Management Accounting and Control Systems

Transcription

1 Tijdschrift voor Economie en Management Vol. XXXVI, 3, 1991 Management Accounting and Control Systems by H.P. HOLZER4' and H. NORREKLIT'"'" I. INTRODUCTION Management accounting in the US and elsewhere has recently received more publicity than usual. Outdated management accounting systems were found to produce misleading cost numbers and performance measures. Radical changes in manufacturing technology and philosophy, combined with intensified global competition, had made many traditional systems obsolete. In response, significant efforts have been made in both industry and academy to conceive and apply new costing systems that meet the requirements of the changed environment. In addition to this impetus arising from developments in industry, there are ongoing academic research efforts in the discipline. The goal of this paper is to discuss and analyze the developments motivated by the important changes in management accounting's environment and to describe the status and progress of scholarly research in the field. 11. BRIEF HISTORY OF MANAGEMENT ACCOUNTING Modern management accounting has a rich history going back almost 200 years. The need for cost accounting and tools for planning, coordinating, and control, first arose during the industrial revolution " Uiliversity of Illinois at Urbana-Champaign, U.S.A. *"arhus School of Business, Denmark. The authors would like to thank Professor Timothy O'Leaiy of the University of Illinois for reviewing the paper and for his helpfill suggestions.

2 (Johnson (1972)). A common view is that modern management accounting began in the 1920's, although the term became widely accepted only in the late 50's. During the twenties and thirties a controllership function emerged in many important corporations that assumed increasing importance during subsequent decades. The most important and influential academic contributions to the developing discipline were made by Clark (1923), Dean (1951) and Anthony (1965). Clark discussed and popularized the concepts that underlie modern cost accounting ; Dean popularized discounted cash-flow models for investment planning ; and Anthony developed a widely recognized conceptual framework for control systems. The most significant practitioner influence came from the publications of the National Association of Accountants and the Controllership Institute (now the Financial Executives Institute). The latter sponsored many excellent research studies, including the noteworthy Solomon's Divisional Performance : Measurement and Control (Solomon (1965)), which provides an excellent overview of existing practices and their underlying rationale~. Starting in the 70's, the environment of many management accounting systems underwent important changes. These include the introduction of new management philosophies and new technologies NEW UFACTURING PHILOSOPHY AND TECHNO- LOGY A major impetus for new practices in costing, production planning, and control has come from recent developments in manufacturing philosophy and technology. The driving force behind this development is the greatly increased global competition in the manufacturing sector that has forced manufacturers to seek more efficient production methods and to produce products of better quality. A. Just In Time (JIT) One recently and widely applied production system in the manufacturing sector is the just-in-time technique made famous by Japanese manufacturers, notably Toyota. JIT's principal objectives are continuous improvement in productivity and quality. JIT is a so-called "pull" system that tries to minimize inventories. Ideally, products or parts are delivered or produced just when they are needed for a product or service : the demand for an item triggers production or de-

3 livery of the item. The signal which triggers may be verbal or it may be by means of a "Kanban" (Japanese for card) (Huge (1988)). The goal is to maintain a constant flow. Since there are no inventories between consecutive stages of a production process, a stoppage at any stage, for whatever reason, will bring the entire process to a halt. The fact that defects and errors lead to a stoppage of the entire production process forces management to a high level of quality awareness. One of the leading theses of the JIT philosophy is "simplicity and do it right." Under JIT philosophy, inventories, especially work-in-process inventories, are viewed as a liability that should be minimized as much as possible. In addition to lower inventories, the advantages of applying the JIT philosophy to a manufacturing process include reduction in time (smoother and faster flows), less space (fewer inventories to be stored), better quality (defects are corrected immediately), and better service to customers (reduced lead times). JIT should be viewed as a company-wide continuous effort to improve productivity and quality, not limited to the factory. B. Advanced Technologies (AT) A number of new technologies have recently been widely applied in industry in addition to the JIT philosophy. A basic understanding of these technologies is necessary to appreciate their implications for management accounting. Material Requirements Planning (MRP) systems employ computerized methods for coordinating detailed production plans in multistage manufacturing systems that require a large number of materials parts and subassemblies. The system starts with a master schedule of the timing and quantities of finished products to be produced. A bill of materials lists the quantities and timing of all materials and parts requirements, which is used for preparation of complete production schedules. MRP systems that go beyond manufacturing and include capacity, purchasing, marketing, and financial planning are referred to as Manufacturing Resource Planning I1 (MRP 11). Under MRP systems, the time of production is determined by a production schedule, and in that sense it can also be viewed as a "push" system. MRP systems have been widely used, although there are far fewer applications of MRP 11.

