PUSHING THE ART OF MANAGEMENT ACCOUNTING

Despite the many strides the profession has made over the years, some still believe that management accounting practices haven’t taken as strong a hold in organizations as they should. The author describes the challenges that are slowing the adoption of critical management accounting tools in broader business

 

By Alexander Mersereau, CMA, FCMA

 

Management accounting practice has developed substantially over the past

century, but recent studies suggest that the practice is no longer making the strides that it once did. Unless management accountants take a hard look at the effectiveness of current practice, this situation isn’t likely to improve. In some companies, radical changes are needed to the structure of the finance function, the nature of the interactions management accountants have with other managers and the performance metrics used to guide the function itself.

The good news

The early part of the 20th century was a period of rapid development for the field, when scientific management sought to identify what costs should be and economic organizations began to use budgets and relate returns to levels of investment. However little development occurred in the following years and, by the early 1980s, management accounting had reached a point of stagnation. H. Thomas Johnson and Robert S. Kaplan, writing in 1987, declared:

Today’s management accounting information, driven by the procedures and the cycle of the organization’s financial reporting system, is too late, too aggregated and too distorted to be

relevant for managers’ planning and control decisions... Management accounting reports are of little help to operating managers as they attempt to reduce costs and improve productivity.1

This call for renewal was widely heeded. Their book Relevance Lost: The Rise and Fall of Management Accounting became a best seller for the editor of Harvard Business School Press and set off a wave of innovation and interest in the management accounting profession worldwide. mong the numerous technical innovations that came from this period were activity-based cost  management, the Balanced Scorecard, benchmarking, life cycle costing, target costing, economic value added measures and strategic cost management. Management accounting was also able to

build upon innovation in other fields such as Total Quality Management, Six Sigma, Kaizen and Business Process Reengineering. The development was rapid and interest spread well beyond the

management accounting community. Peter Drucker, writing in the Harvard Business Review in 1990,2 declared that “the most exciting and innovative work in management today is found in

accounting.” Fifteen years later, it’s a good idea to ask ourselves what has happened to this reform. On one hand, the new tools that came from that period are evidently in use. Advanced management accounting practices such as ABC and non-financial  performance measures are included in all major management textbooks. Studies of activity-based cost management (ABC) have reported generally positive user perceptions of benefits. Most of the larger companies appear to have experimented with Balanced Scorecard (BSC) techniques and studies have linked elements of scorecard use to

higher profitability. Economic value added (EVA) research has reported positive results. On the other hand, despite these positive results it would appear that the adoption of advanced management accounting practices once again has slowed.

Slipping standards

Studies estimate that the use of ABC has fallen and is now below 20%, and the percentage of those considering implementing ABC has also fallen. Of companies that have introduced activity based

techniques, only a minority claim that it is embedded in their organization. Strategic cost  management techniques, such as attribute costing, seem little known outside academia. The majority of firms adopting EVA measures apparently don’t use them significantly. Balanced Scorecard researchers have concluded that most users make little attempt to link their non-financial performance to strategy and that only a small minority attempt to validate the cause and effect linkages included in

their models. Moreover, Balanced Scorecard practice seems to have developed an independent momentum, excluding the finance function altogether in some organizations. There is even

pressure for management accountants to do less. In his autobiography, Jack Welch complained: “The budget is the bane of corporate America (and) never should have existed” and research that

would enable organizations to move beyond budgeting is underway. Therefore, it isn’t surprising that despite the wave of innovation in management accounting in the late 1980s and early 1990s, a recent study by IBM consulting reported that less than half of managers received role-specific information to support ad hoc decisions. Fewer still received frequent operational metrics related to processes under their control and very few could obtain information across functions, processes and

geographies. A similar study by Accenture/Economist Intelligence Unit reported a significant gap between potential and actual practice.3 These indications of a slowing pace of management accounting change may be due to a range of factors. In some cases, new management accounting tools aren’t adapted to organizational strategy or structure and can’t be used. And in some cases, innovation has failed due to implementation-related factors. However, the main problems aren’t

technical or structural; they lie in the need for a better management of the management accounting process itself.

