The evolution of management accounting

This paper starts with introducing importance of management accounting literature and reviews the historical development of cost accounting from 1850 through 2000, includes origin of management accounting and controlling practices. In addition it identifies the management accounting theoretical development, and the main critiques that shapes the development of management accounting, thus creating a ground for future research or reviews.

As well as it presents challenge existed in the field and concludes by advocating field-based research to discover the innovative ractices being introduced by organizations successfully adapting to the new organization and technology of manufacturing. 1. Introduction 1. 1 Importance of knowing the literature A wealth of literature exists regarding the historical development and evolution of management accounting so accountants have many reasons to study this literature. It helps them to understand the sources of many of today's practices; it leads to rediscovery of old ideas that have been lost.

It enables one to support proposal with past writings quoting from an important work and can help them to sell a proposal or ive credence to an idea. As with study of any literature, it provides accountants with opportunities to improve their verbal abilities, both written and oral and familiarizes accountants with the intellectuals and innovators who have shaped how account proactive their profession in addition it illustrates the state of the professionalism of the field and leads them to an awareness of the controversial topics in the field.

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In addition to the financial summaries, the railroads developed a system of reporting operating statistics for evaluating and con-trolling the performance of their sub-units. Statistics such as cost per ton-mile and the operating ratio (operating in-come divided by sales) were routinely reported for various sub-units and classes of service. Later in the 1880s, the newly formed mass distribution [Chandler, 1977, Chapter 7(cited on R. kaplan1984)] and mass production enterprises adapted the internal accounting reporting systems ot the railroads to their own organizations.

The nationwide wholesale and retail distributors produced highly detailed data on sales turnover by department and by geographic area, generating performance reports very similar to those that would be sed 100 years later to monitor the performance of revenue centers in the firm. Mass production enterprises formed in the 1880s for the manufacture of tobacco products, matches, detergents, photographic film, and flour. Most important was the emergence of the metal-making and fabricating industries.

Andrew Carnegie's steel company was a particularly good example of the importance of cost accounting information for managing the enterprise. Shinn's [the general manager's] major achievement was the development of statistical data needed for coordination and control. Shinn did this in part by introducing the voucher system of ac-counting hich though it had long been used by railroads was not yet in general use in manufacturing concerns. By this method, each department listed the amount and cost of materials and labor used on each order as it passed through the sub-unit.

Such information per-mitted Shinn to send Carnegie monthly statements and, in time, even daily ones providing data on the costs of ore, limestone, coal, coke, pig iron, Spiegel, molds, refractoriness, repairs, fuel, and labor for each ton of rails produced. These cost sheets [were] called "marvels of ingenuity and careful accounting. " These cost sheets were Carnegie's primary instrument of control. Costs ere Carnegie's obsession.... Carnegie concentrated . .. on the cost side of the operating ratio, comparing current costs of each operating unit with those of previous months, and where possible, with those of other enterprises....

These controls were effective..... "The minutest details of cost of materials and labor in every department appeared from day to day and week to week in the accounts; and soon every man about the place was made to realize it. The men felt and often remarked that the eyes of the company were always on them through the books. " In addition to using their cost sheets to evaluate the performance of department anagers, foremen and men, Carnegie, Shinn and Jones relied on them to check the quality and mix of raw materials.

They used them to evaluate improvements in process and in product and to make decisions on developing by-products. In pricing, particularly non standardized items like bridges, cost-sheets were invaluable. The company would not accept a contract until its costs were carefully estimated [Chandler, 1977, pp. 267-268] (cited on R kaplan1984). Interestingly, the development of these elaborate cost reporting and estimation schemes by the 1880s focused exclusively on direct labor and materials, what we call today prime or direct costs; hat is, little attention was paid to overhead and capital costs.

Carnegie's concern was almost wholly with prime costs. He and his associates appear to have paid almost no attention to overhead and depreciation. This too reflected on the railroad experience. As on the railroads, administrative over-head and sales expenses were comparatively small and estimated in a rough fashion. Likewise, Carnegie relied on replacement accounting by charging re-pair, maintenance, and renewals to operating costs. Carnegie had, therefore, no certain way of determining capital invested in his plant nd equipment.