4 Soon after the introduction of computerized MRP systems in manufacturing, use of the computer in the design of products (Computer Assisted Design--CAD) and in the engineering of production processes (Computer Assisted Engineering--CAE) developed. CAD led to tremendous improvement in the productivity of designers and in the quality of designed products. In many cases combining CAD and CAE not only led to better quality of products at a lower cost, but also to a significant reduction of the time required for these functions. Combining or closely linking the two functions permits simulation of process design changes before the product is produced, which may greatly improve the product's manufacturability and reduces production cost. Computer Assisted Manufacturing (CAM) uses the computer for planning, implementation, and control of production processes. Total Quality Control (TQC) has as its premise that everything done in the manufacturing process should be done right the first time. Usually, but not necessarily, this involves statistical process control (STP), a statistical procedure that monitors critical factors in a manufacturing process. The process is shut down when a critical factor falls outside an acceptable range. Numerical Control (NC) employs machines that are programmed to run by a set of codes ; nowadays they are usually programmed and controlled by computers, and we speak of computer numerical control (CNC). Numerical Control machines are flexible ; they can do different jobs, and because they can switch from one job to another in a very short time, they significantly reduce setup costs. Other advantages are improved quality and reduction in direct labor hours. C. Flexible Manufacturing Systems Flexible Manufacturing Systems comprise all the techniques that facilitate flexibility by reduction of setup time in order to reduce inventories. Three techniques are usually discussed under this heading : Just in Time (JIT), Islands of Automation (IA) and Computer Integrated Manufacturing (CIM). The JIT approach discussed above may be viewed as a first step in simplification and the elimination of waste in a manufacturing process. Islands of Automation, a second step, applies automation to individual processes or functions, usually a group of machines dedicated to the production of a family of products, with the use of robots and automated vehicles for manipulating and moving the product. While IAs require large capital investments, JIT can be

5 implemented with almost no capital investments. Costs related to the investment in high technology equipment replace the cost of labor. Computer Integrated Manufacturing is the final step on the road to automation, and links the AIs into one integrated system. In its ultimate form, CIM will provide computerized links from product design, to production engineering, to the actual manufacture of a product. In the manufacturing process the shift from labor to technology costs is complete and we approach a factory without people. D. Consequences of Developments in ~anufacturin$ Consequences of these developments for the manufacturing organization can be shown in Figure 1, where we compare the features and functions of traditional manufacturing with those of modern high technology. Note that advanced technology affects all functions in the factory. It will drastically reduce hierarchical levels in the organization. This has important implications for control. AT will also change the firm's relationships with suppliers through the establishment of JIT deliveries with an ideal of zero defectives. AT must also aim at improving customer service through significantly shortened lead times. In the words of Drucker : "in the future the factory is not a place at all, it is a stage in a process that adds economic value to materials" (Drucker (1990))'. E. The Impact of Advanced Technologies on Cost Functions Introduction of JIT will lead to important changes in a firm's cost functions. CAD and CAE have greatly reduced the time required to introduce new products, which, in conjunction with increased global competition, has shortened the product life cycle. Because of a product's shorter life, the relative importance of design and development costs is much greater. As much as 90% of a product's life cycle costs are committed before production starts (Berliner and Brimson (1988)). Management must therefore pay more attention to planning these costs ; not only are they relatively more important, but they must be recovered much faster than in the past. Rapid technological change also shortens the useful life of many manufacturing facilities, which may be obsolete long before their physical exhaustion.

