Does the Future of Management Accounting Lie in Strategic Management Accounting - Essay Example

This project focuses on comparing the traditional management accounting system with the contemporary strategic accounting system. Initially,both these accounting concepts have been examined to have a thorough understanding of them. Then the limitation of the traditional management accounting system has been identified. Further evaluation on the different techniques of strategic accounting has been discussed. Finally, concentration has been made on how the strategic accounting system overcomes the drawbacks of the traditional accounting system. Table of Contents ABSTRACT 3 Introduction: 5 Management accounting system v/s strategic accounting system: 6 Limitation of management accounting system: 7 Strategic management accounting as a substitute of management accounting system: 11 Conclusion : 14 Bibliography 16 Introduction: The concept of accounting has been around since the time started. In the early days when people started conducting trade they learned to arrange financial information in a systematic manner. As time progressed further the concept of accounting gained popularity and people introduced several changes to make it more effective and useful for maintaining financial records. Management accounting is a branch of the traditional accounting system that is used by the managers to obtain the valuable information about the business. Management accounting plays a vital role in the decision making process. Managers use management accounting to derive information while making business decisions. With time the international business environment has undergone several changes. Due to the effect of globalisation, businesses have lost their geographical boundaries; therefore there has been a requirement of an accounting system that assists in understanding global business environments. The governments of the different nations are also more concerned in making the business activities more transparent by making the accounting standards stringent. Therefore, the management has to maintain an effective accounting system so that information regarding the external environment can be used to make the business policies proactive. Requirement of an effective and advanced accounting system has resulted in the development of a strategic accounting system. In the given project a thorough comparison will be made between management accounting system and strategic accounting system. The main aim is to analyse how far strategic accounting system is effective in overcoming the drawbacks of management accounting system and to assist managers in developing a sustainable business environment. Management accounting system v/s strategic accounting system: Management accounting provides the information required by the managers for planning, controlling and decision making (Jiambalvo, 2007, p.2). In the process of decision making related to resources allocation, making investment and developing control in the business, this accounting practice has an important role to play. Basically, management accounting is a set of different practices and techniques that are used to answer general questions, few of them have been discussed below: What is the average cost per unit produced? What is the required rate of return from the new project? Which of the activity requires highest expenditure and which one is the most profitable one? These questions explain quite clearly that how management accounting system is used by the managers to derive vital information about the business. Management accounting has two main roles; first of all it generates day to day reports to provide information regarding the cost control process and secondly it generates special reports for the managers to assist in strategic decision making process. For example, the daily reports can be used to understand how the regular activities are conducted in the business, whether the resources are consumed per schedule, is the process operating as the plan and so on. Again, the managers use the special reports to ascertain that how the cost of operation can be minimised, how the production can be increased without having an effect on the existing operation process, whether to continue production of a specific product or not and many other similar vital factors. “Strategic accounting has been defined 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” (Inman, 1999). Because of changes taking place in the external environmental factors, importance of fast movement of information is gaining high demand. The traditional management accounting system lacks in reviling these information fast enough to the management. According to Brouthers in 1999, “strategic accounting is a comparatively new and unexplored segment of strategic management” (Truch, 2004, p.54). He suggested that to optimise performance of an organisation the management should align strategy to be followed by the firm with the changing external environment. There lies the difference between the management accounting system and strategic accounting system. Although, both these accounting systems are concerned with providing required information to the management; however the nature of the information provided is not same. The management accounting system provides information related to the business, therefore mainly financial information is conveyed to the managers to make them aware of the financial health of the business. On the other hand, the strategic accounting system takes into account both financial as well as non-financial information related to internal and external environments of the business. A comparison of both these accounting systems will be discussed in more detail in the later section with the advantages as well as the disadvantages that are associated with them. Limitation of management accounting system: Management accounting is more concerned with recognising as well as evaluating the transactions and economic activities taking place in an organisation. These accounting policies are used for identifying, recording and classifying all the economic transactions