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The Factors That Impact Outsourcing On Accounting Functions Accounting Essay

In today’s competitive environment, outsourcing accounting has become an important decision making element in a business. All the business houses cannot ignore the accounting of financial data of their company. A company failed to maintain proper financial records can lose their business as these records are the fundamental source of accounting information. Global economy is slowly and steadily recovering from one of the worst recessions experienced in the last 50 years. To recover from the situation companies are increasingly looking at accounting outsourcing services to reduce costs and to be competitive in the market in the near future.

Accounting functions such as general ledger, accounts receivable, accounts payable and payroll are essential in business. These functions can be handled easily by purchasing accounting software which is user friendly and available in the market such as User Business System (UBS) and Mind Your Own Business (MYOB). However, the diversity of businesses in the world have created disadvantages to the SMEs capabilities in order to sustain their competitive advantage since resource constraints generally are much more significant for SMEs than they are for large firms (Marriott and Marriott, 2000). Svedberg et al. (2006) found that many large companies dedicate their employees or even their whole departments to handle a certain function of a company. Most certainly, SMEs do not have these resources. Fortunately, the presence of outsourcing practices has offered a great helping hand or an alternative for business survival in general for SME. United Nations Conference on Trade and Development [UNCTD] (2000) found that generally, SMEs plays important role to economic growth development in both developed and developing countries. However, many SMEs do not keep proper financial records and accounts as they are not aware or convinced of the usefulness of accounting and financial reporting requirements for control and decision-making purposes (UNCTD, 2000). Ismail (2002) added that SMEs are lacking accounting knowledge and support to perform accounting functions thus they are more likely to outsource their accounting works to accounting firms. As a result, having improved accounting information would permit SME owners to manage their firms better and would allow them to access finance more easily. (UNCTD, 2000).

It is no longer an easy task to sustain a competitive advantage in the global business environment nowadays. Previously, accounting functions served mainly for month end reporting or record keeping purposes. Today, the evolution of accounting such as management accounting has made accounting functions to have more roles to play in any business. Moreover, it has created an advantage for business competitiveness in the market. Businesses able to sustain their competitive edge as managements are looking at the accounting information for appropriate decision making.

In short, accounting functions seem to be relatively important in every business operation. However, in the context of diverse businesses, SMEs seem to have disadvantages in sustaining a competitive advantage in terms of capital and resources. In accounting, a resource deficit means that the company is lacking in terms of people or knowledge to fulfil the accounting functions. The higher the resource deficit, the more attractive outsourcing option becomes (Dibbern &Heinzl, 2001). This is particularly relevant for SMEs, since resource constraints generally are much more significant for SMEs than they are for large firms (Marriott and Marriott, 2000). Ismail (2002) claimed that most of the small and medium enterprises (SMEs) tend to outsource their accounting works to accounting firms due to lack of accounting knowledge and support. This is because they rely on the statutory accounts as their main source of information. UNCTD (2000) stated that many SMEs lack skilled accounting personnel and infrastructure to implement existing accounting rules and regulations. As further elaborated by Everaert et al. (2006), SMEs lack of access to expertise because the accounting functions do not only require knowledge of generally-accepted accounting rules or the tax regulation, but also require that one knows how to apply the rules in a given business environment. Apart from that, Ismail (2002) added that SMEs do encounter difficulty to draw and retain skilled employee.

This may be due to less number of expertises and insufficient of knowledgeable accounting support to handle full set of accounts. As an alternative, some SMEs choose to outsource accounting works relative to utilize highly paid and experienced accountants, CPAs, and MBAs with prior experience in outsourcing accounting and taxation related processes. These service providers have earned the reputation of being reliable, efficient and trustworthy by turning over business processes to companies that consider these tasks their core competency, organizations now have the ability to become more profitable, more efficient and far more competitive by focusing on the tasks that are most important. Although Bragg (2006) and Burkholder et al. (2006) have discovered the reasons and risk factors of outsourcing business function in general, however, those studies were performed abroad. Therefore, this study will explore the reality of Malaysian SMEs in terms of outsourcing accounting functions.

