A report on Management Accounting Risks and Control Strategy

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In the current era of globalisation, businesses are striving to establish an international presence for themselves and take advantage of a broader consumer market, cheaper access to resources or a more productive pool of employees. In such a scenario, establishing the profitability of the business and keeping track of the utilisation of the resources that the organisation is employing towards achieving its overall objectives assumes even more criticality. One of the useful functional disciplines within the organisation that is used for this purpose is the area of management accounting.

Management Accounting performs the dual role of highlighting any risks or threats to the organisation from a financial sustenance and growth perspective on the one hand, and facilitating the establishment of a control mechanism so as to monitor these risks and take relevant measures against them on an on-going basis (Steffan, 2008).

According to Hongren et. al. (2006) the management accounting measures, analyzes, and reports financial and non financial information that helps managers make decisions to fulfill the goals of the organization. In other words, it involves performing these duties effectively and efficiently, the management accountant differs from all other functional areas of accounting (cost and finance). This accounting information are not only valuable in the areas of control and risk, however are also used to coordinate product design, production, and marketing, generally speaking, it focuses on internal reporting.

In today's business environment, the risk being faced by organizations are increasing geometrically, and this is not limited to any sector of the economy, agricultural, (gene engineering), manufacturing (significant reduction in product life cycle arising from technological changes and the need to meet changing customer demands), service industry (outsourcing, technological changes), banking, (frauds) the list is certainly endless. To able to remain competitive, organizations, must as of a necessity, be able to anticipate and meet customers changing needs. While needs can be said to be external to the organization, failure to be able to manage and control risks from within automatically means failure to manage external risks.

The study of risk faced by organizations and control measures taken to mitigate it is certainly not a current phenomenon. Scholar, writers and experts have written on various aspects, from political, economic, internal and external, among others. With respect to Banks, it also includes reputational risks. According to Draghi the governor Bank of Italy's, banks that have links with criminal organizations, even they are unaware of such links risk their reputations that could endanger their stability. Today, globalization and the financial crisis which has increase integration of financial centers have also promoted this type of risk. It is a common occurrence today where cases of frauds and embezzlement in companies have greatly affected profitability and growth.

Research Aim

The aim of this study is to assess the influence of Management Accounting Risks and Control Strategy on the performance of the companies, their financial status and decision-making in the United Kingdom.

Research Objectives

The above research aim can also be synthesized further as the following research objectives:

To explain in detail, the field of management accounting, the range of activities covered by it and the role that is played by management accounting across the firm from a strategic perspective in general and in the finance department in particular

To enumerate and assess in detail, the risks that are highlighted by the discipline of management accounting, and the impact that these risks would otherwise have on management or financial decisions made by the firm in question

To conduct a detailed analysis on some of the prominent tools that management accounting provide to the organisation to put in place, control strategies to shield the firm from the risks thus identified

To establish the various ways in which the risks identified and the control mechanisms facilitated by management accounting influence the organisation overall

To draw suitable inferences on the relevance of management accounting on the overall decision making process of any firm and to make recommendations to augment the effectiveness of this discipline of management

Research Questions

Based on the research objectives mentioned above, the research questions that this study will try and answer are:

What is management accounting and what aspects of the functioning of the organisation are covered by management accounting?

What are the risks faced that an organisation would be safeguarded against by the adoption of the suite of tools provided by management accounting?

What are the most commonly used tools of management accounting that business firms benefit from in the establishment of control strategies to shield the firm from risks?

What is the overall significance of management accounting to the contemporary business firm? To what extent are the strategic decisions made by the firm influenced by management accounting?

Contextual Background and Research Rationale

Literature Review

Definition of concepts

Management accounting

Management accounting can be defined as the application of professional skills in the preparation and presentation of accounting information in such a way as to assist management in the formulation of policies and in the planning and control of the operations of the undertakings (Sizer, 1996).