As on the railroads, he evaluated performance in terms of the operating ratio (the cost of operations as a percentage of sales) and profits in terms ot a percentage ot book value ot stock issues [ n I , 1977, p. 268 (cited on C and er R. kaplan 1984)]. Thus, cost accounting practice in the late 1800s did not include the allocation of fixed costs to products or to periods. Despite the enormous capital invested in these new manufacturing enterprises, there was apparently no systematic method for forecasting investments or coordinating and monitoring capital investment.

Andrew Carnegie is reported to have undertaken almost any new investment that would reduce his prime operating costs: Carnegie's operating strategy was to push his own direct cost below those of all competitors so that he could charge prices that would always ensure enough demand to keep his plant running at full capacity.... Secure in his knowledge that his costs were the lowest in the industry, Carnegie then engaged in merciless price cutting during economic recessions. While competing firms went under, he still made profits [Johnson, 1981, p. 515] (cited on R. kaplan1984).

Management accounting development was highly nfluenced by scientific management theory, based on which accounting received academic basis and directions for purposeful development (Chatfield, 1977 cited on Darius Gliaubicas (2012)) The scientific management movement in American industry provided a major impetus to the further development of cost accounting practices [Chandler, 1977, pp. 272-283] cited on R. kapaln(1984)). The major fgures in this movement were engineers who, by detailed Job analyses and time and motion studies, determined "scientific" standards for the amount of labor and material required to produce a given unit of output.

These standards were used to provide a basis for paying workers on a piece-work basis, and to determine bonuses for workers who were highly productive. The names associated with developing the scientific management approach include Frederick Taylor, Harrington Emerson, A. Hamilton Church, and Henry Townen. This approach included not only the development of work standards but also a new form of organization, supplementing the traditional operating or line functions with staff function designed "not to accomplish work, but to set up standards and ideals, so that the line may work more efficiently.

The "scientific management" advocates also started the practice of measuring and allocating overhead costs to products. Innovations came primarily in deter-mining indirect costs or what was termed the "factory burden," and in allocating both indirect and direct (or prime) costs to each of the different products produced by a plant or factory so as to develop still more accurate unit costs.... In a series of articles published in the Engineering Magazine in 1901, Alexander Church began to devise ways to account for a machine's "idle time," for money lost when machines were not in use.

Henry Gantt and others then developed methods of btaining standard costs based on standard volume of throughput by determining standard costs based on a standard volume of, say, 80 percent of capacity; these men defined the increased unit costs of running below standard volume as "unabsorbed bur-den" and decreased unit costs over that volume as "over-absorbed burden" [Chandler, 1977, pp. 278-279] (cited on R. kaplan 1984) Also, under performance of scientific management theory, a need for operative and perspective information has formed (Fleischman ; Tyson, (2007) cited on Darius Gliaubicas (2012)).

Metcalfe ideas had high influence on cost accounting development. In his book "The cost of manufactures", published in 1885, he discussed separation of direct and indirect costs in order to make ettective management decisions . Formation ot modern management accounting methods, were also influenced by General Motors ideas. In 1919 it was created promoting salary system; started implementing flexible budgets, developed transfer pricing method Du Pont Powder company, was one of the first USA companies, that started developing several activities at the same time Oohnson ; Kaplan, 1987).

When company diversified its activities, management required such accounting system that ould help controlling all products value chains, coordinate performance of individual subdivisions, while meeting owners' interests. Du Pont company's executives, wanted to control return on capital that owners invested, and at the same time Justify investment financing decisions. That is why was created ROI ratio. When World War I ended, cost accounting became a profession (Loft, 1990).

Under the influence of great depression in 1933, USA government established mandatory provision, to form fair practice codex, which would include paying employees' reasonable wages and determining weekly working hours. Therefore cost accounting pecialists had to ensure two main functions, while following fair practice codex: (1) ensure, that prices would not be lower than prime costs and (2) to harmonize costs calculating rules and methods Oohnson & Kaplan. 1987).

