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“One of the functions of Management Accounting is to provide information for control purposes within an organisation.”
- The importance of control within an organisation
- The ways in which management accounting information can be used for control.
- The factors which may influence the effectiveness of control information.
In simple terms, management accounting is the amalgamation of the two important functions ‘management’ and ‘accounting’. Thus when the principles of management and accounting are married to achieve corporate objectives the process is deemed to provide tangible results. Accounting has been defined by the American Accounting Association as, “the process of identifying, measuring and communicating economic information to permit informed judgements and decisions by users of information.” On the other hand, Management according to Drucker (1974) consists of the performance of functions like planning, controlling, organising, communicating and motivating.
The following paper will analyse the key functions performed by management accounting. This paper will also attempt to highlight the contribution of management accounting in achieving control in the organisation. Besides, the paper will also provide a descriptive analysis of how effective control can be implemented within an organisational context. According to Johnson and Kaplan (1987) management accounting emerged since the early nineteenth century with the emergence of managed and hierarchical enterprises. The industrial revolution and in particular the rapid growth of railways led to an even faster growth of management accounting systems. Hence according to Johnson and Kaplan (1987) management accounting systems evolved to motivate and evaluate efficiency of internal processes and not to measure the overall profit of the organisation.
Information is a powerful tool for every organisation. In today’s competitive and volatile business environment, information is one of the important tools which provides organisation with a competitive edge. In an organisation, managers would require information that will help them in making decisions and controlling activities. As highlighted by Drury (1998:3), information is needed to estimate selling prices, costs, demand, competitive position and profitability of various products that are made by the organisation. Accounting information provides the managers the power to assess the credit worthiness of a potential borrower. It can be said that management accounting is that branch of accounting which is concerned with the provision of information to people within the organisation to help them make better decisions.
Organisations perform tasks to achieve organisational objectives, which are derived from the mission statements and which are then broken down into long and/or short term objectives. The successful achievement of these objectives depends on effective management processes. The processes will yield desirable results only when efficient performance management and measurement systems are in place. This further highlights the importance of having a system of control and review in the organisation. Control therefore involves a comparison of actual performance with plans so that deviations from plans can be identified and corrective action can be taken (Drury, 1998: 13).
Importance of Control
Control is not very different from monitoring. >From a human resource management perspective, it is essential to control/monitor the performance of individuals, as it in turn has an impact on the overall organisational performance. Various benchmarks and performance indicators are decided, which vary from one organisation to other and from one industry to other, which accurately measures how well a company is doing in relation to its past performance and how well is it performing on an industry wide basis. Performance can be measured in both qualitative and quantitative terms. Quantitative measures are easier to measure and interpret, thus accounting ratios, turnover, profit levels etc, provide a sound basis of measurement for performance.
Control, therefore, serves the purpose of ensuring that the gap between actual and target performance is minimised. The control process enables management to assess whether or not the objectives included in the long-term objectives are likely to be achieved or not. An effective control system would highlight potential problems and provide warning signals if the likelihood of meeting the long-term objectives was bleak.
The importance of having control mechanisms can only be understood in light of explaining the consequences of lack of having one. Lack of any kind of control in the organisation would mean that individuals would be doing whatever they wish to do. There would be no clear aims and objective towards which the individual would be working. This would lead to ultimately the organisation losing a sense of direction as well as prolonging the achievement of strategic objectives and to a great extent slowing down the growth of the company.
Lack of appropriate control mechanisms would mean that employees in the organisation would not be appraised accurately. The scenario where the manager has the data and statistics relating to the actual performance against the required performance would mean he would be providing a more objective appraisal and feedback and thereby giving the employee more tangible targets to work towards; comparing that to a scenario where the manager does not have any such information would only mean that the appraisal is subjective, biased and flawed. This could ultimately have an effect on the motivation and morale of the employee. Control mechanism would avoid the occurrence of any such scenario, as the benchmarks would already be set against which the employee would be measured.
A control system is a communication network that monitors activities within the organisation and provides corrective action in the future. Emmanuel et.al (1990) states that four conditions must be met before any process can said to be controlled:
- Objectives for the process being controlled must exist.
- The output of the process must be measurable. In other words, a mechanism must be in place for ascertaining whether the process is attaining its objectives
- A predictive model of the process being controlled is required so that causes for non-attainment can be identified and proposed corrective actions evaluated.
- There must be capability for taking action so that deviations from objectives can be reduced.
