Traditionally, management accounting has been dominated by quantitative, financial information. The management accounting techniques, such as Activity Based Costing and the Balanced Business Score Card, are mainly developed as a reaction to changing information needs driven by a growing competitive environment. Activity Based costing systems measure more accurately the costs of activities, products, services and customers. Balanced scorecards link current decisions and actions to long-term financial benefits. The balanced scorecard is used to evaluate business performance by a set of indicators with a financial, customer, business and organizational learning perspective. The difference between traditional management accounting systems and new developed techniques merely lies in the expansion of the type of management information they generate. Non-financial and qualitative information, such as quality and process times and more subject information on customer satisfaction and new product performance, are considered important aside the traditional financial related information. This paper aims to analyze the use of management accounting techniques in support of decision making in the organization.
Management accounting is the process of identifying, measuring, reporting and analyzing information about economic events of organizations. The process should be driven by the informational needs of individuals internal to the organization and should guide their operating and investment decisions (Atkinson et al, 1997). The figure below shows the four main functions of management accounting: operational control, product and customer costing, management control and strategic control.
Functions of Management Accounting Information
Provide feedback information about the efficiency and quality of tasks performed
Product and customer costing
Measure the costs of resources used to produce a product or service and market and deliver the product or service to customers
Provide information about the performance of managers and operating units
Provide information about the enterprise’s financial and long-run competitive performance, market conditions, customer preferences, and technological innovations.
The four different functions relate to the different demands for management accounting information. Generally speaking, operational information is primarily used to control and improve operations. Middle management uses the information to plan and take decisions, while at the highest organizational levels management information is used to support strategic decision making.
These management accounting techniques are mainly developed as a reaction to changing information needs based on the growing competition for both manufacturing and service companies. It seems that these techniques might be also useful to integrate sustainable considerations into decision- making, due to their growing attention for quality, non- financial aspects, activities and long-term perspective.
In the accounting literature it is well remarked the “external” orientation of Strategic Management Accounting. It can be interpreted in different ways. Firstly it can be referred to “competitors”. Simmonds (1981) developed a conceptual framework underlying the importance of competitors’ information (related to cost, prices, market share and so on) in developing and monitoring the business strategy. Later, various authors recognized the value that competitor information plays in achieving a competitive advantage (Jones, 1988; Bromwich, 1990; Ward, 1992; Moon & Bates, 1993). Secondly, the term “external” can be referred to “suppliers and customers”. In a value chain perspective Shank & Govindarajan (1993b) widely demonstrated the usefulness of external information that enable the company to fruitful exploit linkages with suppliers as well as customers. Ultimately “external” can be referred to the “market”. It means focusing on the product offer to satisfy customers’ needs but taking care in the meantime of the product attribute costs (Bromwich, 1990). Moreover it is possible an interpretation as satisfaction of customers needs by achieving a desired target profit/cost (Monden & Hamada, 1991; Morgan, 1993; Ewert & Ernst, 1999) or performance (Narver & Slater, 1990). Therefore, according to these criteria, fourteen strategic management accounting techniques have been identified in previous works (Cravens & Guilding, 2001).
Strategic Management Accounting techniques
Activity Based Costing/Management (ABC/M)
The technique is based on the definition of the activities performed by the company; they are considered the ultimate causes of indirect costs (Cooper et al., 1992). ABC strategic focus consists in the management of the activities through which it is possible to define actions aiming at achieving a competitive advantage (Palmer, 1992; Shank and Govindarajan, 1989).
It considers products as a bundle of different features; in this vein, Bromwich (1990) sustains the possibility to view product attributes as cost objects. The attributes differentiate the products, and from the contact between product attributes and consumers’ taste the market share is determined. In this sense it can be interpreted the external (market) orientation of the technique.
The technique involves identifying the best practices and comparing the organization’s performance to those practices with the goal of improvement. There are many types of benchmarking (Miller et al., 1992; McNair ; Leibfried, 1992) but, in general, they underline the external strategic orientation toward competitors.
Competitive Position Monitoring
The technique is constituted by the provision of competitor information. In particular they regard sales, market share, volume and unit costs (Simmonds, 1981). Basing on the information provided, the company is able to assess its own position relative to main competitors and, consequently, control or formulate its strategy.