During World War II, the importance of standard cost accounting method has reduced, because government wanted to trade only with those companies, whose production costs were close to actual, not standard costs (Fleischman & Tyson, 2007). About 1954, management accounting definition was mentioned for the first time. In Simon (1954) research that included employees from 7 biggest USA companies, it was ound that management accounting information is used to fulfill three main control functions: (1) registering performance results, (2) managing attention and 3) solving problems.

Performance results were given in financial reports. Attention managing was based on comparison of plans budgets and actual results. Problem solving function has been implemented by making decisions, such as: manufacture or buy, what if analysis or alternative pricing decisions. Also, a need to calculate direct production costs, to perform absorption and marginal costing has grown at about 1950 (Chatfield, 1977). In 1960s, when USA companies influence in worldwide economy has decreased, responsibility accounting has formed, which allowed determining who is responsible for individual scope (Kaplan, 1983).

In 1970s first costs managing accounting methods were created. Activity based cost management method, and value adding costs and product lifecycle analysis methods were formed (Hoskin & Macve, 1988). In 1981 strategic management accounting definition was introduced. Management accounting purpose became helping company's management to manage its strategies Oohnson ; Kaplan, 1987). Porter (1985) created value chain model. Also, at 1985, competitors' analysis has grown stronger, because of five competitive forces, PEST and SWOT methods (Porter, 1985).

These methods allowed assessing, not only company's internal environment, but also to foresee performance risk factors in external environment, this way creating a competitive advantage. In 1987, customers' profitability analysis was discussed (AnandaraJan & Christopher, p an & Norton ( ) created a balanced scorecard system, which allowed company's management to transform objectives provided in strategy, vision and mission into performance indicators, which allow assessing the success of mplementing competitive performance strategy. Darius Gliaubicas (2012 P. 4-26) 3. Origin and Managerial Controlling Practices of Management Accounting In the period preceding the Industrial Revolution, economic advancement predominantly occurred in the Middle and Far East (Chatfield 1977 ). Some of the oldest surviving business records dace back to the Chaldean-Babylonian, Assyrian and Sumerian civilizations. Various types of service businesses and small industries were established and the oldest known commercial documents date from 3500 BC (Chatfield 1977:5). In Babylonia formal legal codes made record keeping compulsory.

The most famous is the Code of Hanunurabi, which required that an agent selling goods for a merchant should give the merchant a sealed memorandum quoting prices. All these records were kept on clay tablets (Chatfield 1977:5) In Egypt the introduction of papyrus as a writing surface made writing less cumbersome and permitted a wider use of supporting documents. Despite the early progress, the development virtually stagnated for several thousand years. This might be ascribed to the inability to express goods in terms of a single substance (monetary unit) (Chatfield 1977:7) (M. shotterl 999. p . 244).

Once of the oldest and largest surviving records of a system of responsibility accounting was maintained by Zenon. a manager of a private estate of the finance minister of Ptolemy II in 256 BC. Each of the supervisors of the areas of the estate had to render frequent accounts of all transactions. The accounts were rised and audited on a regular basis. This form of accounting system spread throughout the Mediterranean and the Middle East and was later adopted and modified by the Romans. The essential aim of this form of accounting system was the protection of the property of the owners (M . hotter 1999 p. 4)1. None of the above ancient forms of accounting provided any aid for decision-making or resembled cost accounting. Until the Industrial Revolution, records did not allow for separate costing by product lines and mad: no distinction between capital and revenue expenditure. This resulted in an inability to estimate the profitability of a product, a capital investment or an increased investment in labour (Chatfield 1977:11) The Industrial Revolution which gained momentum roughly between 1760 and 1830 in this period accounting historian place the exact time as the origin of management accounting is 1812 (H.

T. Johnson and R. S. Kaplan, 1987) the industrial revolution can be ascribed to a vast number of reasons, but the most well known arc the technical inventions that reformed the manufacturing world. These include the steam engine by James Viratt in 1765, the spinning Jenny by James Hargreaves between 1764 and 1767 and Arkwright's spinning frame in 1768 (Ashton 1948) This period Britain was also associated with a sharp growth in the population, a more extensive use of capital, and the conversion of rural into urban communities as well as a rise in new social classes (Ashton 1948 ).

