problems arise by relying exclusively on management accounting information

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With rising global competition, tremendous growth in technology and wide fluctuations in currencies and prices, an organization's management control system must provide timely and accurate information to control product costs, measure an improve productivity, devise better production processes and motivate and evaluate the performance of managers (Johnson & Kaplan, 1987). At the same time, there are potential problems that can arise by relying exclusively on management accounting information. This school of thought indicates that management accounting information is often driven by the procedures and cycle of the organization's financial reporting system and is too aggregated and distorted to be relevant for managers planning and control decisions (Johnson and Kaplan, 1987). Therefore, the question arises whether greater emphasis to precision in accounting is required to help managers make better business decisions or is there a high opportunity cost associated in maintaining precise and accurate accounts. The discussion in this paper is aimed towards analyzing this trade off with respect to management accounting techniques of costing and performance measurement.

This paper will initially discuss briefly about the background and evolution of management accounting systems and its benefits to an organization. Starting with cost accounting, its relevance to an organization will be understood and the two major techniques - traditional costing methods and Activity Based Costing (ABC) will be analyzed by providing contrasting views on their usefulness to an organization and the tradeoff between their accuracy and cost. It will be seen that the evolution of ABC is a shift towards more precision in accounting but the ABC system is still based on estimates. Next, the performance measurement aspect of management accounting will be introduced leading into a discussion on whether greater emphasis should be laid on precision or the design of performance measures. On the whole, the paper will demonstrate that an increased precision in management accounting is indeed required but should not come at the cost of losing productivity, deviating from the overall strategy and a cost that is in excess of the benefits of precise data. Management needs to make quick decisions, which can be made on the basis of estimates rather than accurate information. Finally, it will show how technology has made it possible to maintain accurate accounts at a low cost.

The breakthrough in management accounting systems came with the invention of the railroads (Kaplan, 1984). Effective management systems were necessary to coordinate efficiently logistical, conversion, and distribution activities of these large-scale enterprises and to provide performance benchmarks for managers looking over the sub units (Johnson and Kaplan, 1987). By 1925, the DuPont Powder Company and General Motors had developed most of the modern management accounting costing and performance measurement techniques which became the model for many corporations (Kaplan, 1984). The key focus of management accounting systems through costing and performance measurement methods was to help managers make better business decisions, evaluate departmental performance and motivate managers.

It was designed to serve as an aid for managerial decision-making and hence companies faced no external compulsion for the preparation of management accounts (Khan and Jain, 2007).

Cost accounting methods

Organizations typically have production departments and service departments. The former directly produce or distribute the firm's output and the latter provide services to other departments (Kaplan & Atkinson 1998). In order to calculate the price of the final product, it is important to inculcate the cost incurred by all departments to produce the product, into its price. Young (2003) suggests that managers mostly use cost accounting principles to reduce company's expenses and progress its productivity by ensuring that the organization does not have all its products as loss leaders i.e. sold at or below cost. He further indicates that cost accounting serves to highlight areas where cross subsidization is taking place, thus allowing senior management to assess whether that cross subsidization is consistent with the organization's overall strategy. Hence, a degree of precision is indeed required in the numbers that are reported in order to perfectly price the product and decide if an intermediate service in the production process should be internally or externally provided.

The traditional cost system is a two-stage process, where in the first stage all organization expenses are assigned, either directly or through assignment from service departments, to production departments and in the second stage, costs are assigned to the end product through the production departments (Kaplan & Atkinson, 1998). The assignment of service department costs to production departments sets up an internal market for the supply and demand of internally produced services. This promotes cost control and efficiency by providing incentives for efficient performance by the managers departments and motivates prudent use of these services by the managers of production department (Kaplan and Atkinson, 1998). However, Complications in cost accounting arise when an organization provides multiple goods and services particularly when it uses different kinds of amounts of resources to manufacture the goods or provide the services (Young, 2003). The drawbacks of the traditional costing system and to some extent its lack of accuracy in accounting led to the evolution of ABC system.