The world renowned international association of management or managerial accounting says that managerial accounting is an integral part of management is concerned with identifying, presenting and interpreting information used for:

Formulation of strategy;

Planning and controlling activities

Decision making;

Optimising the use of resources;

Disclosure to shareholders and other external parties to the entity;

Disclosure to employees; and safeguarding assets (CIMA, 2006)

Concept of Risk

Managers are as a matter of fact individuals with different idiosyncrasies and as such their perception and understanding of risks differ significantly. Based on this, two managers in similar situations handle risk is bound to differ. Risk is part of every day business and each decision managers makes involve risks; for instance, to enter or leave a market.

Thompson (2005) has suggested 4 approaches to handling risks. The maxim approach, this involves looking only at the worst possible outcome for each; maximise approach, this seeks out the opportunity that offers the highest possible outcome; the minimex-regret approach, also known as regret approach, this takes a decision today based on tomorrow's/next week's expected outcome; the expected value approach, this involves calculations. The expected value of the decision is the major influence. The risk with the highest expected value is taken.

Definitions of risk vary depending on the outlook of the writer. However, traditionally, risk can be defined as exposure to danger, injury or any other adverse consequences. In the field of accounting, risk is seen in terms of probability, cost-volume analysis, discounted cash flow, hedging techniques. Risk management is the methodological approach adopted by firms to handle the risks resulting from the normal / daily operations. To effectively manage risks, firms should develop a strategy for treatment of risk that matches their appetite. However, effective risk management involves risk assessment, risk evaluation, risk treatment and risk reporting (CIMA, 2006).

Adams (1995) stated hat the propensity to assume risk is inherent in each individual but the degree of risk to be assumed varies. No doubt managers (managerial accountants) do take risk but these risks is based on individual preferences, which might be influenced by individual personality traits, cultural processes and other social institution in his environment.

Cost Benefit of Risk Management

Each action taken by the managerial accountant is to mitigate risk and advance benefits to the organization. Having said that it is expected that there are cost and benefits to the organization

Management and Risk

A risk taker who wishes to minimise risk for example by taking a decision where the standard deviation of expected profit is low or by using the minimax cost or minimax regret criteria may value information more highly than a risk seeker who may be content to base his decision on expected values only.

Control

Control involves all methods of taking actions to ensure costs are within predetermined target. Control leads to a reduction in excessive spending for instance wastage of material than the budgeted productivity level. The control process involves setting targets and receiving feedback information in order to ensure that actual performance are in line with set target and, if not corrective actions taken.

Relationship between Control and Risk

Risk

A risk is a situation in which the occurrence of future uncertain events is known but the possibilities of such future events can be quantified. The quantification of occurrence of such events is usually called probabilities (ICAN, 2010). Risk associated with organizations can be adjusted by the following methods accounting rate of return; payback adjustment method; finite horizon method, risk premium method, risk analysis etc.

In terms portfolio theory, risk can either be systematic or unsystematic.

Systematic risk is a risk that affects every security or company in the system where the system is the entire capital market of the economy. Unsystematic risks are peculiar or unique to each security or company.

The long run trend for corporations to evolve into organizations of gigantic size and scope including a great verity of specialized technical operations and employees has made it possible for corporate executives to exercise personal first hand supervision of operations. In an origination, the corporate executive must follow the policies and procedures which are formed by them so as to achieve its objectives. The objective o f an organization can not be achieved if management is not up to its expectations. (Burn, 1991).

Although profitability is the main aim of almost all organizations, still yet, some do not employ an effective control system. The strategic management field explain why some firms succeed and other fail and solutions available to management accountants.

Two theories are formulated by strategic management to deal with these situations. These are the collusion based and competence based theories. The collusion based theory is concerned with the firms restricting or preventing the entry of new competitors who might threaten to reduce output, prices and profit; in this theory, is affected by industry structure such as bargaining power of suppliers, while the competence based theories is concerned with the firm's competitive advantage which enables the firms competitive advantage which enable the firm to earn profit even under an intense competition. Collusion-based theory suggest that all things being equal, the profit of the firms in an industry should increase as tacit collusion in the industry increases, and competence-based theory suggest that all things being equal, a firms profit should also increase as it becomes more competent relative to competitors in its industry (Holmes & Burns, 1991).

