Issues in Budgeting: Management and Cost Accounting

Today's management accountant information, driven by the procedures and cycle of the organisation's financial reporting system, is too late, too aggregated, and too distorted to be relevant for managers planning and control decisions.

The above quote is the opening paragraph in Johnson & Kaplan's book, summarising what they felt was wrong with management accounting, below is a set of bullet points that develop the key arguments made in the book.

Main Arguments:

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• Management accounting systems and techniques in the Western World were as they had been since 1920.
• Information systems were geared towards financial reporting, as was the decision making process, causing a general drift from cost management to cost accounting.
• Existing management accounting could not adapt to new competitive environments, management styles, production techniques and organisational structure.
• Management accounting facilitated the growth of large enterprises, throughout in early C20th and was not just a by-product.

The first argument that will be analysed is the issue that management accounting techniques had not changed since the 1920's. On the whole Johnson & Kaplan’s argument was true, from 1920 to the mid 1980¡¦s there were no pioneering new management accounting techniques that were established. The issue raised is why no new management techniques were developed. During the 1920's and onwards USA firms such as General Motors and Dupont were using to a great extent heavy mass production and Fordist principles. They could out produce and under cut competition while providing a high quality product to a market that was in very high demand. From this point in the 1920's to the 1970's these firms could produce huge amounts of products and sell them to an ever-expanding market. Competition was essentially localised, markets were secure and the USA was becoming more consumer society orientated, for reasons such as the introduction of the credit card, baby bust etc. Research revealed that firms did not need to change. The following quote summarises why no key issues techniques developed:

There was little incentive to minimise manufacturing costs, as increased costs could be passed on to the consumer¡¨(Changing Nature Of Issues In Management Accounting. Scrapens, Hopper, Ashton). In a situation where firms did not need to keep or require elaborate costing records, organisations had no real need to invest capital or time developing them. Where existing methods were producing acceptable results measurement, firms had as if it is not broken why fix it approach. It was not until the 1970s that firms in the USA (and to large extent firms in the UK) experienced many external environmental changes that highlighted internal problems.

"Major companies in manufacturing industries that had been prospering and leading the world in the 1900's were bleeding red ink and many were dying." (Reflections of a recovering Management Accoutnant. Johnson 1988). The issue is why did these firms struggle and dissolve during the 1970's to the present day. Johnson & Kaplan clearly believe it was to do with a lack of development of management accounting techniques. They claim that because of shareholders predominant stakeholder interest, organisations, and particularly management accounting within them suffered greatly, becoming subservient to it. The implications of which caused poor even disastrous operating decisions for long-term prosperity. In the sense that management accounting was geared to producing good year-end results.

Johnson & Kaplan argue that information systems during the late 1970's and early 1980's were heavily influenced by the needs of shareholders. This is a very valid statement, as at this time database technology was starting to be implemented and firms opted for packages that aided external reporting because of statutory requirements and the high costs involved. However is was not until the 1980's during the Thatcher-Reagen era that capital gains legislation was lifted and shareholders were free to invest divest with no tax penalties for disloyalty. This is the point in time that US and UK directors became focused on maximising share value and dividend, both of which are short-term strategies. Read also Johnson and Johnson financial analysis

External reporting was of high priority in the 1970's and early 1980's, but whether this caused management accounting to lose relevance, assuming it had relevance to lose in the first place, is debatable. Johnson ; Kaplan argue that when management accounting was relevant during the period of 1880 to 1920 it facilitated the growth of huge US companies, it was not merely a by-product. But other theorists argue that management accounting did not have the impact within these organisations as Johnson ; Kaplan believed.

"Evolution of accounting systems is analysed as an aspect of overall changes in the pattern of control of the labour process." Kaplan studied Lynman mills stating that cost accounting was used to monitor performance and improve task efficiency, which lead to the firms resultant profits. Hopper ; Armstrong argue that it was the close discipline of labour and the extension of the working day that lead to profitability. Hopper ; Armstrongs underlying point was that management and cost accounting developed, as a tool for the control of labour, and improvements in this lead to higher profits. They further state that bureaucracies were not sought after because of transaction costs, but as a tool to intensify corporate controls of labour. Both theorists have merit and are supported by evidence from case studies, it is true when Johnson ; Kaplan state that firm used tools such as budgeting and ROI to develop, conversely there is evidence that show it was also used as a method for controlling labour. This example of conflicting theorist's views highlights the need to analyse Johnson & Kaplan's arguments in a broad to context.

