How To Rejuvenate A Mature Business Essay

, Research Paper

The last two decades has seen a revolution in management accounting theory and practice due to the challenges of the competitive environment in the 1980s. Kaplan and Johnson (1987) identified the failings and obsolescence of existing cost and performance measurement systems which led to re-examination of traditional cost accounting and management control systems. Conventional financial and management accounting methods have developed primarily as a result of corporate legislation in the 1930s forcing companies to provide externally published financial accounts.

Management accounting is primarily focused as a decision making tool for running a business, hence they require more flexibility. According to Kaplan management accounts have become a subset of financial accounts and that they reflect more on the external rather than internal requirements of the company. Most of the managerial decision-making and control systems in use in the late 1980s were described by Johnson and Kaplan as stagnant. As a result, they went onto research in new accounting systems raising the profile of internal accounting systems by use of financial and non-financial measures although their work was seen as controversial by Drury but is now considered of key importance to manufacturing industries aiming to become world class. This essay aims to discuss the ways in which new management accounting techniques can bring life into mature businesses, in particular those using non-financial measures.

Most companies still use the same cost accounting and management control systems that were developed decades ago in a competitive environment drastically different from today. These systems have major drawbacks described below:

· They distort product costs i.e. absorption of production overheads into product costs for the purpose of stock valuation. The external financial reporting process was purely driving this allocation of overheads for stock valuation.

· They do not produce the key non-financial data required for effective and efficient operations, hence they are of little help to operating managers’ seeking to reduce costs and improve productivity.

· The data produced reflected on external reporting requirements far more than the reality of the new manufacturing environment.

· Failure to provide accurate product costs as they were distributed by simplistic and arbitrary measures usually direct labour based.

· The short term profit pressures led to a decline in long term investment.

These poorly designed or outdated systems can distort the realities of manufacturing performance. As companies become more efficient by using new technologies, labour costs are accounting for a smaller proportion of a company’s overall cost, hence the allocation of overheads to labour hours will become irrelevant and counter-productive to the company’s operations.

The most enduring management accounting innovation was the return on investment (ROI) measure which provided an overall measure of the financial performance of each operating units or the entire company. The ROI, initially developed by Du Pont and General Electric in the early 20th century, came about due to the excessive focus on achieving short-term financial performance. As ROI control was introduced, managers aimed to achieve good performance by making operating and investment decisions on developing new and better products/processes, increasing sales and reducing operating costs. But it later became evident that during hard times, when sales were decreasing and operating costs were increasing, ROI targets could still be achieved through financial entrepreneurship by reducing discretionary expenses and exploiting accounting conventions. The creation of wealth through these activities will not help companies survive as world-class competitors.

Problems of ROI are only surfacing now because of:

· the difference in size of organisations, changes in the competitive environment and the rapid movement of technology

· less pressure for short-term financial performance in the last two decades

· current managers have little knowledge of their organisation’s technology hence they rely on creating value through accounting activities

Cooper and Kaplan introduce the Activity Based Costing (ABC) systems for manufacturing expenses as a replacement for traditional cost allocation systems. ABC is an internal accounting system designed to track overheads to cost units. ABC attempts to track overhead costs to units as accurately as possible hence the concept of the cost driver is essential to this system. A cost driver is a unit measure of a particular overhead that can be assigned to a user of that overhead. For example, in attempting to allocate administration overheads to products, the cost driver may be the number of invoices generated for that product. Hence the product generating most invoices will acquire the largest share of the administration overhead. There does not have to be one driver per overhead. There can be more drivers per overhead if they are relevant to the organisation. The ABC model is shown below:

A more accurate means of allocating overheads means that product costs can now be more accurately assessed. ABC analysis allows companies to discover profitable products that have not been properly exploited because the