Transaction Cost Economics and Evolutionary Theories - Essay Example

Transaction Cost Economics theory and Evolutionary Theory Introduction: Management accounting is the process of producing accounts specifically designed to serve the needs of the managers, the importance of this accounts is to facilitate monitoring and control of the operations of an organisation, management accounting provides regular information on how different aspects of the organisation are performing in relation to the forecast of the budgets, they also provide information regarding deviations that occur between the actual outcome and the budgets and therefore facilitate the identification and in the problem solving activity. Management accounting is concerned in identification and provision of financial and economic information to managers within the organisation to enable them make proper decisions, maintain control over business operations, monitor budgets and profit performance and direct the organisation to success in the future.1 Management accounting is crucial for planning and the process of problem solving such as determining the most cost effective method of production, it is also important in that it involves the development of budgets that help in the forecasting on future production cost and levels of production and profits. Management accounting involves the preparation of budgets that aid in planning, coordination of the activities of various departments, budgets provide a means of communicating the organisations goals and plans, they act as motivation tools and they act as a tool of control where actual and activities are compared with the budget and any deviations are investigated and corrective actions undertaken. Roles of management accounting include: a) Providing information that facilitates allocation of cost between costs of goods sold and inventory and this aids in profit reporting. b) Providing information for effective planning, control and performance measurement c) Provide relevant information to help managers arrive at the most optimum solution and therefore it aid in the decision making process in an organisation. d) It also provides information for routine conduct for the day to day operations of a business organisation.2 Transaction Cost Economics theory and Evolutionary Theory: Transaction cost economics studies organisations in a way that different institutional arrangements are considered alternative ways of organising economic activities.3Transaction cost economics explains why certain transactions are associated with a certain form of organisation whereas other transactions are associated with other forms of organisation; specific institutional arrangements are chosen to govern specific transactions because they offer distinct sets of control devices which other forms do not offer, therefore institutional forms differ in their ability to solve problems and the form of control they offer.4 Evolutionary theory also referred to as the old institutional economics as Foss (1994) defined it, this theory tends to investigate the possibility of transforming the already existing structures of organisations, therefore the evolutionary theory observes organisation forms as having emerged from the already existing organisational structures in order for them to solve specific problems of control.5 Similarities between the transaction cost economic theory and the evolutionary theory: The transaction cost economics and the evolutionary theory explain institutions and institutional changes, the changes according to the two theories are caused by advancement in information technology, different organisational structures and new management practices.6 According to the transaction cost economic theory organisations adopt or design a new form of organisation whereas to the evolutionary theory new organisational forms emerge from existing ones. Management accounting according to the two theories is seen as one that provides information for planning and controlling of an organisation, facilitate allocation of cost, facilitate decision making and one that provide information for the day to day routine conduct, therefore management accounting is responsible for the smooth running of an organisation by the way it facilitates control and planning. The two theories explain the process of management accounting change as one that is caused by the day to day routines which shape relations that exist between institutions and individuals or groups, changes are made by a few individuals in an organisation according to the transaction cost economic theory and to the evolutionary theory changes are made by the workers where management accounting processes are adopted according to the day to day needs. The two theories however recognise that the rate and the ease of an organisation to change from one form of organisation to another form of organisation depend on the existing form of organisation; this is because the existing form may have certain constraints that resist change. The two theories therefore recognise the constraints that influence change and also the existence of factors that lead to resistance to change. Both theories also try to explain the importance of different organisational forms to the success of the organisation, firms need to change if they want to survive in the long run and this include adopting more cost effective means of production, therefore the two theories emphasise the importance of organisational change in any given organisation. However different organisation forms will be adopted by firms depending on the transaction and control needs of that organisation. Differences between the transaction cost economic theory and the evolutionary theory: Transaction cost economics theory argue that individuals and firms tend to be rational and the main aim for change is to achieve the most optimum ways of doing things while to the evolutionally theory change is a process in which routines emerge which deviate from the original rules but are eventually institutionalised and formalised.7 The evolutionary theory states that management accounting changes have the following characteristics: The institution changes over time, There exist inertial forces that ensure continuity of change over time and The selection of new efficient systems is evident Therefore the evolutionally theory argues that management accounting changes are more complex than the rational selection stated by the transaction cost economics, to the evolutionary theory changes are shaped by a combination of a random, systematic and inertia forces.8 The evolutionary theory states that changes are faced with resistance due to competing interests, the lack of capability and due to a mental allegiance, however to the transaction