CHAPTER 2

LITERATURE REVIEW

2.0 Accounting Function

Accounting is defined as financial activity that measures and provides statements or assurances about financial information (Meigs and Meigs, 1970). In addition, Drury (2005, p.6) described that accounting is a language that communicates economic information to people who have an interest in an organisation such as managers, shareholders and potential investors, employees, creditors and the government. There are many types of accounting functions in business. Finance and accounting functions range from accounts payable, accounts receivable, general ledgers and internal audit services to lease administration, payroll, property accounting, sales audits and taxes (Alan, 2002: 50). Other accounting functions that are vital to the efficient operation of a small business are the insurance register, records of leaseholds, and records of the firm's investments outside its business (Krell, 2006).

2.1 Outsourcing Accounting Functions

The outsourcing of accounting and finance functions will become prevalent and continue to grow (Shailendra, 2004). The global market for outsourcing finance and accounting functions is expected to grow at a 9.6% Compounded Annual Growth Rate (CAGR) and exceed $47.6 billion in 2008 according to a new report from IDC (Casale, 2004). More specifically, the elements of finance and accounting services that can be outsourced are as follows:

General accounting

Audits

Accounts payable

Banking

Financial services solutions

Credit services

Tax services

The accounting function is among most commonly outsourced, though this is usually limited to only a few of tasks within the function, however, there are opportunities to outsource a wide array of services in this area if a company is willing to work with multiple suppliers to achieve this goal (Bragg, S.M. , 2006, p 129). For instance, cash management services are offered by most regional banks. Taxation, financial reporting, and internal audit services are provided by all of the largest auditing firms, such as Ernst & Young LLP and Deloitte & Touche LLP. Outsourcing Accounting Online to India [OAOI] (2007) suggested that by switching to outsourcing of accounting, it enables companies to reduce overhead and focus on theircore business. In addition, they also mentioned that the time spent on bookkeeping problems would add little or rather no value to a company’s customer relationship. Moreover, they also said that outsourcing services helps such companies manage their work well. As the total cost for managing the accounting work by outsourcing firm is far lesser than hiring in-house staff, almost every company is making accounting outsourcing a part of its long-term sustainable business model (OAOI, 2007). Outsourcing of accounts payable helps in reducing the administrative costs and cost saving without capital investment. The accounts payable outsourcing services includes data capture, data processing, invoice entry and payment disbursement. The technology is capable in transforming the accounts payable; by outsourcing the accounts payable, it improves the accountability, reduces cost and effort in the SMEs (OAOI, 2007). When come to paying taxes and filing returns usually it means taking valuable time out of SMEs core business operation. By outsourcing tax processing, SMEs can save time and avoid penalties arising from late payment and filing. SMEs can stay free from the pressure or keeping track of changing laws and the latest technology (OAOI, 2007). However, outsourcing should be undertaken with caution as there will be loss of direct control over quality and leads to additional coordination expense and delays where prompt management and business decision will be affected; besides, it will also jeopardizes employee loyalty because of the job-loss fear (Brown & Wilson (2005), Aubert et al (1998), Earl (1996)). Another concern of having outsourcing is the exposure to data security and customer privacy issues. This will also atrophies of in-house capability to perform outsource services. Finally, the dependence on one supplier compromises future negotiation leverage (Bragg, 2006).

2.1 FACTORS INFLUENCING ACCOUNTING OUTSOURCING

2.1.0 The Resource Factor

Recent literature presents empirical evidence regarding the outsourcing of e-government services and stresses that resources are one of the major factors involved in contracting out government services (Ya Ni and Bretschneider, 2007; Domberger and Fernandez, 1999). This is because some contractors have better infrastructure and expertise in the field than the government. Therefore, outsourcing becomes a better option than incurring a large investment. In addition, a company may be able to free up resources for other purposes by outsourcing certain functions or departments to third parties. In other words, outsourcing allows a company to redirect its resources.

2.1.1 The Risk of Outsourcing Factor

However, the risks involved in outsourcing accounting functions lead to the public disclosures of various types of accounting information. The decision-makers handling outsourcing are aware of these risks before they make the decision to hand over a function to a supplier.

