perspective and financial perspective. (Balanced Score Card Institute) (Balanced Score card-Source: Balanced Score Card Institute) A case of UNUM Corporation can be cited to show how it used the balanced score card to direct the company to its strategic vision. The five year scare card was developed to meet its performance goals. It focussed on internal communications almost as an obsession along with an innovative compensation scheme resulting in company’s success. It is disability and special risks insurance company with 7200 employees with operations in the U.S., Canada, the U.K., Pacific Rim, Europe, Bermuda and Latin America having reported a total revenue of $ 4,076,700 million and a net income $ 370.3 million in 1997. Established in 1848 and listed in 1986 with New York Stock Exchange. On being listed, its corporate goal was set as 61592 signifying to earn six dollars per share with 15 percent return on equity by 1992. This was accomplished in 1991 itself. The vice president of the company is reported to have said that the 61592 goal was a powerful motivation. Encouraged by this, the company went about setting a balanced goals and a developed a balanced score card as below. (UNUM Corporation) (Source UNUM Corporation) The above brief review would show that strategic management accounting can be used as an adjunct to financial accounting and that the former in a way serves as tool in planning and control hither to the domain of budgetary control. Whether it is being practiced for the purpose of planning and control can be inferred through case studies documented in the literature. Hirsch (2000) states that strategic management involves planning, implementation and control. In the planning stage, also called strategic planning or strategy formulation, designing of a mission, setting up of goals and objectives and strategies for achieving them are spelt out. The planning stage takes into account of both internal and external environment of the business along with its strengths and weaknesses. In the control phase, how the planned goals and objectives achieved are measured. Management accounting has a crucial role in this strategic planning. Implementing and controlling which are also the functions of traditional budgeting and budgetary control. Whatever the company does should be within an organised framework. Thus when it wants acquire an asset or whenever an investment opportunity comes up, it should be seen whether such an acquisition is in alignment with the company’s strategic plan and how it will aid in accomplishing the company’s mission. The same should apply for controlling also by relating back to the mission, goals and objectives of the plan. The above said tools such as activity based costing, value chains and others and also theory of constraints (TOC), just in time (JIT), and activity based management (ABM) aid in planning, implementing and controlling. Thus when the managers do the planning for a period of three to five years, they must find answers not only for this period but also for the period beyond five years. Some of the questions for which the managers need answers are in this perspective are in connection with what environment of the company is facing, its current strategy and its current performance, long-range goal of its business, its major areas of operations, market segments currently being addressed, how they full fill the needs and the availability of resources for the company, its human, financial and physical capabilities, its strengths and weaknesses, details of the competitors and how they are comparable to the company, what can be the company’s reasonable objectives and goals with the given threats and opportunities, strategies to achieve them and the monitoring programs in place to keep track on the progress towards their achievement. (Hirsch, 2000) A company’s mission statement has to correspond with its strategic management accounting system. (SMAS). The SMAS if well developed gives information to the managers on the separable costs of the products or services through activity based costing (ABC). Thus ABC is more important as a strategic management tool than as a means of knowing short term profits. Thus if the current mission statement is to serve customers orders whether small or big and if the managers find this costly through ABC, then mission statement is altered. (Palmer, 1992) Conclusion Relying on historical data from financial statements alone for planning and control i.e for budgeting and budgetary control can be dangerous because of timeliness during which time position would have changed. Hence, non-financial indicators must also be taken into account as a form strategic management accounting for the purpose of planning and control. The SMA practices listed above have more to do with non-financial indicators than the historical data from financial statements which alone traditional budgetary practices rely upon. Management accounting had also been practiced in the traditional way since early 1900s until 1980s when the concept of strategy was infused into the management accounting techniques. The above stated SMA practices developed since 1980s embrace strategy for the purpose of planning and control of the organisational activities. However, the practices are fragmented and are yet to develop in to a separate discipline. Strategic management accounting has now become an integral part of decision support system that is capable of providing information to decision makers who had hitherto been relying on only financial accounting information. As seen above, the five key factors of mission statement, goals, objectives, operational strategies and performance measurement are focussed in the same direction to facilitate achievement of corporate goals. Besides the balanced score card stated above has become complementary to the above SMA practices by integrating an organisations vision and strategy. References Balanced Score Card Institute, Balanced Scorecard Basics, viewed 10 October 2009 http://www.balancedscorecard.org/BSCResources/AbouttheBalancedScorecard/tabid/55/Default.aspx. Bromwich, M., 1990. The case for strategic management accounting: the role of accounting information for strategy in competitive markets, Accounting, Organizations and Society, 1.5(1/2), 27-46. CIMA, Chartered Institute of Management Accountants, CIMA Official Technology, 2000:50. Coad A, 1996, Smart work and hard work explicating a learning orientation in strategic management accounting. Management Accounting Research, 7, 387-408. Cooper R and Kaplan, R.S., 1988, Measure costs right: make the right decisions, Harvard Business Review, Sept- Oct, 96-103 Drury Colin, 2004, Management & Cost Accounting, Cengage learning EMEA. Guilding Chris, Cravens S. Karen, Tayles Mike, 2000, An international comparison of strategic management accounting practices, Management Accounting Research, 11, 1 13 ~ 13 5 Ford, H., 1932. My Life and Work, New York, Doubleday, Page and Co. Heagy, C. D., 1991. Determining optimal quality costs by considering cost of lost sales, Journal of Cost Management, Fall, 64-72. Hirsch L. Maurice, 2000, Advanced Management Accounting, Cengage Learning EMEA Innes J, 1998, Strategic Management Accounting, In: J. Innes, Editor, Handbook of Management Accounting, Gee, London, 33. H. T. Johnson Kaplan RS, Norton DP: 1992 Using the Balanced Scorecard as a Strategic Management System. Harvard Business Review 1996, 75-85. Lancaster, K. J., 1966. A new approach to consumer theory, Journal of Political Economy, April, 132-157. Lord, B.R., 1996, Strategic Management Accounting: The emperor's new clothes? Management Accounting Research, 7, 3: 347-366. Palmer, R.J. 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Tomkins Cyril and Carr Chris, 1996, Reflections on the papers in this issue and a commentary on the state of Strategic Management Accounting, Management Accounting Research, 7, 271 – 280 UNUM Corporation, Building and Implementing a Balanced Score Card, 10 October 2009, http: //www.exinfm.com/training/pdfiles/Balanced%20Scorecard%20Cs.pdf. Wilson, R. M. S., 1995. Strategic Management Accounting, in Ashton D. J., Hopper T. M. and Scapens R. W. (eds.) Issues in Management Accounting, 2nd edition, Prentice-Hall, London, pp. 159-190. Read More