In the United States of America the effect of the industrial Revolution was not as marked and immediate as in the United Kingdom. Although it did have an indirect effect on the US economy. the factors that had the most remarkable effect were the corning of the railways and the telegraph around 1840 (Chandler 1977). After 1840 and especially trom 860 the railways and the telegraph revolutionized t traditional ways of production and distribution.

Coal provided a cheap and flexible source of energy which enabled the railways to provide the fast, regular and dependable transportation so essential to high volumes of production and istribution (Chandler 1977:79). Technological innovation, the expanding income per capita as well as the rapid growth of the poralation increased the complexity of existing production and distribution processes and increased the volume and the speed of transactions.

The existing market mechanism was often no longer able to co-ordinate these transactions effectively. According to Chandler (1977:484 ) created a need for administrative co-ordination. To address this need entrepreneur's large multi-unit organizations and appointed managers to administer them. (M . shotter 1999 P. 1 5) According to traditional history management accounting evolved from the techniques of cost accounting that were developed in England before and during the Industrial Revolution (M. shotter 1999 p 216).

The need for cost accounting developed when the double-entry bookkeeping system was not able to provide owners with product costs for purposes of pricing, particularly in the engineering sector. As engineering firms grew more and more competitive, cost estimates were needed for bidding on special contracts for which no market prices existed (Chatfield 1977:159). At that stage manufacturers guarded their cost methods as industrial ecrets and bookkeeping texts generally ignored the subject (Chatfield 1977:1 59 ).

Edwards, et al. (1995 ) suggest that management accounting was purely concerned with making the best use of available resources within certain constraints. Management accounting was viewed as an independent variable", which passively served the needs of the organization and neither neither shaped nor was shaped by the organization or society Support for their view can be found in the number of case studies of archival records of organizations that operated before and during the Industrial Revolution in the United Kingdom.

In 1740 the accountant of the Melincryddan Smelting Works distinguished between variable and fixed cost while deciding on the most profitable location, whilst Cyfartha Iron Works was recharging production overheads to cost centers and writing off general overheads to the profit and loss account in the 1790s (Comes 1996:16). Walsh & Stewart (1993) suggest that they found evidence of the implementation of accounting systems for purposes of managerial control in two separate studies, carried out before and during the Industrial Revolution.

In their study of the operations of the New Mills Woollen Manufactory for the period 1681 to 1703, they ound evidence of costing for purposes of pricing as well as information to control the flow of material. At New Lanark Cotton Factory, which was studied from 1800 to 1812, they found a much more sophisticated system of control over not only materials but also over the laborers. Accounting was used for the purpose of measuring productivity as well as to control the behavior of laborers (Walsh & Stewart 1993:790).

Edwards et at. (1995: 6) ascribe the difference between their view of the origin of management accounting and the other views mentioned below to the differences in environmental circumstances between countries. They contrast the long industrial history, steady rate ot economic development and relatively ample supply of labour of the United Kingdom with the United States where industrial development started much later and industrialization took place more rapidly against a background of labour shortages.

Edwards et at. (1995) are also of the opinion that it is unduly restrictive to equate the development of management accounting to the use of accounting information to control human activity. As discussed above, they advocate a much broader role for management accounting. M. shotter1999 . P217) Chandler (1977) disagrees with the aforementioned view of management accounting being an "independent variable" and suggests that it played an important role in the development of the giant firm.

According to him modern cost accounting originated during the middle of the nineteenth century with the advent of the railways and later the chemical, steel and metal working industries in the United States of America. These organizations were growing in size and their processes were growing in complexity, creating a need for cost information to determine prices and evaluate the performance of the businesses.

He is of the opinion that management accounting did not merely arise because the growing organization needed it, but that it facilitated this growth by means of focusing attention on the advantages of buying internally rather than through the market. Chandler also suggests that management accounting was not merely applied for the purpose of product costing, but also to aid internal control. Williamson's (1975) transaction cost theory supports Chandler's view. He suggests that management accounting is a means of determining the prices of products in large corporations in the absence of a market system.