Competitor Cost Assessment
Differently from the previous technique, Competitor cost assessment concentrates uniquely on cost structures of competitors (Simmonds, 1981). The main critique regards the sources of such information. Ward (1992) suggests some indirect sources like physical observation, common suppliers or customers and ex-employees of competitors. Competitor performance appraisal based on public financial statements. A relevant source of competitors’ evaluation is constituted by public financial statements. Moon ; Bates (1993) underline the strategic insights that it is possible to obtain from this type of analysis. The technique, which represents an elaboration of common and traditional methods, finds strength in today’s evolution of IASB that could permit a simpler comparison between companies of different countries.
The technique considers customers or group of customers as unit of accounting analysis (Jones, 1988; Guilding ; McManus, 2002). Customer accounting includes all the practices directed to appraise profit, sales or costs deriving from customers or customer segments. Because it is widely related with “relational marketing”, this accounting approach is classified as strategic management accounting technique.
Integrated Performance Measurement
The consideration of both financial and non-financial measures defines Integrated performance measurement system (Cross ; Lynch, 1989; Nanni et al., 2002). Balanced Scorecard belongs to this technique, and it has been widely demonstrated its role in strategic management cycle through the four perspectives (Kaplan ; Norton, 1996a, 1996b, 2000; Malina ; Selto, 2001).
Life Cycle Costing
It aims at calculating the total cost of a product along its life cycle (from the design to the decline, through introduction, growth and maturity) (Berliner ; Brimson, 1988; Shields ; Young, 1991; Wilson, 1991). Its clear long term accounting perspective and market orientation make it part of the strategic management accounting techniques. In a similar vein, Total Cost of Ownership has been underlined as a long term and strategic orientation strategic management accounting tool (Ellram ; Siferd, 1998).
Product quality has become a precondition to compete in the market. In this way the technique classify and monitor costs as deriving from quality prevention, appraisal, internal and external failures (Heagy, 1991). Modern competition requires also the monitoring of safety and environmental costs. In a strategic perspective, the technique must support the pursuit of quality (Simpson ; Muthler, 1987; Carr ; Tyson, 1992).
According to Shank ; Govindarajan (1989, 1993a, 1993b) costing systems are progressively getting into strategic management process. It means that costing systems must explicitly consider strategy and the pursuit of long-term competitive advantage. The authors underline the marketing and competitive concepts to which the technique refers (product positioning and market penetration).
Strictly related to competitor accounting, Simmonds (1982) comprises into strategic management accounting a pricing technique. It regards the use of competitor information, like competitors’ reactions to price changes, price elasticity, economies of scale and experience, in the pricing process. It is present both competitors and market orientation.
According to the technique, the target cost results from the difference between the product price, derived from how much the market can support, and a desired target profit. Through an accurate product design, the costs must be contained to achieve the target cost (Monden ; Hamada, 1991; Morgan, 1993). External market factors intervene frequently in this management accounting technique.
Value Chain Costing
Developing the value chain model (Porter, 1985), Shank ; Govindarajan (1992b) propose an approach to accounting that considers all the activities performed from the design to the distribution of the product. The strategic implications regard the exploiting of the economies and efficiencies deriving from the external linkages between the company and both suppliers and customers.
The pricing decision is one of the most crucial decisions which the management has to take. The term pricing refers to the assignment of a selling price to a produced or a service provided by a firm. Of course, sometimes the term price is used for the purchase price of some resource acquired by a firm. However, in such case it should, more precisely be termed as cost to the purchasing firm. Pricing is not a one time affair. It may have to be revised from time to time. It, thus, requires dynamic decision making keeping in mind the market behavior, management needs, legal restrictions and social environment. The price of a product may thus vary over time classes of customers and places. However, while pricing the basic premise of maximizing contribution towards meeting the fixed costs, does not change.
In the last two decades, accounting researchers (Drury ; Tayles, 2000) appear to have uncovered evidence that full cost (referred to in the economics literature as normal cost) pricing is the dominant form of pricing behavior. These findings confirm the earlier ones for the UK (Finnie and Sizer, 1983; Scapens et al., 1983).
Influence of Management Accounting
The pricing of a product is largely influenced by the cost of the product (Hoskin ; Macve, 2000). The price of a product is usually fixed by taking into account the cost of the product. Such cost may be computed either by Absorption Costing (full cost method) or Marginal costing (variable costing method).