It must be noted, that for any control mechanism or system to work efficiently, it must be supported by efficient communication systems. Any activity in the firm, which will have an impact on its development and profitability, will only work when it is communicated at all levels of the organisation. Thus, control measures supported by a positive communication system are imperative for the control structure to provide beneficial results.
Management Accounting and Control
From management accounting perspective, budgeting is an important variable to ensure effective control. Budgeting provides managers with the tool to ascertain which costs do not conform to the original plan and enables them to operate ‘management by exception’ system. This would help the managers to identify inefficiencies which might arise from the purchase of inferior quality materials. It is important to note that it would be misleading to compare actual costs at one level of activity with budgeted costs at another level of activity. Thus it is important that the original budget must be adjusted to the actual level of activity.
In addition, management accounting also provides scope to prepare performance reports which would indicate whether the scheduled production of x number units has been achieved or not. The reasons could vary from inefficiency of the manager in managing or in failing to meet the budgeted sales demand or drafting of an incorrect sales budget; whatever the cause performance report indicates how efficient the manager has been in controlling the costs by comparing actual against total.
Management accounting also presents information about performance, which is done by comparing budgeted outputs and costs with actual outputs and costs. This can be achieved by preparing management audits. According to Drury (1998), management audits in that sense investigates the entire management control system and focuses on the following aspects of organisational performance:
- The nature and functioning of the organisation’s managerial systems and procedures.
- The economy and efficiency with which the organisation’s services are provided.
- The effectiveness of the organisation’s performance in achieving its objectives.
While producing management audit, the control aspect within it would involve exploring questions on the ways of comparing objectives with the needs of the population, methods of identifying activities that are not meeting objectives, the use of investment appraisal techniques and the methods of monitoring projects against the initial appraisal.
Besides management audit, performance reports also provide measures to monitor activities. Drury suggests that performance reports must not be used as a tool to blame the employees. Instead it should be used to monitor activities and identify those items which do not proceed according to plan and the report must take into account the variability in costs. The rationale is that some costs vary with changes in the level of activity; hence it is important to consider the variability.
In the preceding paragraphs communication was identified as an important tool in effective control implementation. Besides communication several other factors like filtering ‘noise’ from the data is important. Inaccurate information can distort the very purpose of control. Therefore an effective control system should ensure that data and information must be relevant. From an accounting perspective it is imperative that relevant and irrelevant costs are accurately distinguished and so that the possibility of inaccurate budgets is minimised. This can only happen when resource analysis and management audits are performed on a regular basis. Moreover, the analysis must use factors which make the analysis more objective rather than subjective.
From the preceding paragraphs it can be concluded that having a control system is imperative for an organisation to meet its long terms strategic goals and objectives. Control system provides a tool for the managers not only to assess the performance of their staff but also it helps to asses their own performance in terms of identifying inefficient practices. It provides them with the opportunity to review and reassess the working methods so that unnecessary costs can be minimised, organisational performance can improve and the organisation stays with budget. Management accounting provides various options like budgets, management audits, and a performance report structure which helps the managers achieve the objective of effectively managing their function. However, control systems can provide best results only when accompanied with an equally efficient communication structure. For any system to work efficiently it is imperative that the benefits, rationale and method of the system are communicated to all staff members at all levels. Thus in conclusion it can be said that the information provided by management accounting aides in maintaining control in the organisation and one of the core purposes of management accounting is to provide information for control and monitoring purpose in the organisation.
- Atrill, Peter and McLaney, Eddie, Management Accounting for Decision-Makers, (2004), FT Prentice Hall
- Black, Geoff, Introduction to Accounting and Finance, (2005), FT Prentice Hall
- Drucker, P. Management: Tasks, Responsibilities, Practices, (1974) Heinemann
- Drury, Colin, Management and Cost Accounting, (1998), 4th edition, Thomson Business Press.
- Emmanuel, C.R., Otley, D.T., and Merchant, K., (1990), Accounting by Management Control, Chapman and Hall
- Johnson, H.T., Kaplan, R.S., Professors, customers and value: bringing a global perspective to management accounting education, in Performance Excellence in Manufacturing and Services Organisation., American Accounting Association
- Garrison, Ray, Noreen, Eric, Seal, Willie, Management Accounting: European Edition (2002), McGraw Hill Higher Education
- Horngren, Charles, Stratton, William O., Sundem, Gary L., Introduction to Management Accounting, (2004), FT Prentice Hall.
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