The vital question that is raised is whether the drop in performance, profits etc. of US organisations in the last 30 years was down to poor management accounting. It is a very bold statement to make, as there are numerous factors that affected organisations in the USA. The mass production systems were no longer as viable, there was massive saturation in the market and the markets could not be developed any further. Firms lacked innovation because of pressures of shareholders returns; therefore there was reduced investment in R;D, new equipment and training of staff. All these factors coupled with the increase in global competition, particularly from Japan-Germany lead to many of the large firms going bust or struggling hugely.

As previously mentioned the difficulty in determining whether Johnson ; Kaplan's points were correct was whether the above could have been avoided with accurate cost information. Assuming that cost information was inaccurate and outmoded in US manufacturing as Johnson & Kaplan discusses, would that have prevented the firms struggling as they did. The evidence suggests it would have not made a substantial difference, as many factors were beyond the control of these organisations. Accurate cost information could not have avoided the rise in shareholder dominance, saturation of markets, and the advent of the rapid increase in global competition (Drury, 2004).

Were Johnson & Kaplan Correct In What They Said? To a degree, Johnson & Kaplan were correct about what they said about US manufacturing up to the 1980's. But when the book was published in 1987, many changes and transformations had already started to occur. As mentioned previously, Johnson ; Kaplan's point about the dominance of financial reporting coupled with information systems being geared to external reporting did need attention. The constraint on companies, in the late 1970's and early 1980's was the cost, reliability issues of having two separate information systems providing information for both external and internal reporting, as at this point the two could not be integrated. Organisations were forced to go with financial reporting systems because statutory rulings.

The argument that management accounting techniques were as they were since 1920 does also have merit. But Johnson & Kaplan only researched US firms, had a relatively small sample size and used case studies to a high degree compared to actual physical research within organisations. A very large proportion of firms still used the same production methods up to 1970's i.e. mass production. So with such a production method being used for a great proportion of the C20th, there was no real need for new accounting methods to be developed and utilised.

Johnson ; Kaplans other main argument in relevance lost was that the existing management accounting methods could not adapt to new competitive environments is also applicable. But other factors were related to the US's lack of competitive products, such as quality, level of innovation, reliability and flexibility. Do Johnson & Kaplan's Claims Still Have Merit? It is established up to the 1980's US firms were dominated by financial reporting measurement, they were no longer competitive on a global basis and there were no "new" management accounting techniques. Management accounting methods had not changed enormously, but if firms had made use of ABC and balanced scorecard it is not convincing that they would have been in a different situation during the latter half of the C20th. One main point that Johnson & Kaplan did not convey from there research was: "Fundamental changes in the use of management accounting practises."

Although the above quote concerns UK research, it can be regarded as representative of Western organisations. Modern organisations are acknowledging the importance of advanced accounting techniques, with increasing focus on commercial orientation. Recognising the fact that the company must be able satisfy the ongoing-concern concept and generate profits in the future. This aspect of organisational behaviour contrasts with Johnson & Kaplan¡¦s view that firms were geared to a short-term outlook.

The huge development of hardware and software advances in computers over the last twenty years has had the biggest impact on management accounting and organisations. Johnson & Kaplan state that information needs lagged behind, but recent information systems deal with basic transaction processing, right up to executive support systems (ESS) that can aid strategic planning years in advance. Effective management information systems provide support for planning, measuring, controlling, communicating etc. but most importantly they are accessible and easily used by any member of an organisation. Modern IS has allowed knowledge to be ¡§freed up¡¨ throughout intranets and networks, employees and managers a like can make key decisions on a much more timely basis with real time information. Effective IS in organisations can easily avoid the "lateness" of cost information and variances, which Johnson & Kaplan cited as a major problem.

Such developments have serious implications for the accountant, whose "traditional" role is now being phased out with the rise of modern IS. Research has indicated that the modern day accountant is much more involved with the daily running of the organisation than ever before, now have a: "More proactive, and central role within the management process." (Changing Nature Of UK Management Accounting Practise. Burns, Ezzamel, Scrapens. 2000).