1. Computation of Cost under Absorption Costing
The cost of a product is determined after considering both fixed and variable costs. The variable costs such as those of direct material, direct labor, etc. are directly charged to the products. The fixed costs are apportioned on a suitable basis over different products, manufactured during the period. Thus, in case of absorption costing all costs are identified with the manufactured products.
In case of absorption costing, there is no problem regarding variable cost since they are fixed per unit of output. However, the following two problems are encountered regarding fixed costs.
a) Allocating of fixed cost
A company may be manufacturing two or more products), A major problem is regarding allocation of the common fixed costs, These costs may consist of indirect material, e.g., lubricants, stores and spares; supervisory labor, indirect expenses such as power, depreciation, etc. In allocating these costs the first step should be to collect and classify them under homogeneous groups, e.g., all costs relating to operating of machines may be put in one group, those relating to manual workers in another group and so on. However, in spite of all best efforts, an individual cost item may not fit in entirely in a particular group. In such a case it may be put in the group which suits it most (Ahmed ; Scapens, 2000). After having classified the costs they will be charged to different products on one or more commonly used methods such as a percentage to direct labor, machine hour rate, labor hour rate, etc. Thus, the price of the product, calculated according to the full cost method will be affected by the basis of allocation chosen.
b) Selection of Number of Units
Having allocated the costs over different products, another problem would be to select the number of units over which fixed costs have to be distributed. This number is important because the fixed cost per unit decreases as the number of units increase. Consider the following example:
Direct Material Cost per unit: $5
Direct Labor Cost per unit: $3
Total Variable Cost: 8
Total Fixed Overhead: $ 10,000
The selling price per unit at different levels of output will be different as shown below:
Output in thousand units
Variable Cost per unit
Fixed Cost per unit
Total Full Cost
Mark Up (say 10% of cost)
The determination of number of units may be taken on the basis of demand of the product. However, it has already been said that making a correct estimate of demand is difficult because it is affected by several factors. Some people suggest that normal volume should be considered. Normal volume may be determined by taking average of demand for the last few years. If this is done, the price determined will be more or less stable. This is desirable but it may not fit in well under changing business conditions.
2. Computation of Cost under Marginal Costing
In case of marginal costing, only variable costs are considered while calculating the cost of a product. The greatest advantage of this approach is that some of the difficult problems of indirect cost al1ocation and spreading of fixed costs can be avoided (Innes et al, 2000). However, this method would give good results only when
a) A reasonable correct estimate of the demand for the product is made.
b) Mark up added to variable costs is sufficient enough to cover not only the fixed costs but also provide for reasonable profit.
The fixation of the selling price of the products according to marginal costing system has two problems. There is always a danger of considering the marginal cost as full cost in time to come. If this happens, the consequences may be serious. Of course, this is not the fault of the system but of misuse of cost data by operating management on account of lack of understanding. Proper education of the use of cost data may solve this problem. The conventional accounting systems which are still very popular with business firms are unable to measure variable costs properly (Burns ; Scapens, 2000). The reason may be the overwhelming influence that inventory costing and income determination still continue to have on costing systems. On account of these reasons it is still widely accepted that no other method can give better result than full cost pricing. Marginal cost pricing system is generally recommended only while pricing a special order or in a distress situation (Norris, 2002). For example, in those cases where a firm has surplus capacity, and has an opportunity to sell additional units of product in a foreign market or in an isolated sector of domestic market, any price above the variable cost will be welcome since it will yield a contribution towards fixed cost and thus increase the total profit of the firm.
In 1939, Hall and Hitch uncovered evidence that firms did not, typically, adhere to the marginalist principles of neoclassical economics by setting prices at a level which equated marginal revenue with marginal cost. Rather, Hall and Hitch found that price was set by adding a (fairly constant) mark up to full cost. Not surprisingly, economists fought back vigorously in defense of their marginalist, neoclassical paradigm. Edwards (1952, p. 298), for example, based on his own case study research and direct business experience, contended that:
“Those who argue that the automatic basing of prices on conventional cost statements is the rule . . . . . . . . . have not taken adequate account of the informal and unrecorded stages in the price fixing process. Before the preparation of the cost estimate and between its preparation and the actual determination of price, discussion usually takes place . . . . . . about the assumptions underlying the cost figures and about the market situation.”