The cost of co-ordination internal transactions by means of management accounting is lower than the cost incurred when entering into these transactions through the market, thus Justifying its existence. A study by Fleischman, Hoskin & Macve (1995)(cited on M. shotter1999) of the Boulton & Watt engineering practice during the beginning of the eighteenth century revealed that costing techniques to determine piece rates for laborers were 'once-off exercises to establish fair prices, and thereafter only received sporadic attention.

Based on these findings, they essentially agree with Chandler (1977), Williamson 1975) and Johnson and Kaplan (1987) that entrepreneurs did not really need cost accounting, as long as they were paying market prices for the output of each worker. Similarly, Fleischman et al. (1995: 171) agree that detailed attention to the efficiency and control of labour was only required when entrepreneurs took the manufacturing process out of the hands of contractors and brought the workforce under their direct control.

To sum up all evolution of management we should analyses four stage as follows The demand for information for internal planning and control apparently arose in he first half of the 19th century when firms, such as textile mills and rail-roads, had to devise internal administrative procedures to coordinate the multiple processes involved in the pertormance ot the basic activity (the conversion ot raw materials into finished goods by textile mills, the transportation of passengers and freight by the railroads). In the first stage, management accounting is seen as a technical activity necessary for the pursuit of the organizational objectives while in the second stage it is seen as a management activity performing a staff role to support line management hrough the provision of information for planning and control. In the third and fourth stages management accounting is seen as an integral part of the management process With improved technology, information is available in real time to all levels of management.

The focus, therefore, shifts from the provision of information to the use of the available resources to create value for all the stakeholders. Figure 1 shows four stages of management accounting evolution and how each stage encapsulates the previous ones. 3. Reduction of waste of business resources 4. Creation of value through effective use of resources Source: IFAC, 1998: 6. imported from (Nelson Maina Waweru,2010 p . 167) Fig. 1 . The evolution of management accounting 4. Management Accounting Theories Regardless of how management accounting emerged, the economic framework played a central role in shaping it.

Other subject areas, such as management science, organization theory and lately behavioral sciences were undoubtedly present, but economics and specially the marginal list principles of neoclassical economics, had the dominant influence in the last century. The evolution of management accounting in the last century can be also assessed on historical grounds. Figure 2 below shows our main theoretical frameworks that can be used to describe the development of management accounting. They are then discussed in the subsections that follow. 2 Management accounting development : theoretical tramework 4. 1 Old conventional wisdom. Traditional textbooks have a list of topics that, despite the differences in orientation, are common to all. It is agreed that the final developments in management accounting occurred in the early decades of the twentieth century to support the growth of multi-activity and diversified corporations such as Du Pont (Kaplan, 1982 and 1984; Scapens, 1985; Boritz, 1988; Johnson and Kaplan, 1987; Atkinson, 1989; and Puxty, 1993) cited on(Nelson Maina Waweru, 2010) .

This stage is based on the absolute truth approach and principles of management which were rooted in an engineering view. Giglioni and Bedeian (1974) cited on (Nelson Maina Waweru, 2010) provide a good overview of the roots of management control issues that lie in early managerial thought. Emerson (1912)( cited on Nelson Maina Waweru, 2010) may be credited with the first meaningful contribution to the development of 20th century management control theory, in 'The Twelve Principles of Efficiency where he heavily stresses the importance of control.

Church (1914) cited on (Nelson Maina Waweru, 2010) also contributed to the development of early management control theory; for him one of five organic functions of administration was control, identified as the mechanism that coordinates all the other functions and in addition supervises their work. Fayol (1949) cited on (Nelson Maina Waweru, 2010) identified control as one of the five functions of management, control being the verification of whether everything occurs in conformity with the plan adopted, the instructions issued and principles established.