cost economics changes are deliberate actions that involve the formation of new rules and routines, therefore the evolutionary theory recognises the existence of resistance of an organisation to change whereas to the transaction cost economic theory changes do not face resistance because changes are made in the form of new rules and routines by one person with unlimited capabilities of rationality. According evolutionary theory management accounting can shape or be shaped by the institution but to the transaction cost economics management accounting influences and shapes the institution, to the transaction cost economics the organisation is assumed to be governed by one person with unlimited capabilities of rationality and therefore no room for motivational or behavioural problems, therefore the organisational structure is adopted or designed.9 To the evolutionary theory new organisational forms usually emerge from already existing forms whereas to the transaction cost economics theory an organisation will choose the most appropriate form of the organisation depending on the purpose and the problem to be solved, therefore the organisation form is usually deliberately formed according to the transaction cost economics theory whereas to the evolutionary theory organisational forms are formed from existing ones.10 The evolutionary theory states that changes in an organisation is a continuous process that occurs over time, recent forms of organisations according to this theory are seen as superior, advanced or higher to the older forms of organisations, this is in contrast with the transaction cost economics theory that states that changes only occurs when an organisation optimally and rational chose a new form or designs a new form of structure.11 Organisation forms according to the transaction cost theory are chosen on the basis of the efficiency and effectiveness compared to other forms of organisations, therefore a certain form of organisation will be chosen rationally in terms of improving efficiency and effectiveness in the organisation.12 Therefore transaction cost economics tends to assume that different organisations tend to exist because different transactions require different modes of control which offer distinct control devices, whereas to the evolutionary theory different organisational forms are seen to emerge from already existing organisational forms as a result of human action, the existing organisational forms are transformed to form new organisations, this transformation is a continuous process whereby organisations formalise and institutionalise emerging forms of organisations. The transaction cost economics theory argues that people are guided by rationality and optimality in the decisions they make, rationality means that any decision made is one that is cost minimising and at the same time benefit maximising, therefore the transaction cost economic theory states that decisions made by the organisation are usually rational decisions. The transaction cost economic theory does not depict the process that occur within the firm when the organisation decides to move from one form of organisation to another, to the evolutionary theory this process is properly explained whereby changes from one form of organisation occurs due to the day to day interactions as people find new and better ways of doing things. The transaction cost economic theory does not recognise external factors that influence management control inside the organisation; this is in contrast with the evolutionary theory that recognises the external factors that influence management within the firm.13 The transaction cost economic theory also does not recognise the role of values and beliefs in the process of organisational changes, whereas the evolutionary theory recognises this role of this factors that determine changes in an organisation.14 To the evolutionary theory organisations change is caused by the day to day interactions whereby people find new and better ways of doing things. Historical costing and fair value costing: The historical and fair value costing are alternative costing methods for valuing assets and liabilities, the historical costing method dictates that assets and liabilities be recorded at their historical cost, the historical cost is computed by adding up the actual purchase value and incidental costs associated with the asset or good. The fair value costing can be defined as a rational and unbiased estimation of the market price of assets and commodities, the fair value costing takes into account the relative scarcity of a good, production cost of a good, the potential risk and the perceived utility of the good. Advantages of historical costing The historical costing method makes it easier for auditors when auditing an organisations accounting records, this is because the historical costing method leaves an auditing trail that can be easily be followed by auditors. The historical costing method is also reliable and the values obtained are unbiased compared to those of the fair costing method, therefore this method is more accurate and consistent compared to the fair costing method. Another advantage is that the historical costing method involves the matching of the cost of resources used against the revenues and services of the production function, profits are termed as efforts and revenues as accomplishment by an enterprise in this method of costing.15 Disadvantages of Historical Cost Historical costs do not eliminate or solve any issues arising as to what to include or exclude in the balance sheet, it is also a very simple method for the control of contracts, and this method also overstates the earnings and understates capital assets of an organisation. Advantages of the Fair value costing method This method is reliable when it comes to contracting issues; also it is an easy in determining the accounting value of assets and liabilities of an organisation. This method also provides a good estimate of assets and liabilities value that depict the market value of this assets and liabilities. Disadvantages of Fair Value The fair costing method may value assets in such a way that the values depict unrealistic gains as incomes, this method also does not provide a clear and distinct path way for auditors, this is in contrast with the historical costing method that provides a clear path way for auditors to follow.16 This method may produce biased and unreliable values of assets and liabilities because it is takes into account scarcity, utility and risks of assets and goods in its valuation process, this factors are not easily measurable and therefore causes biasness.17 Contributions of the two theories to management accounting: The evolutionary theory has contributed to our understanding of