Kaplan & Atkinson (1998) describe the ABC system through a series of steps. Starting with identifying activities being performed by the organization's various support resources, the cost of these support resources to the various activities is traced in order to determine the total cost of performing each of the support activities. The next step involves tracing the activity costs to products by identifying a cost driver for each activity. The activity cost driver rate is calculated and used to drive activity costs to products. Finally, for each product (or service or customer) the quantity of the cost drivers used is multiplied by the standard cost driver. Hence ABC corrected the arbitrary allocations of factory overhead to products and was instrumental in assigning other indirect expenses to products and customers. The goal of ABC was not to allocate common costs to products but rather, measure the usage of resources and then allocate in the product and services to customers (Kaplan & Atkinson, 1998). Its main focus was to measure the total cost of the resources used to produce a firm's end product (Cooper and Kaplan, 1992 sighted in Kee, 2001).

It is evident that the shift from traditional costing methods to ABC was indeed a shift towards more precision in accounting. Kaplan & Atkinson (1998, p.112) state: 'Activity-based cost methods provide more accurate information about business activities and processes and about the products, services, and customers serviced by these processes than do traditional cost systems.' Further, they suggest that the development of ABC was to provide more accurate ways of assigning the costs of indirect and support resources to activities, processes, products, services and customers. Managers at all organizational levels perceived ABC data as more accurate and reliable than those generated by traditional costing and were willing to use them for decision-making and performance evaluation (Geri and Ronen, 2005). Hence, with a purpose to focus management attention to resource consumption, the evolution of ABC from traditional costing methods demonstrates a shift towards precision in accounting. However, there are also arguments that question its feasibility and accuracy.

Whilst the Activity Cost Drivers are the main highlights of the ABC system, they are also its most costly aspect (Kaplan & Atkinson, 1998). Geri and Ronen (2005) suggest that ABC is based on subjective arbitrary cost allocations. It maybe a more complicated system but not necessarily accurate and useful for decision-making since it does not predict profits when production volume changes. Also, when a firm faces an internal capacity constraint an opportunity cost is created which ABC ignores and therefore fails to differentiate between a bottleneck and a resource with excess capacity, thus making it unsuitable for operational decision-making and rendering precision useless (Kee, 2001). Kaplan & Atkinson (1998) indicate that ABC systems are based on many estimates which are made, not because actual costs cannot be traced, but because the cost of doing it is greatly in excess to the benefits of doing a detailed and accurate cost tracing. They further suggest that the goal of the ABC system is not to have the most accurate cost system but to have the best cost system, one that balances the cost of errors made from inaccurate estimates with the measurement cost.

The question arises if cost accounting and management accounting as a whole based on approximations is useful for decision-making. Research suggests that management accounting based on approximations is more useful than numbers that are more precise. Management needs quick information to make better decisions and take prompt actions. For this, it is often willing to sacrifice precision to gain speed in reporting (Khan and Jain, 2007). The ultimate goal of the management accounting techniques is to be approximately right and thus there is an appropriate tradeoff between accuracy and the cost of measurement. The degree of acceptable approximation depends on cost and the objective of the costing exercise. Greater precision is required for productivity enhancements than for costing products, services and customers (Kaplan & Atkinson, 1998).

Performance Measurement

Another major aspect of managerial accounting is performance measurement. Bourne et al (2003) defines performance measurement as a technique to use multi-dimensional set of performance measures for the planning and management of a business. The set of measures is multi-dimensional as it includes both financial and non-financial measures, internal and external, which quantify what has been achieved and also helps predict the future (Bourne et al., 2003). Examples of financial measures include ROI and EVA. Non-financial metrics have been more rapid in their growth, as quality, quality measurement and customer satisfaction have become buzzwords in the industry (Meyer & Gupta, 1994). Another reason is that cost focused measurement systems provided a historical view rather than giving an indication of future performance (Bruns, 1998, cited in kennerley & Neely, 2002). Durden, Hassel & Upton (1999) state that non-financial performance indicators are an integral component of the management control system and that adoption of these performance indicators is positively correlated to performance. Therefore, greater use of these indicators leads to higher performance. Another measure of performance the combines both the financial and non-financial measures is the Balanced Scorecard.