The perceived risk factors as discussed by Bragg (2006) are as follows:

Changes in supplier circumstances – One change might be supplier financial difficulties. This risk can be minimized by using independent consultants or service providers.

2. Supplier failure – For instance, accounting information is also important for decision-

making if the supplier fails to make a report on time because this may delay

management arrangements or plans.

Loss of confidential information – This is a particular concern when low-wage

supplier employees have access to sensitive information and have a monetary incentive to sell it.

2.1.2 The Operations Management Factor

SMEs may gain advantages from the focus on core business activities such as manufacturing and sales that they are able to establish when they transfer their non-core activities to an external provider (Nicholas, 2006). In this way, companies are able to achieve better decision-making and management. Outsourcing can also enhance control within a company. Hence, companies can reduce their administrative costs and increase competitive advantage (Domberger, Hall and Li, 1994; Domberger; Meadowcroft and Thompson, 1986, 1987; Domberger, Fernandez and Fiebig, 2000; Hodge, 2000).

2.1.3 Firm Size

In this study, one of the objectives is to determine if differences in SME firm size in Malaysia have any effect on the decision to outsource accounting functions (Domberger, 1998; Gilley, Rasheed and Al-Shammari, 2006; Ang and Straub, 1998).

2.2.4 Types of Industry

We added this construct to further examine whether industry type can make a significant difference to SMEs deciding to outsource (Domberger, 1998).

2.3 Critical Factors Contributing to Outsourcing of Accounting Functions

Based on existing studies of outsourcing in general and particularly within accounting, seven independent variables that contribute to outsourcing decisions were identified. These are costs, resources, competencies, operation management, and the risks of outsourcing, firm size, and types of industry. One of the two theories underlying this research is Resource-Based Thinking (RBT), which states that a company's resources are controlled by the company and its employees. These resources include business assets such as business processes, organisational characteristics, aptitudes, information, and knowledge (Barney, 1991; Rodriguez and Diaz, 2008; McIvor, 2009). It also involves the firm’s capability to reconfigure and exploit all of its resources to achieve competitive advantage. This expertise is implicitly encoded in the firm’s routines and in the know-how acquired by individual firm personnel throughout its history (Prahalad and Hamel, 1990). The crux of the RBT is that the more limited the necessary resources of the firm, the greater the tendency for the firm to rely on external expertise to overcome this weakness (Prahalad and Hamel, 1990; Winter, 1998). Hence, the lower strategic value of resources results in more opportunities to outsource. According to this approach, a firm should focus on those activities that constitute its core competences and outsource the rest of the activities (Rodriguez and Diaz, 2008; Prahalad and Hamel, 1990; Quinn and Hilmer, 1994; Venkatesan, 1992; Quinn, 1999; McIvor, 2009).

2.4 Benefits of Accounting Outsourcing Services

Get advantages of our affordable accounting outsourcing services. Accounting outsourcing delivers maximum benefit of accounting services increase efficiencies, flexibility & high security for your business data. The world of global accounting outsourcing is expanding in terms of the number of players and beneficiaries, services, speed, space, and connectivity. Outsourcing has become the magic word in a world of competition where accounting outsourcing services providers and buyers are mutually benefited through the exchange of quality accounting outsourcing services for money. There has been a remarkable growth in the outsourcing industry in many developing countries like India because of their expertise in reducing costs while enhancing quality services in financial accounting. Advantages of accounting outsourcing are multifaceted and ever increasing.

Making the best use of accounting outsourcing services

Concentrate on other business priorities

Automate complex and voluminous processes

Cost Savings

Access large, skilled, and viable labour pool

Create competitive advantage

Get the work done in quick turn-around-time

Enjoy the benefits of advanced collaboration capabilities

Improve customer satisfaction through efficient and timely processing of requests, service changes, and projects

Free themselves from the hassles of managing employees and records

2.5 Advantages of Outsourcing

Cost Savings

There can be significant cost savings when a business function is outsourced.  Employee compensation costs, office space expenses and other costs associated with providing a work space or manufacturing setup are eliminated and free up resources for other purposes.