It is interesting to note that Lawson 1920) cited on (Nelson Maina Waweru, 2010) wrote the first text devoted entirely to the subject of management control, while Urwick (1928) cited on (Nelson Maina Waweru, 2010) became the first author to identify a set of five control principles: responsibility, evidence, uniformity, comparison and utility. One of the first empirical studies of corporate organization and control was performed by Holden, Fish and Smith (1941), where one of its conclusions was that control is a prime responsibility of top management.

Historical studies have played a conspicuous role in management accounting in recent years. Both research and practice have been strongly influenced by Kaplan (1984) and Johnson and Kaplan (1987), cited on (Nelson Maina Waweru, 2010) who call for more relevant product costing. As a precedent, Chandler (1962 and 1977) cited on (Nelson Maina Waweru, 2010) showed the importance of cost and management control information to support the growth of large transportation, production and distribution enterprises during the perid of 1850-1925.

Management accounting systems evolved in the late 1880s to provide information about internal transactions, and by mid 1920s they were being used for diverse activities like lanning, controlling, motivating, analyzing and evaluating (Boritz, 1988). Johnson (1981 and 1983), Johnson and Kaplan (1987) and Lee (1987) cited on (Nelson Maina Waweru, 2010) made a convincing case for the development of managerial accounting practices in the US. 4. 2 Agency theory. The irruption of economics in the field led academicians to work on very elegant Mathematical models.

Agency theory and transaction costs are a refinement of the mathematical modeling based on economic concepts and theory. The agency theory assumes that there exists a contractual relationship between members of a firm. It recognizes the existence of two groups of people; principals or superiors and agents or subordinates. The principals will delegate decision making authority to the agents and expect them to perform certain functions in return for a reward.

Both the principals and the agents are assumed to be rational economic persons motivated solely by self-interest but may differ with respect to preferences, beliefs and information densen and Meckling, 1976) cited on (Nelson Maina Waweru, 2010). The principal/ agent relationship can exist throughout any organization and usually starts from the shareholder director nd ends with the supervisor-shop floor worker. In an organization context, which involves uncertainty and asymmetric information, the agent's actions may not always be directed to the best interests of the principal.

Agents' pursuit of their self interest instead of those of the principal is what is called the agency problem densen and Meckling, 1976) cited on (Nelson Maina Waweru, 2010) to counter this behavior, the principal may monitor the agents' performance through an accounting information system. The owner can also limit such aberrant behavior by incurring auditing, ccounting and monitoring costs and by establishing, also at a cost, an appropriate incentive scheme densen and Meckling, 1976). ited on (Nelson Maina Waweru, 2010) Agency theory is based on several assumptions: Individuals are assumed to be rational and to have unlimited computational ability. They can anticipate and assess the probability of all possible future contingencies. The contracts are assumed to be costless and accurately enforceable by courts. The contracts are expected to be comprehensive and complete in the sense that for each verifiable event, they specify the actions to be taken by the contracting parties. However, this assumption may not hold in most developing countries where Judicial systems still lack the necessary resources to act efficiently.

Both principals and agents are motivated solely by self- interest. The agent is assumed to have private information to which the principal cannot gain access without cost. The agent is usually assumed to be work averse and risk adverse (Batman, 1990: 343) cited on (Nelson Maina Waweru, 2010). Furthermore, agency theory concentrates on problems encountered by the owner when the manager relies on asymmetric information to cheat and shrink (Mackintosh, 1994). Asymmetric information is not a one-way street as is assumed by agency theory.

Owners would also have access to private information, which they would use in negotiating contracts. However, according to Baiman(1990), the above criticisms are less compelling if we view the principal-agent model as a frame work for analyzing issues and highlighting problems which arise and must be considered in applying managerial accounting procedures to real world situations. Consequently, agency theory offers insights into some of the tough issues and difficult problems involved in he design of management accounting systems. . 3 Contingency theory. The contingent control literature is based on the premise that a correct match between contingent factors and a firm's control package will result in desired outcomes. Contingencytheory explains how an appropriate accounting information system can be designed to match the organization structure, technology, strategy and environment of the firm. It suggests that universal applications are inappropriate and a framework for analysis is developed to suggest alternative performance measures,

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