But Despite the apparent simplicity of measuring business performance, the question of how it can be measured is complicated by two factors: One, it is not always obvious which measures a firm should adopt; and two, the measures that will be most relevant to the firm will change over time (Neely, 1999). Meyer and Gupta (1994) point towards a paradox that better coordination and control in organizations is best achieved through multiple, uncorrelated and ever changing performance indicators that render it difficult to know exactly what performance is. They identified the reasons behind the paradox as an instant high growth of performance measures, poor correlations among these performance measures and a continuous change in dominant measures. In fact they argue that all performance measures are flawed and as limitations are exploited, new measures replace existing ones.

Various other studies are supportive of the claims made by Meyer & Gupta (1994). Survey data suggests that between 40 and 60 per cent of companies significantly changed their measurement systems between 1995 and 2000 (Frigo & Krumwiede, 1999, cited in Kennerley & Neely, 2002). Kennerley & Neely (2002) suggest that ineffective management of the evolution of measurement systems is causing a new measurement "crisis", with organisations implementing new measures to reflect new priorities but failing to discard measures reflecting old priorities resulting in uncorrelated and inconsistent measures.

Therefore, with performance measures being uncorrelated and continuously changing, the question arises whether it is important to focus on the precision and details of specific measures or to the process of performance measurement system design. To quote Eccles (1991), "Enhanced competitiveness depends on starting from scratch and asking: "Given our strategy what are the most important measures of performance?" "How do these measures relate to one another?" "What measures truly predict long-term financial success in our businesses?" "Many managers worry that income-based financial figures are better at measuring the consequences of yesterday's decisions than they are at indicating tomorrow's performance". Kennerley & Neely (2002) in their literature review suggest that Johnson & Kaplan (1987) highlight the failure of financial performance measures to reflect changes in competitive strategies of modern organizations. They indicate that while profit remains the ultimate goal, it is considered an insufficient measure and encourages short termism.

According to Johnson and Kaplan (1987), management accounting lost its relevance since the benefits from a more accurate and more responsive management system were not worth the cost of maintaining it. They further indicate that an increased emphasis of reporting quarterly, managers focus their attention to getting the reports, which are not quite useful to reduce cost or improve productivity. Therefore, not only does the accounting system fails to provide relevant information to managers, but also distracts their attention from factors critical for production efficiencies since monthly accounting statements can signal increased profits even when the long-term economic health of the firm has been compromised. Khan & Jain (2007) also argue that timeliness is often more important than precision to managers and that management needs information rapidly and is often willing to sacrifice some precision to gain speed in reporting. Thus, in management accounting approximations are often as, or even more useful than, number that are more precise. Since precision is costly in terms of both time and resources, managerial accounting seems to place less emphasis on precision.

Advancements in technology have reduced the costs of collecting, processing, analyzing, and reporting information. With production processes under direct control of digital computers, it is now feasible to measure and attribute accurately the resource demands made by each product in a diverse line. Combining technology with software systems, it is possible to report information that is more accurate, more timely and hence more effective. So indeed, precision and accuracy is required in managerial accounting for better decision making, but only if it comes in timely and at a low cost. It is up to the organizations to assess the opportunity cost of collecting accurate information and analyze the tradeoff.

To conclude, the paper discussed the management accounting concept through techniques of costing and performance measurement. The evolution from traditional costing methods to ABC demonstrated a shift towards more precision, but the drawbacks of ABC indicate that it is still based on estimates and approximations. Accuracy in data can lead to better decisions, but there is a tradeoff between precision and cost that needs to be analyzed. Also, this cost can be reduced by the use of software and technology. Performance measures, mostly non-financial, have been growing steadily and are continuously changing with new measure being uncorrelated to the previous ones. Hence, rather than precision, more emphasis should be laid on the design and suitability of the performance measure to the organization. Some measures can be misleading and may encourage short-term growth while neglecting the long-term strategy. Therefore, precision in management accounting, at a relatively low cost, could be more useful for cost based methods than performance measures.