Focus On Core Business

Outsourcing allows organization to focus on their expertise and core business.  When organizations go outside their expertise, they get into business functions and processes that they may not be as knowledgeable about and could potentially take away from their main focus.  An example of this is when a grocery store decides to add video rental to their operation.  If too much focus is put on that part of the business they lose focus of the core business which is grocery.

Improved Quality

Improved quality can be achieved by using vendors with more expertise and more specialized processes.  An example of this would be contracting out a cleaning service. An outside service would have the resources for hiring, proper training and facility inspections that may not be available if the function were kept in-house.

Customer Satisfaction

The advantage of having a vendor contract is they are bound to certain levels of service and quality.  An example of this is if your IT function is outsourced and the technician calls in sick, it is the vendor’s responsibility to find someone to replace them and meet your support needs.

Operational Efficiency

Outsourcing gives an organization exposure to vendor specialized systems.  Specialization provides more efficiency that allows for a quicker turnaround time and higher levels of quality.

2.6 Disadvantages / Risks of Outsourcing

No Managerial Control

Whenever you outsource your work to another company, the managerial rights for that particular work rest with the other company. Of course, there is a contract signed between both companies, but management control surely rests with the other company. This other company may not have a motivated and driven workforce as your company. They might be only interested in making out of the venture, without paying much attention to proper work management.

Confidentiality and Security Dangers

This is one of the IT outsourcing disadvantages. For any type of business to run successfully, there is certain private and confidential information which cannot be let outside the company. This includes salary payments, financial status and personal information about employees among other things. There could be a risk when this information is shared with another company. If any potentially private information sharing is taking place between both companies, it is important to take all this into account while forming the contract and should be mentioned in it. Do a quick background check on the company you are outsourcing your work to

Bad Publicity Attached with Outsourcing

Not everybody likes the sound of the word 'outsourcing'. If there are people around you who are practicing outsourcing themselves or like the idea, then you are safe. But in case people you deal with have a strong disregard for outsourcing or have had a bad experience like losing their jobs due to outsourcing, then it may not be good for your company. Outsourcing does bring some amount of bad publicity which can be reflected through people's outlook towards the company.

Possibility of Hidden Costs

This is another major disadvantage of outsourcing wherein the other company may not mention certain expenses in the contract and come up with them later. If you try to drag the other company to court, you will have to bear legal expenses for the same and pay your lawyer too. Since the other company makes the contract, you will also be at a disadvantage when you try to battle against them in court. Review the contract thoroughly before signing on the dotted line to avoid this problem.

Issues with Quality

The other company has agreed to carry out your business for profit. The price for the other company will be pre-determined as per the contract. Thus, the only option left for the other company will be to reduce their expenses to increase their income, at the cost of quality of work. Also, whenever you demand any changes in the work, the other company will ask for more money as it would be something apart from what is stated in the contract.

Dependency on another Company's Financial Status

This is another peculiar disadvantage of outsourcing. You have to depend on the financial stability of the other company for your survival. Since the other company is doing your work, if it goes bankrupt and for some reason cannot continue doing your work any further, you are left stranded and cannot do much about it either.

Types of outsourcing accounting problems

The types of outsourcing problems highlighted in the literature can be classified as financial, technological, legal, human resource and management and control. The documented problems or concerns which have been experienced by firms involved in outsourcing are listed below:-

• Extra-use charges and hidden costs (Bresnen and Fowler, 1994; Cullen,

1997; Ernst and Young, 1994)

• Cost of service changes (Cullen, 1997)

• Short-term savings offset by long-term costs (Ernst and Young, 1994)

• Loss of economies of scale for very large service-user firms which are subject to

transaction-based charges (Chalos, 1995; Dobbie, 1991)

• Transitional personnel-related costs associated with remuneration payouts,

placement costs and potential lawsuits and union difficulties

(Cullen, 1997; Ernst and Young, 1994)

• Cost of conversion and implementation (Ernst and Young, 1994)

• Cost of management team to monitor and manage the outsourcing relationship

(Ernst and Young, 1994)

• Exposure to vendor's financial strength and profit motive

(Cullen, 1997; Ernst and Young, 1994)

• Potential litigation costs for contract breaches (Ernst and Young, 1994)

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