related to the business. Therefore, this accounting system is used to enhance the knowledge of the management so that they can take the necessary action for risk minimisation. To recognise the cost component in the production process, management accounting identifies different costs associated in the production process. After accumulating them, the total cost of production is ascertained and then it is distributed equally among the total number of units produced. In this manner, per unit cost of production is calculated. Using this information the management takes vital decisions regarding the profit margin, the selling price per unit, changes required in the production cost and in the production volume. However, the cost incurred while conducting different activities are simply neglected and thus management fails to have a proper cost control system. In the management accounting system, cost-volume-profit analysis is conducted to gather financial information that can be used in the decision making process. Cost-volume-price analysis studies the relation between cost (expense), sales (revenue) and the profit (net income). This technique interprets what will be the effect on each of these factors if one of them changes marginally. For example, if the management has to make a decision regarding expansion of the production capability, it will analyse whether this expense will result in high profit or not. While investing in new ventures or changing the production scale of any specific product, management use this technique to understand the relation between cost, volume and profit but they neglect external factors like demand, consumer behaviour and completion prevailing in the market. Therefore, non-responsive attitude towards external environment makes management accounting systems less reliable in decision making process. The management accounting system not only provides information about the production cost but it is also used to analyse the financial health of the business through variance analysis. Variance analysis is an accounting tool that identifies the difference between actual costs and the budgeted cost related to sales, overheads, profits and many more. The managers use this technique to verify whether the production process is operating as per predefined budget. If the management identifies any deviation (variance) they dig deep to find out the reasons for deviation and thus the issue is resolved. However, this technique of management control is losing its popularity among the mangers because it fails to highlight the reasons behind such deviation. There is a possibility that the budget which is used as a standard in the variance analysis process has some loopholes and thus the technique provides irrelevant results. The variance analysis technique is quite cumbersome and time consuming. At first the different variances related to sales, raw material, labour and overhead should be calculated and then each of them has to be interpreted to derive required information. For the lower level managers who do not possess much technical knowledge about variance analysis, interpretation of the result is not an easy task. For example negative variance for labour productivity is a matter of concern but on the other side a negative variance in raw material cost is a highly appreciable one. Hence, it is quite possible that the management fails to interpret the information and so the whole management control system becomes useless. Apart from the above mentioned limitations existing in some of the commonly used management accounting tools, there are several other limitations that need to be considered while using management accounting. Being a traditional accounting system, it lacks predefined standards. As a result, different organisations often develop their own management control system; therefore the control system loses its reliability. Another limitation of this traditional accounting system is excessive reliance on quantitative data. No doubt quantitative data is reliable but sometime qualitative factors should also be taken care of. Assume a situation where the management has to decide whether to change the production location or not. According to management accounting system, quantitative factors like reduction in labour cost will be taken into consideration. However, non-quantitative factors such as goodwill in the society may not be considered. As a result the decision may not be appropriate and possibility of failure remains high. In the globalised world solely relying on management accounting system while making decisions is not a good idea. In the contemporary world businesses need to develop proactive strategies to survive in the market. Instead of developing strategies for the whole organisation it is more appropriate to set specific strategies for each strategic business unit. Management accounting considers the whole organisation as a single unit thus it cannot be used to analyse performance of different strategic units at the time of setting individual strategies for them. After considering the limitations of management accounting system it can be concluded that it needs to be renewed to fulfil requirement of contemporary businesses. Making decisions solely on financial information may result in poor strategies that fail to provide a competitive edge to the business. Therefore, the management should take into account innovative and more sensitive accounting systems that fulfil the requirements of the present world businesses. Strategic management accounting as a substitute of management accounting system: The changing external environment has shifted the businesses requirement regarding accounting information. This makes the traditional accounting system outdated and thus the managers are trying hard to introduce necessary changes in the accounting system to make it more efficient and this was the main cause for the development of the strategic accounting system. Many companies are relying on the strategic accounting system as a substitute of the old management accounting system. Johnson and Kaplan (1987) argued that the traditional accounting systems failed