System of Controls and Definition

System of controls indicated the various types of control devices that can be applied in an organization for effectiveness and efficiency (Carmichael & Willingham, 1996). The control devices are:

Accounting Control:

Vance and Boutell (1999) defined accounting control as comprising the plan of organization and the procedure and records that are concerned with the safeguard of assets and the reliability of financial records and consequently are designed to provide reasonable assurance.

This definition however ensures the following:

That transactions are executed in accordance with management's general or specific instructions.

That transactions are recorded as necessary to permit preparation of financial statement with generally accepted principles or any other criteria applicable to such statements and to maintain accountability for assets.

That access to assets is permitted only in accordance with management authorization.

That the recorded accountability for assets is compared with the existing assets at measurable intervals and appropriate action is taken with respect to any difference.

Horngren and Foster (1990) defined accounting control as comprising the methods and procedures that are mainly concerned with the authorization of transactions, the safeguard of assets, and accuracy of the accounting records. Both

Both definitions have one thing in common, that is, the safeguard of assets and the good accounting control help increase efficiency thereby reduce waste, unintentional errors and frauds.

Administrative Control

This can be said to be the plan of the organization and all methods and procedures that help management to plan and control operations. According to Vance and Boutell (1999) administrative control is not limited to the plan of the organization, and the procedures and records that are concerned with the decision processes leading to management's authorization of transaction.

Budgetary Control

Budgetary control involves determining internal standards of performance and feedback to those concerned. According to Ekezie (1990) budgetary control is concerned with the executive aspects of budgeting.

Definition of basic terms

Debarshi (2010) defines management accounting as a branch of accounting which deals with presenting and providing accounting information to the management in such a systematic way that it can perform its managerial functions of planning, controlling and decision-making in an effective and efficient manner. In effect, it serves as a decision support system for senior management as they go about making their strategic decisions on the chosen direction of the company (Epstein & Lee, 2010). This strategic orientation of management accounting is also apparent from another definition by Batty (2005), who explains management accounting as the accounting methods, systems and techniques, which coupled with special knowledge and ability, assists management in the task of maximising profits or minimising losses.

The above definition is already reflective of a couple of tenuous links, the strength of which will be put to test by the study that is being proposed in this document. First of all, the definition suggests that management accounting aids managers in the control function, thus suggesting that there is an element of cover against risk that is accorded by diligence in this area. Secondly, the relevance of management accounting on supporting and aiding decisions made by those at the helm of affairs at the organisation is also evidenced from the definition, which in turn makes a case for a detailed study to examine the strength of this association between the two.

Accounting scandals and calls for more proactive corporate governance

In the period starting from the late 1990s and running into the beginning of the current decade, a number of scandals have been exposed including Enron and WorldCom in the United States, and subsequently, Parmalat in Italy (Collier et al, 2006). A common thread linking all of these scandals was the lack of adequate management oversight and window-dressing of the financial records including the balance sheet, profit and loss and cash flow statements.

These developments were highly instrumental in calling to account, the management accounting function and its role within the organisation as a control and risk alert mechanism, with academicians and practitioners alike acknowledging the existent gaps in the practices being followed by management accountants. This was also accompanied by an acceptance of the need for executives on the board to take a more proactive role in monitoring of financial results reported and overall corporate governance. It hence becomes critical to revalidate this pivotal role of management accountants in managing risks and effecting control mechanisms within the organisation, thus reinforcing the relevance of the present study.

The recent global financial crisis

Following the recent global financial crisis and the credit crunch that gripped the financial markets and affected organisations and individuals alike since 2007, a number of groups of stakeholders have invited censure for having precipitated a crisis of this magnitude (Knoop, 2010). Apart from the individual borrowers, banks, credit analysts and regulators, one of the salient groups that were criticised over the mess that followed was the management accountants. Organisations, especially banks have had to take additional measures to make their financial statements even more transparent as a result of the crisis. This again makes a case for assessing the effectiveness of management accounting systems and practices today in ensuring that organisations make timely and accurate strategic decisions on their chosen direction of business, and are adequately equipped to monitor progress against these strategic imperatives using the tools of management accounting.

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