Researchers (Soin et al, 2002) claimed to have uncovered substantial evidence of ‘implicit marginalism’. This phrase describes the situation where, although firms may not consciously think in terms of equating marginal revenue and marginal cost, they nevertheless act as though they were doing so. In the same way, while an expert billiards player may not consciously be aware of the theorems of geometry, he nevertheless acts in accordance with them (Friedman, 1953, p. 21). In other words, marginalist theory may be vindicated even if firms do not explicitly and consciously act in accordance with its assumptions. The position has been well articulated by Langholm (1969). The marginal theory of price was never intended to serve as a blueprint for entrepreneurial decision making or indeed to describe or explain in detail what actually takes place in the firm. It is of the nature of an explanatory device on a much higher level of abstraction, permitting only broadly generalized deductions about the aggregate effects of entrepreneurial behavior. Its merit as such was never a fully settled question. But obviously, it takes more to disprove it than demonstrating that actual price makers do without marginal reasoning. The crucial question is whether the prices reached in a different way, produce aggregate effects which are predictable in the marginal system.
Although there have been a number of case study-based research programs whose findings directly undermine marginalist theory it seems, nevertheless, that implicit marginalism has remained the mainstream orthodoxy in economics – Cyert and March’s (1992) A Behavioral Theory of the Firm notwithstanding. Leading management accounting texts (Horngren et al., 2002) in discussing the importance of using relevant costs for pricing decisions, refer also to the survey results of accounting researchers, as indicating the widespread use of full cost pricing and thus of a gulf between theory and practice. The implicit marginalism and instrumentalist arguments, however, imply that these survey findings cannot, per se, be considered to have refuted or seriously undermined neoclassical price theory. The question remains, however, as to the extent to which the theory is supported by empirical evidence.
It seems, therefore, that behavior in accordance with the postulates of neoclassical theory via the practice of implicit marginalism, would involve a considerable amount of sophisticated analysis by management – mostly bypassing the firm’s formal accounting system – whether it be a traditional absorption or activity based one. It is possible, of course, to fall back on a sort of functionalist argument, that since the (implicit) application of marginalist principles produces optimal solutions, only firms applying such principles would survive. This argument is actually employed by Friedman (1953) to support, his contention that firms must be achieving the same outcome as would be achieved using marginalist principles, no matter how unlikely this would appear from the pricing rule of thumb actually used. The argument is very problematic, however, since there are so many other contingent variables affecting survival.
According to Nelson and Winter’s Evolutionary Theory of the Firm (1982), for example, firms must continually search for solutions to problems as they interact with their environment. The outcomes of search however, are subject to stochastic variation. Differential outcomes from search result in differential rates of survival and growth in firms. Consequently, differential survival rates cannot be invoked as confirming the application of marginalist principles (i.e. since only those practicing it will survive, most surviving firms must be practicing it). It is doubtful therefore, whether deductive reasoning can provide the necessary answers and further empirical research is needed to provide insights into the nature of the cost information used in pricing/product mix decisions. Based on existing econometric and case study evidence, it seems, the marginalist controversy remains unresolved. There is increasing concern by government leaders, policymakers and the public over the accelerated rate at which natural resources are being depleted, and the associated environmental degradation. As a result, many businesses and business leaders have recognized “sustainability” as a worthwhile goal: companies should strive to conduct business in a sustainable manner. However, there is no widely-accepted definition of sustainability.
Can we expect the profit motive to induce companies to adopt sustainable business practices? Does economic theory, and do observed business practices, suggest that the goal of maximizing long-run profits is consistent with the goal of sustainability? If timber companies harvest all of the forests under their control, without replanting, their subsequent profits from timber sales presumably will be zero, so the companies would appear to have economic incentives to harvest forests responsibly, and to replant. Companies, unlike individuals, have indefinite lives, so they might be more motivated than individuals to make long-term investments in the environment, if those investments also offer long-term economic returns.
Unfortunately, neither observed business practices nor theory provide strong support for this line of reasoning. Many industries in both renewable and nonrenewable resources, such as oil and timber, are depleting these resources at alarming rates. Finance theory postulates that companies should maximize the present value of future free cash flows. With appropriate assumptions, free cash flows over the life of the company equal the sum of earnings over the life of the company, so that accounting theory postulates that companies should maximize current and future profits.