to provide required information to the businesses in the global world. Therefore, firms are paying extra attention towards the strategic accounting system to link their businesses with the external world. Simmonds in 1981 defined that strategic accounting provides required information about the business as well as the external environment where it operates. This information is essential in developing strategies and controlling the business. The traditional accounting system failed to do so; therefore the management and the accountants with assistance of regulatory bodies took required action to introduce new and modified accounting strategies, called strategic accounting system. With this accounting system a business acquires an outward look to evaluate its competitive position in the market. Lord in 1996 summarised basic characteristics of strategic accounting system, the summary is provided below: Collecting information regarding costs, volumes and market share of the competitors. Exploitation of cost reduction strategies by continuous improvement with the help of non-financial performance measures. Introducing required changes in the accounting policies to match with the organisation’s strategic position. (Collier & Agyei-Ampomah, 2008, p.50) As discussed earlier, the traditional accounting system considers all the cost incurred during production and then distributes it over the final products. Hence, this system fails to provide minute details related to cost and efficiency of the company. Therefore, the management in contemporary business environment prefer techniques like life cycle costing and activity based costing (ABC) over the traditional accounting practices. These strategic techniques are discussed in details as follows: Life cycle costing: Unlike management accounting, life cycle costing is not just concerned with collecting information related to production cost but it take into account the whole process of production starting from as early as the designing stage to minimise cost of production. Life cycle accounting is used to introduce in the production activity from the very early stage. This accounting concept applies principles of economic to improve the design as well as resources allocation decision. In this manner the accounting technique considers all the cost components incurred throughout the life cycle of the product. Life cycle costing follows a long term approach where present costs as well as the future costs associated with the production process are taken into account to minimise the total facility costs. The management believes that required changes should be introduced in the designing phase while developing the product. This will provide a chance to analyse the cost of raw material, cost of activities and cost of other facilities required in the production process. As per the economic concept of cost, with increase in total number of units produced the operating cost of production goes on declining but initial capital cost increases. Therefore, on adding both these costs total life cycle cost is calculated. This cost first declines with increase in production volume and then reaches a minimum point. If the production is increased further, again total life cycle cost starts increasing. Therefore, the management will produce optimum number of products for which total life cycle cost is lowest. Life cycle costing assists the management to take proactive action while controlling the cost of production. The management takes into account both quantitative as well as qualitative information to make decisions and thus the loopholes of management accounting system can be alleviated. Activity based costing (ABC): This is a modern method of allocation of overheads incurred in the process of production. According to this costing technique, all the overheads are accumulated to form a cost pool and then these costs are assigned to different activates with help of cost drivers. Cost drive is an activity that has a direct cause-effect relation with the resources consumed in the production process. “The term ‘activity’ refers to any event, action, transaction, or work sequence that incurs cost when producing a product or providing a serve” (Weygandt, Kimmel & Kieso, 2009, p.153). The main theme of activity based costing is: products consume activities and activities consume resources. Therefore, the management can analyse cost incurred by each of the activities. Management identify all those activities that incur high costs. If any of the activity is not that essential, management can easily replace that with a less costly activity or can simply omit it. In this manner the management can have a more scientific control over the production cost. Activity based management is an extension of activity based costing. Activity based management assists managers to take strategic decisions. This technique takes into account the cost incurred in respect to products, territories and customers. Activity based management is used to improve product quality, time and cost incurred in the production, logistics and other characteristics of the activities (Lewis, 1995, p.114). As a result, external information such as the demand pattern, degree of competition in the market and economic condition are used along with internal information such as production cost associated with different activities, availability of resources and other overhead costs to make strategic decision in the organisation. Conclusion : After making a thorough comparison between traditional management accounting and contemporary strategic accounting, it appears that management accounting suffers with certain limitations. This makes the traditional accounting process less effective in the present business environment. Traditional accounting system fails to provide required information to assist managers in decision making process. However, the strategic accounting is effective enough to provide both internal as well as external information (financial & non-financial) and thus managers can take proactive actions to develop more suitable strategies. 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