Usefulness and limitations of accounting for decision making

Published: Last Edited:

This essay has been submitted by a student. This is not an example of the work written by our professional essay writers.

The purpose of this essay is to critically analyse the usefulness and limitations of accounting information for decision-making, considering constraints under which the users of accounting information actually operate. However, a prior discussion of subjective expected utility (SEU) model will be done to better understand the purpose of Accounting and its products, accounting information. Scope of discussion will be limited within the context of individual and group decision-making. In the conclusion users of accounting information are identified and their constraints summarised. In conclusion accounting information user's constraints are identified and their needs are summarised.

A sample of definitions in accounting textbooks is supplied by Kieso and Weygaardt (1992.p.3) they identified three essential aspects of accounting as:

Accounting identifies, measures and communicates financial information

This information is about economic entities

To interested parties, being users of financial information (Koornhof, 1998)

Clearly the above mentioned aspects views accounting as more than just a technique of measuring data. Accounting, if seen as a form of information system helps in communicating information from source (the accountants) to receivers (users). This accounting information is used in deciding among alternative course of actions, so a user can make an informed decision. In order for accounting information to be useful a number of qualitative attributes are identified by accounting literature. Hendriksen and Van Breda (1991, p.123??) argues that qualitative attributes of accounting information improves its usefulness in decision making. These attributes should be; robust i.e. stand the test of time; pervasive i.e. applies to all accounting entities; implementable i.e. capable of application and susceptible to objective verification.

In order to understand the decision making process different models of decision making have been suggested. A model by definition being a theoretical view of real world may not be perfect but it provide us a tool to better understand a complex situation such as decision making process of an individual or a group. Simple model of decision making as suggested by (Arnold and Turley, 1996, p.29) consist of six-steps. It's a rational decision process which means that it is based upon thinking, comparing and evaluating alternatives.

The steps/stages

define the situation and the desired outcome

research and identify options

compare and contrast each alternative and its consequences

make a decision i.e. choose an alternative

design and implement an action plan

evaluate results

Accounting is concerned directly with stages 2, 4 and 6 - where quantitative information is required about performance currently expected and about future alternative courses of action (Arnold and Turley, 1996, p.31)

It can be argued that this model makes the decision making process too simple and linear. Also process can become a waste of time, energy and money if there is too much attention to detail in researching alternatives. Delay in decision making may result in waste opportunities. Besides it may be difficult for an individual decision maker to know when to move on from one stage.

Another model that helps in understanding the decision making process is called subjected expected utility (SEU) model which is based in a decision theory promoted by L. J. Savage in 1954. It is based on the basic assumption that individuals make rational choices in order to maximise their utility i.e. personal happiness. Its rational choice model based on how people should behave if they are rational. The model makes some basic assumption; that information is available about all possible alternatives; that individual decision maker has sufficient mental capacity to evaluate all alternatives including the capacity to make the necessary forecasts about future outcome; individual decision maker know and can rank order preferences i.e. (logical order a<b<c); lastly that a decision maker always seek to maximise utility. These assumption makes SEU model very demanding and thus makes is difficult to apply the model in real world situation (Arnold and Turley, 1996, p.32)

SEU model fails to give recognition to the fact individual's rationale may be limited by many other things such as environment, education, conceptual thinking and maybe even limited mental capacity. Thus the notion of bounded rationality with results from cognitive limitations of their minds seems more appropriate description of individual decision making. (Arnold and Turley, 1996, p.32)Decision-maker usually satisfice: rather than maximising ones utility. Decision maker use "status quo" as an anchor to find a "good enough" solution. For example in determination of predetermined overhead rate a decision would be required to select overhead cost driver. A decision maker's may have his or her own conceptual driven approach in making this vital decision, while be constrained by time pressure. It is impossible to provide accounting information to the decision maker for all pros and cons of different overhead cost driver may have. Furthermore, cost effectiveness of collecting such information might just exceed its benefits.

Accountants need to take into consideration the notion of bounded rationality while providing information to the users of its information for aid decision making. Users of accounting information are bounded by many constraints in their decision making process. Moreover, these constraints differ between individual and group decision making process. In the book "A Behavioural theory of the Firm" it is argued by the authors that goals of an organisation are a compromise between members of coalition made up of the stakeholders. The outcome of decision making is a compromise or "trade off" between the interests of the various stakeholder groups (Cyert and March, 1992). Accountants are faced with dilemma arising due to the principal-agent problem. Most corporations have follow principal-agent arrangement. Principal i.e. shareholders hiring the agent i.e. management to pursue the interests of the former. Constraints arising from conflict of interests of different stakeholders.

In corporation decision process involves delegation of decision process. This in turn may lead to suboptimization. It occurs when different subunits each attempt to reach a solution that is optimal for that unit, but that may not be optimum for the organization as a whole (Arnold and Turley, 1996, p.33). Accountants need to keep decision-usefulness of the information for different self-interested units yet confining to accounting principles and organisational goal. Recording and measuring inter-divisional transactions e.g., transfer pricing should be followed to abide by basic accounting principles and reducing conflict of interest between different sub-divisions within an organisation, while still being true towards organisational goal.

Role of managerial accounting is to find a middle path to keep the accounting information relevant for individual as well as group to aid them in decision making. Without over loading individual or group decision-maker with too much or irrelevant information. Providing information that is understandable by the individual decision maker and group as a whole. To adherse constraints of principal-agent problem, accountants should abide managerial accounting practices for information designed to resolve principal-agent problems.

To summarize, accounting and its product, accounting information should be flexible. Since different users require different information to satisfy their needs and make rational decisions. These needs are very dynamic and changing constantly. Accounting information system should response to changing expectations and needs of its users to facilitate in decision making. Accounting ethos lies in being non-discriminatory and yet providing its users them with the information to make sound judgment in short and long run.

As Goethe said, "Accounting is the fairest invention of human mind."