Consider an oil company with oil reserves that can last 100 years at a given level of production. Assume a discount rate of 8%. Assume, for simplicity, that the company anticipates zero inflation and a constant sales price for oil. How important are the resources available to the company during the last 50 years of this 100-year period, to the value (and the stock price) of the company today? The answer is, not very important. Consider an even more extreme question. How important are the resources available to the company during the last 80 years of this 100-year period? The answer is that because of the 8% discount rate, approximately 80% of the value of the company today derives from oil sales over the first twenty years. Only 20% of the value of the company derives from the last 80 years.
When the actions of a company impose costs on third parties, the economic terminology is that a negative externality exists. For example, if a company discharges pollution into a river, then there is a negative externality that constitutes a cost to people who live downstream. If the company can pollute the river without violating environmental laws or incurring negative publicity that ultimately affects sales, then this negative externality can be difficult to remedy.
Despite numerous laws and regulations designed to limit the costs imposed by negative externalities, they are pervasive. Examples today include cruise ships that dump sewage into coastal waters and the economically-motivated introduction of invasive foreign plants and animals that then displace or destroy native species, harming the people and industries that appreciated or depended on them.
One type of externality is called the tragedy of the commons. The term literally refers to overgrazing of common lands that can occur in an agricultural community, because each family realizes that if they limit the opportunity for their animals to graze on the commons – which would be the socially-responsible behavior – they would make themselves worse off in the short-run without improving their situation in the long-run. Acting alone, one family does not materially affect the health of the pasture. Similarly, companies in many industries today take advantage of public goods that are subject to the tragedy of the commons. The most poignant examples relate to resources that cannot be owned by one company or country, such as the oceans and atmosphere. For example, ocean fish populations for some species no longer support commercial fishing: depletion of these fish populations constitute both an environmental tragedy and an economic tragedy for small fishing communities. Limited attempts have been made to use the efficiency of the marketplace to limit the costs imposed by negative externalities. For example, governments have experimented with pollution credits for certain types of emissions. Because companies can buy and sell these credits, they have incentives to reduce emissions without being subject to blanket emission-caps that might not make sense for a particular company and community. Such attempts do not represent a move away from the single-objective, profit-maximizing framework of our economy, but rather constitute efforts to use regulation to induce for-profit companies to internalize part of the cost of negative externalities.
Conclusions ; Recommendations
The accounting literature seems to accept research findings, which are at variance with neoclassical assumptions and then attempts to rationalize this so-called reality gap. The mainstream economics literature, on the other hand, seems to accept the implicit marginalism hypothesis and thereby rejects a reality gap. Indeed both literatures appear to neglect the possible insights provided by the other. The accounting literature ignores the implicit marginalism argument of the economics literature, while the economics literature has tended to accept any evidence of incremental reasoning as equivalent to the full application of marginalist principles. It has also largely avoided any discussion of the difficulties of ascertaining avoidable cost and could benefit greatly from the insights provided by contributions to the accounting literature such as those on activity-based costing.
It could be said, according to the conducted literature review, that strategic management accounting literature is rather fragmented by nature, and it includes many different – but often very close and overlapping – avenues. It could also be noticed, that strategic management accounting literature of the 90s relies mainly on the academic strategic discussion of the 70s and 80s, which is later strongly criticized, particularly from the subjectivist point of view, but also due to the changing competition environment. More realistic framework for studying management accounting in supporting strategic management accounting could be outlined by taking into consideration the complex nature of management and decision making. Strategic management is e.g. usually connected with high uncertainty and disagreement of objectives (Thompson ; Tuden, 1959; Burchell et al. 1980), and the individual or organizational actions might usually be described as only bounded rational (Simon, 1972). Decision makers do not have all the needed relevant information or the information is unconscious or ill-structured (Pihlanto, 1983). Such concepts as individual commitment, values and strategic intent have been increasingly weighted in strategic management literature (Bourgeois ; Brodwin, 1984; Prahalad et al, 1990). In this sense, from the point of view of strategic management, the impetus of management accounting might only be indirect by nature. Strategic consequences could, however, be seen e.g. in creating, legitimizing, promoting or stopping the strategies, shared values or strategic intent by giving visibility to some intended or unintended issues. According to the normative literature, changing contingency factors seem to guide management accounting practitioners and academics to the fascinating developments and relevance seeking. On the other hand we have evidence that it could be very hard and only partially successful to really change institutionalized systems like accounting in organizations and there could also be other than economically rational reasons to arrange accounting systems in organizations in some particular way. Furthermore, external influences are reflected in organizations through complex and sometimes unanticipated processes.
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