Getting involved

 

At the heart of the management accounting process is a communications system, or a set of communications systems, that provide information to managers. The ability of management

accountants to improve the scope, timeliness or quality of the information they provide depends on how well they understand and manage these systems. There are three main areas in management accounting systems in which communication problems can occur, which are illustrated here using

the tale of The Three Monkeys. The three monkeys that most people know are Speak No Evil, Hear No Evil and See No Evil. In this medieval Japanese illustration, a trio of monkeys is depicted with one having his hands over his mouth, another covering his ears and a third his eyes. The original

use of this image seems to have been to illustrate wisdom. The three wise monkeys, as they were referred to, counselled the disciplined avoidance of evil. Conversely in modern times the image of the three monkeys has been used to emphasize stupidity and negligence, or the unwillingness of

people to get involved. Here they are used in the latter sense to illustrate the need for management accountants to become more involved in this communications process. The management accounting

communications process begins with a set of inputs to the accounting information system. This data is then encoded into information using a language (accounting) and transmitted to a recipient. Here is our first monkey, the speaking one. The management accountant can’t possibly observe, measure and report on everything. She must select from a wide field what to report, how to report it and when. To do this well, she must anticipate how this information ought to be used, have a language at her disposal that succinctly codifies the key data observed, and have a communication medium that reaches the intended audience efficiently and effectively. The next leg of the communications

process is the receipt of the information. Here we confront the second monkey, the hearing one. Managers must be able to correctly decode the reports they receive. They must therefore be familiar

with the concepts used in the accounting models that are used to prepare the reports and understand what the variances in the numbers signify. Finally, managers act on the information received. How they will act depends on how they interpret the message. This is a separate challenge and introduces the third monkey, the seeing one. Individuals interpret and act on information using personal  ecision rules that they have learned over time. A large part of any manager’s decision strategy will be guided by how he views his organization and his role in it, and personal and corporate objectives are never completely aligned. The actions that a manager takes as a result of receiving information

(including actions taken in anticipation) and the consequences of these actions should be of great interest to the management accountant. These consequences become part of the world she must observe. This is the first monkey all over again, and so the cycle continues.

Big picture providers

 

How do some organizations meet the challenges illustrated by the three monkeys? Let’s look again at the first monkey, the speaking one. To be able to communicate to managers, accountants

must have a clear picture of the strategic importance of the phenomena they observe, and they must have a clear idea of how operating decisions are made. Some of this can be learned in university

but most of it comes from day-today experiences within operations. This requires frequent contact between management accountants and other managers. However, the cycles of monthly, quarterly and annual planning and reporting are punishing and accountants regularly work overtime during these periods. To overcome these barriers, some organizations encourage contact by physically locating accountants with other managers. Some deliberately place accountants on inter functional working groups and many ensure that management accountants have either dotted or solid line accountability to operating managers. Some organizations have adopted a structure in which some

management accountants don’t have routine reporting responsibilities. A complicating factor is how

management accountants are themselves received when dealing with operations personnel. Over the years in some quarters accountants have earned a reputation for bringing an unbalanced and overly financial point of view to problem solving, which has diminished their position in the hierarchy. Some managers have characterized financial managers as among those with the least mental flexibility, the most closed minds and the least willingness to take risks. While some of the blame for this impression can be attributed to poor public relations, the selection and training of accountants remains a significant issue. Management accounting requires practitioners with a

“big picture” point of view who are able to challenge operating managers as peers. Formal education may actually have a negative effect on recruitment. Several studies have suggested that

accountants may follow a training regime that is too highly oriented to the financial aspects of their work and not sufficiently directed to the behavioural side. Others have observed that the financial bias to the educational component has the regrettable consequence of attracting candidates to the profession who are more comfortable with a formula-based approach to decision making and less at ease with the ambiguities that characterise managerial work.

Educating others

 

 

Let’s turn now to the hearing monkey, which refers to the ability of managers to understand the ccounting reports they receive. When financial accounts are prepared and distributed externally,

accountants are permitted to assume that the reader is trained in accounting. This isn’t the case  nside the organization, where a vast majority of managers haven’t completed any significant formal

accounting training, and those who have will have forgotten much of what they learned. Some organizations are attempting to overcome this problem by supplementing or replacing financial

reports with symbols or colours (green for OK, yellow to signal issues and red to announce a real problem). While such systems have the advantage of simplicity, questions need to be asked

about the overall content of such communications. What does yellow or green really mean? What about the grey areas in between? And in the political context of organizations, how might these ambiguities be exploited for personal benefit? Rather than reducing the content of accounting messages to one of three possible states, accountants need to help end users become more proficient in reading accounting reports. Some organizations have built accounting training modules for their managers that help them understand the specific reports they receive. Management accountants