Modern accountants require a broad understanding of organisational processes; particularly production processes and should contribute to aiding and implementing the firm's strategic plans. Modern management accountants are now just as involved in organisational activities as production and marketing managers. This role of the accountant is very different to the one conveyed in the writings of Johnson & Kaplan. This new "hybrid-accountant" has been formed by new information technology such as ERP, routine accounts being processed by computers, outsourcing and an increasing need for the accountant to be involved in strategic planning and decision making. Although on the surface management accounting may seem as it was in 1920 (in terms of techniques) its use is very different. "Management by numbers" as Johnson & Kaplan quote is still part of management accounting, but only a part, modern management accounting is now used more so than any other time previously for decision support and strategy. This is reflected in the rise of the new role for the modern management accountant, who can be seen as a linking pin, which binds all aspects of the organisation together.

So in other words, as mentioned previously Johnson & Kaplan were right to criticise aspects of management accounting within organisations, raising key issues about its use. However the main arguments can only be applied up to the 1980's, as at this point in time, information technology developed, manufacturing industry declined (USA) and firms were subject to entirely different global markets. Management accounting techniques although relatively unchanged in theory, were used differently in practise and became an aid strategic planning. Dissemination of information became extremely easy and cheap to implement and costs revenues could be monitored in real time. Organisations have been slow to take up new techniques such as balanced scorecard and ABC as it is undecided whether these methods are appropriate and significantly benefit organisations and generate more "relevant" cost information. As Johnson pointed in his later book, in which he openly criticised ABC: "Listen to the customers, listen to the voice of the process, then the costs will take care of themselves." (Relevance Regained. Johnson 1991)

Research points out that firms are now very keen to use non-financial measures as a critical success factor, and focus strongly on customer orientation. Utilising key performance indicators as a target for long term profitability. This conflicts with the view that organisations were dominated by short-term thinking, obsessed with "short term financial accounting mentality." However, it is important to note the US is still capital market based and shareholders are the dominant user. The main difference between the present and two decades ago are Information technology developments, such as decision support systems and executive support systems allowing non-accounting managers to have access to the same information as accountants and make informed rational decisions. The key point is whether the current trend of long-term vision and strategic planning will continue, it may have to if organisations wish to survive as global competition intensifies. But there will always be an ominous cloud looming because of the stability issues of the economy and stock market within a capital market based system.

Johnson ; Kaplan did raise appropriate and important questions about western management accounting, but these points and arguments were only true of organisations operating up to the early 1980's. Due to recent developments in IT, changes in the use of management accounting information and more focus and long term strategies, Johnson & Kaplan's arguments no longer have a great deal of merit. Their book sent shock waves through the accounting body, with tremors still being felt today. Johnson ; Kaplan sparked the accounting profession to review itself, and have helped organisations re-evaluate the importance of having an accurate management accounting system. Despite their arguments being outdated, "Relevance Lost" has ultimately benefited management accounting practise.

In conclusion cost accounting is the process of tracking and recording and analysing costs associated with the products or activities of an organisation. In modern accounting, costs are measured in accordance with Generally Accepted Accounting Principles (GAAP). GAAP reporting records historical events and assigns a monetary value to each event that has taken place. Costs are measured in units of currency by convention. Cost accounting could also be defined as a kind of management accounting that translates the Supply Chain (the series of events in the production process that, in concert, result in a product) into financial values. Managers use cost accounting to support decision making to reduce a company's costs and improve its profitability.

There are at least four approaches:

• Standard Cost Accounting
• Activity-based Costing
• Throughput Accounting
• Marginal Costing

Cost accounting has long been used to help managers understand the costs of running a business. Modern cost accounting originated during the industrial revolution, when the complexities of running a large scale business led to the development of systems for recording and tracking costs to help business owners and managers make decisions.

In the early industrial age, most of the costs incurred by a business were what modern accountants call "variable costs" because they varied directly with the amount of production. Money was spent on labour, raw materials, power to run a factory, etc. in direct proportion to production. Managers could simply total the variable costs for a product and use this as a rough guide for decision-making.

References

1. Relevance Lost. Johnson & Kaplan 1987.
2. Relevance Regained. Johnson 1991.
3. Changing Nature Of UK Management Accounting Practise. Burns, Ezzamel, Scrapens 2000.
4. Changing Nature Of Issues In Management Accounting. Scrapens, Hopper, Ashton.
5. Dury, C (2004) Management and Cost Accounting. 6th Edition. Hemel Hempstead. Prentice Hall, Europe.
6. Reflections Of A Recovering Management Accountant. Johnson 1998.
7. Management Information Systems. Laudon & Laudon 2000.

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