institutionalisation, learning and change both within and between organisations and capabilities, this theory has also contributed to the body of management accounting through its explanation of how organisation change and the process of formalisation and institutionalisation of this behaviours, rules and routines.18 The theory also argues that organisations will change from time to time and will never stop changing, behaviours emerge and then formalised and they become part of the organisation, and that change is caused by a combination of a random, systematic and inertia forces that lead to change in the form of the organisation.19 The transaction cost economic theory has also contributed to the body of management accounting in that it argues that firms will adopt a certain organisational form that suit their transaction demands and also control needs, decisions according to this theory are made by only a small or one person in the organisation who has unlimited capabilities to make rational decisions and therefore there is usually no room for motivation and behaviour change problem. Transaction cost economic theory states that a firm will adopt or design a certain organisation form that suits its needs, the organisational form adopted or designed is chosen on the basis of rationality and optimality, the evolutionary theory states that an organisation form emerges through day to day routines and people will find new and easier ways of doing things and this causes changes to the organisations form. Conclusion: Management accounting is crucial to the running and success of an organisation; it provides guidelines and also facilitates the control of organisations through the roles it plays in an organisation, it ensure proper decisions are made through the provision of information concerning an organisation. The evolutionary theory is based on the assumption that organisation continuously change over time and that this changes are caused by the day to day interactions where people find new and better ways of doing things, the routines and rules therefore are institutionalised and become the new ways of doing things, therefore to the evolutionary theory the organisational form is flexible and therefore new forms will emerge from already existing organisational forms. The transaction cost economics theory focuses on rationality and optimality in changing the organisation, organisational forms are usually adopted or designed to suit the organisation, this theory also states that the organisation is controlled by only one or a few individuals who have unlimited capability and rationality and therefore no room for motivation or behaviour problem. Changes in the organisation are caused by the advancement in information technology, the existence of different organisational structures and the emergence of new management practices, all the these factors lead to the change in an organisations form. Both theories explain the organisational form and the process of change in organisations, they are both relevant in explaining the role of management accounting, however the evolutionary theory tends to be the best in explaining organisations and the process of change that occur in organisations, it explains the process of change unlike the transaction cost economic theory that is based on rational choice of organisational forms. Therefore the transaction cost economic theory focuses on the bureaucratic form of organisation that was discussed by Weber where a large workforce is arranged in a hierarchy to carry out specific task and that the each person is responsible to the person over and above him in the chain of command, decisions are made by those who hold top positions in the organisation and therefore there are set rules and regulations that govern behaviour in the organisation, however there exist no pure bureaucracies and recently they are considered inefficient forms of organisations due to high administration cost. Fair costing methods are more beneficial compared to the historical costing method, however historical costing is more widely used by organisation for the reason that they make it easy for auditing and because they give accurate and consistent assets and liabilities values. The fair costing method is also not widely used because it requires the estimation of factors that are not directly observed and this leads to biased estimated values, this factors include utility, perceived risks and a measure of scarcity. The two theories have however have contributed much to the study of management accounting and they explain the importance and the causes of change in management accounting, they argue that for an organisation to exist in a competitive environment it has to adopt modern way of doing things and that why advancement in information technology has caused changes in organisations, however there is need for more research to be done on the issue of organisation change regarding the various structure and forms of organisations that are adopted depending on the needs of an organisation. Managers need to understand the importance of adopting appropriate organisational forms that will lead to the success of an organisation; they also need to assess the benefits of each form of organisation before choosing which organisational form to adopt. References: Alan F Coad and John Cullen (2006) inter-organisational cost management: towards an evolutionary perspective, available at www.elsevier.com G. J. Vosselman (2002) Towards Horizontal Archetype of Management Control: A Transaction Cost Economics Perspective, Available at www.idealibrary.com John Burns and Robert W. Scapens (2000) conceptualizing management accounting change: an institutional framework, 11, 3-25. Available at www.idealibrary.com John Burns (2000) Accounting, Auditing and Accountability Journal Bradford: The dynamics of accounting change Inter-play between new practices, routines, institutions, power and politics Vol.13, Issue 5 Mark A. Covaleskia, Mark W. Dirsmith and Sajay Samuel (2003) Changes in the Institutional Environment and the Institutions of Governance: Extending the Contributions of Transaction Cost Economics within the Management Control Literature, Available at www.elsevier.com M. Jensen and Meckling W. (1976) Theory of the firm: managerial behaviour, agency costs and ownership structure, Journal of Financial Economics, 3, 305–360 P. DiMaggio and W. Powell (1991) Introduction, The new institutionalism in organizational analysis, Chicago, The University of Chicago Press Roland F. Spekle (2001) Explaining Management Control Structure Variety: A transaction Cost Economics Perspective, available at www.elsevier.com Robert E. Jensen (2006) Fair Value Accounting in the United States, available at www.trinity.edu Read More