have an important role to play in preparing and delivering training materials. In today’s complex

managerial environment technical functions, especially accounting, need to become more than suppliers of information. They must become a kind of a school where managers can receive

training. Yet in many organizations, accountants are too busy to become trainers and internal reward systems likely discourage such activities. Here the training activity itself needs to be repositioned to make it attractive to accountants. As the scope of management accounting messages widens to include nonfinancial performance indicators, management accountants acquire an additional challenge. Many managers have difficulties visualizing the cause and effect relationships that link value drivers to financial returns. Yet this is the key knowledge needed to manage value, and training is often required to help managers understand better the cause and effect relationships that

underlie shareholder value. The third monkey, the seeing one, refers also to the manager, this time to the conflict that exists between shareholder values and the interests of individual managers. Increasing functional specialization means that managers are increasingly disconnected from

shareholder values. Many managers are strongly committed to the organization without being committed to the financial goals that drive it. Management accountants have a role to play in

instilling financial discipline and conveying financial values to nonfinancial managers. One method is to require operating managers (rather than accountants) to systematically prepare and present the financial analysis of their business unit. Shareholder value training is also important. At the same time that the management accounting function must pay greater attention to the effectiveness of its

internal communications processes, other demands are arising. There is increasing pressure to reduce the overall cost of the finance function as a percentage of revenues. There are increasingly time consuming demands for more detailed external reporting. While these latter goals are important

and must be achieved, putting the priority there only increases the risk that internal accounting communications will fail to achieve their objectives and that management accounting system change

will be further delayed.

The way forward

 

Improving management accounting begins with a commitment to change. For many organizations, this is a huge step. Accountants have been found to be the first to resist accounting change, and the failure of various ABC and scorecard projects has been linked to the unwillingness of accountants themselves

to see the project through. Many accountants are afraid that radical change might endanger existing systems and processes. To ensure that change is permanent, commitment to change must come from

the top and must be sustained. As the previous examples illustrate, improving the management accounting

function often requires structural reorganization. If everyone is consumed by the routine reporting cycles, there will be no one left to assume emerging roles in areas such as management training. In some organizations bringing in new people will be necessary. Management accounting is more than

just accounting, it requires people who understand the behavioural consequences of numbers and who can

link controls to strategy. Last, but not least, the management accounting process requires new metrics.

Most accounting functions measure timeliness, in terms of the delay between the end of the reporting cycle and the issuing of the report, and many measure the cost of the finance function relative to revenues. Few organizations measure the use or the usefulness of the management accounting information provided. The absence of such measures guarantees that things will remain the same.

Diagnostic

Management accountants should conduct frequent analyses of their communications processes. Such a diagnosis would include the following questions:

•  What changes to management accounting practice have you initiated in the last two years?


•  How many people are committed to real change?


•  Do accounting personnel regard themselves as members of the operating team?


•  How much time do management accountants spend with nonfinancial personnel?


•  Are management accounting personnel physically located in such a way as to bring them in regular contact with nonfinancial managers?


•  Do management accountants have a reporting responsibility to operational managers?


•  Do reports to individual managers/units contain a maximum amount of information about that specific unit?


•  Are accountants given responsibilities that can only be discharged by working with operational people?


•  Do the accountants who have these responsibilities have sufficient status to maintain working relationships on the basis of mutual respect?


•  How many accounting personnel do not have significant routine reporting responsibilities?


•  How much financial training is provided for operating management?


•  Does this training explain the links between financial and operational events?


•  Does this training explain why financial goals are important?


•  Are operating managers required to systematically prepare and present the financial analysis of their unit?


•  Do performance measures other than cost and timeliness exist for the management accounting function?


•  What priority is given to these metrics and how are they used?

The more management accountants can respond positively to these questions, the better organizations will become at managing the communications processes that underlie management accounting. This will create a better understanding of the role that management accountants

can play in achieving success and it is in this context that significant management accounting change will occur.

references:

1. Johnson, H. & Kaplan, R. (1987), Relevance Lost: The Rise and Fall of Management Accounting, Boston, Harvard Business School Press, p 269.

2. Drucker, Peter (1990) The Emerging Theory of Manufacturing Harvard Business Review May/June pp. 94-102

3. Accenture Finance Solutions (2004) Best in Class How Finance Business Process Outsourcing Can Help Create a High Performance Finance Function.