How Relevance Was Lost Accounting Essay
There are different terminologies that management accounting can be associated with. According to IMA (2012) definition, management accounting is defined as a “profession that involves partnering in management decision-making, devising planning and performance management systems”. It also helps in providing expertise in financial reporting in order to assist in controlling and implementation of organisation strategies. This was the case in the 19th century as the need for information arose during this period for internal planning and control when firms such as textile, mills and railroads had to develop internal administration procedures in order to co-ordinate the multiple process involved in the performance of their basic activities (Kaplan,1984).
The first part of this paper will illustrate how Kaplan, Johnson and others believe that management accounting has lost its relevance to modern businesses and the reasons behind the relevance lost. While the second part will cover whether strategic management and it tools can help regain the relevance that is lost. A large majority of the practices employed by firms in today’s modern age were innovated by 1925 – mainly due to “management accounting system to facilitate the control and coordination of a firm’s diverse activity” (Kaplan, 1984). During these periods the management control practices “evolved from the demands of senior executives to help them understand their internal operations, to make new product and investment decisions, and to motivate and evaluate the performance of their employees” (Kaplan, 1984).
There were also many cost accounting expansions made between 1850 -1915. For example; the demand for the introduction of railroads had an effect on the steel industry as well as resulting activity for management movement. Due to the changes that have occurred in today’s business environment, the previously developed cost and management accounting need to be further researched in order to meet the control and strategic plans of modern organisations. As a result of the recession by DuPont Corporation and General Motors, there was the need for multi-divisional firms which became the new form of organisational structure. Multi-divisional organisational structure had to be introduced in order to assist management into accomplishing “centralised control with decentralised responsibility” (Kaplan, 1984). As a result, this became a major innovation as people started to realise the possibility of firms expanding which means duties will need to be delegated and the management system will need to be able to evaluate, consolidate and centralise all the duties and performance in relations to the company’s financial policy as a whole (Kaplan, 1984). Therefore, Johnson claimed that this was part of the reasoning behind the idea of how top managers managed by numbers (Kaplan, 1984). Also, in other articles Johnson, Kaplan, Ezzamel and others believe that management had lost its relevance to today’s modern businesses because of the inappropriate use of accounting information to manage (Kaplan, 1984).
Furthermore, there were two major influencing companies which made an impact in businesses such as; the DuPont Corporation in 1903, as well as the reorganization of General Motors in 1920 in which DuPont Corporation incorporated “best practice”. A developed accounting measure was also implemented by using Return on Investment (ROI)-this was used to serve as an indicator of efficiency and also to measure financial performance of the company as a whole. This became the measure used by all managers after WW2.
How Relevance was lost
Based on Kaplan book on Relevance lost, management accounting information today is driven by procedures and the cycles of the organisation financial reporting system is “too late, too aggregated, and too distorted” for it to be relevant to manager for planning and control decision making. The problem caused by management accounting was not due to poor management of accounting but rather it lies with the idea of using accounting information to control operations. Post war, people did not consider it appropriate to control operations. Presumably, if its adoption had been done earlier, the negative consequence in 1970 and 80s may have occurred much earlier. The use of accounting system to report operations was present in the 1970’s as well as in the 1800’s. But however, the system was not used to control processes. According to Johnson, he suggested that the reason relevance was lost, was due to the “inappropriate emphasis on the use of accounting information for management” (Kaplan, 1984). The emphasis on control and planning by managers were not consistent with the new information-intensive capital using technologies after 1950.
Although ROI was able to measure performance and efficiency, it also had other adverse effect on managers in the long run. For example, managers were able to manipulate information therefore, not allowing top managers to know the true accomplishment of the company as a whole. Particularly, Kaplan claimed that due to the “excessive focus on short-term financial performance”, which in turn allowed managers to take advantage of using ROI to manipulate the expected profit of the company such as, engaging in non-productive and non-value-creating activities (Kaplan, 1984).
There were some technologies which rendered management accounting information obsolete such as; increasing the relative importance of overhead in relation to direct labour and shortening of product life cycle.
Johnson and Kaplan (1987) prior to 1920 mangers of most American firms focuses on cost management and believed that the then management accounting system(MAS) had developed the disciplines that were needed to run businesses successfully. Furthermore, another contributing factor to the loss of competitiveness of American firms due to the changes in the way managers thinks about running a successful firm. For instance, businesses lost sight of their processes by which people and customers make it have a competitive advantage and profitable in the global economy. Due to managers losing sight of focus, a large focus was placed on financial results rather than customer satisfaction. Chapman (2005) argues that while special attention is given to the internal affairs of the business sight is lost of the external opportunities and potential business threats.
Moreover, Up until the Second World War, management accounting tools use to serve people well, but after the WW2, it failed to adapt to the new competitive conditions which was used for planning and control. The failures to adapt to the changes were due to rigidity of financial reporting rules which were enforced by a new and powerful accounting profession board, due to high cost of implementing alternative accounting system along those mandated accounting information made companies use the information for more than one purpose.
Management accounting system became gradually less relevant to contemporary organisations due to the period of stagnations (Ezzamel, 1997). During this period there was a gradual shift from cost management to cost accounting. Kaplan strongly claims that the stagnation of management practice innovation was mainly because management practices were driven by external reporting mentality – FASB and SEC. Due to this relevance was lost as an aid for managers in the running of their businesses.
Additionally, rather than MAS contributing to the managing of processes, it was managing results which lead to criticism. According to Johnson, MAS was to be replaced with TQM for the main purpose of decision making. TQM seeks to manage processes by shifting “emphasis from top-down control to bottom empowerment” (Ezzamel, 1997) and also emphases attention on the competitive power which resides in creating relationships between suppliers and customers continuously. (Ezzamel 1994), believes that TQM is motivated by a problem solving approach.
Business schools teachings were a contributing factor to the how firms came to manage by numbers. Johnson stated that graduates were being taught neoclassical economists’ models of business instead of studying ‘real business problems faced by real business people.’ Through this, accounting became known as the language of business. In addition, due to justifications by management accountant writers that supported the idea that financial accounting information could be made “managerially relevant” – i.e. separating fixed from variable costs. This induced the impression that anything could be managed (i.e. fixed costs) – this adversely organised organisations in a manner that made customer satisfaction a difficult task to achieve. The concept that as output increases, costs per unit should decrease – economies of scale.
However, Johnson argued that these management tools that helped to promote new breed of managers ‘were increasingly inappropriate to the global competitive environment.’ Nevertheless, these kinds of graduates and other that came from financial & legal backgrounds dominated top executives. While the “real managers” who had the real technical and marketing experience were in less demand in the labour market.
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