6 FIGURE 1 Conseq~ler~ces of Developments 111 Man~~fnctz~rirzg Features & Functions Traditional Manufacturing Modern Advanced Technology Process & Facilities Hardware Control L Product Design Financial Control Many Dedicated Machines Multiple Setups Large Warehouses Lal-ge WIP Areas Mainframe Mini MicroIPC Constant Demand Fluctuation Frequent Rescheduling Many Engineering Changes Weekly Planning Long Lead Times Large Lot Sizes Vendor Difficulties Life Cycle Declining Many Engineering Changes Many Complex Cornponents Quality Improvement over Cycle Infinite Options Labor Efficiency Little Emphasis on Investment Shop Orientation Focus on Variable Cost overhead Spreading Cost Measurement Functional Interfaces Long Lead Times Hierarchical Flexible Machine Centers Zero Setups No Warel~ouses Drastic Decline in Space Required Multiple networks of Mainframe, Mini, Micro & PC Demand Stabilization Minimum Rescheduling Zero Change Hourly Planning Zero Lead Times Lot Size of 1 Vendor Synergies Life Cycle Much Shorter Few Engineering Change Few Complex Components Zero Defects Limited Options Product Profitability Full Stream Investment Intensive Product Cost is Incurred Minimum Variable Cost Beyond Material Zero Direct Labor Cost, Flexibility, Dependability and Quality Measures Product Teams Flexible and Rapid Decision Making Fewer Levels

7 FIGURE 2 L+ Cyc!e &TT, Crrrh F~OKI arid Matched Co.~t (Berliner and Brimson (1988)). Changes in cost functions as we move from traditional to AT manufacturing affect direct labor. The relative importance of direct labor has long been declining, and in many AT facilities it has already disappeared as a distinct cost category. The disappearance of direct labor means that only material cost remains as a direct cost and that all conversion costs now fall into the indirect cost category. Direct labor has been widely used as one of the bases for the allocation of overhead costs ; new bases for allocating the enlarged pool of indirect costs to products will need to be developed if serious distortion in product costs are to be avoided. A further important related trend is the replacement of variable costs by fixed costs. Direct labor, a variable cost, is replaced by machines and fewer highly skilled workers, whose wages should now be considered as falling into the fixed cost category. Owning and operating AT facilities therefore leaves us only with materials as a direct and variable cost, with all other manufacturing costs being indirect and fixed. Figure 3 shows the changing cost behavior patterns. In the following section we shall discuss the implications of these developments on product costing, planning and performance evaluation. F. Product Costing The change from direct to indirect, and variable to fixed costs, indicates that many traditional costing systems may be producing cost

8 FIGURE 3 Clzangng Cost Behavior Patterns W k V) 0 TECHNOLOGY I n 0 K Q. ISLANDS OF AUTOMATION MFG numbers that are misleading if used for decision making. Many systems are integrated with financial accounting and are used for costing inventories and cost of sales. Inaccurate costs for that purpose are not overly serious. But most managers want to use costs for performance evaluation, pricing policy and long run product profitability evaluation. Before selecting a method to be used for costing a product, the purpose and use of the resulting numbers should be clearly stated. Evaluating the profitability (or a pricing policy) of a product over its life cycle clearly requires different costs than those required for a short run make or buy decision. In multi-product situations in AT environments, the increased amount of fixed period costs, a good part of which will be joint in nature, and the incurrence of development costs (both CAD and CAE) prior to manufacturing and marketing of the product, make product costing a challenging task. It should be obvious that different cost models will have to be used for different purposes. 1. Activity Based Costing (ABC) Activity Based Costing (ABC) has become the accepted term for the recently widely advocated methods for obtaining more accurate costs in circumstances where knowledge of accurate costs is important for decision making.

9 The initial focus of ABC is on the activities performed to produce a product. Costs of these activities are identified and traced via a socalled cost driver for each product, based on the product's use of each activity. Activity based accounting is : "... a collection of financial and operational performance information dealing with significant activities of the business. Activities represent repetitive tasks performed by each specialized group within a company as it executes its business objectives". (Romano (1989)). It is not surprising that the first reported uses of ABC were in industries with multiple products in a highly competitive environment. In such situations profit margins are thin, prices are dictated by the competition, and product profitability is judged on the basis of internally developed costs. If these costs are distorted, management may be unaware that some products are sold at a loss. A cost driver should present the best available measure for the consumption of overhead activities by a product. The most frequently cited cause for the distortion of product cost is that many traditional costing systems ignore the fact that many overhead costs of activities are not related to the volume of products manufactured. Setup costs are still an important cost, even in many AT manufacturing plants. They are not related to volume but to such drivers as number of setups or setup hours. In a multi-product situation there are usually significant differences in volume among products. Setup costs for low volume products should therefore be higher on a per unit basis for the low volume product and lower for the high volume product. Ignoring these relationships in a costing system will lead to overcosting of high volume products and undercosting the low volume products. Another indirectly volume-related activity might be materials handling (cost may be related to weight or bulk); if assigned to products on a volume basis, such as direct labor or machine hours are, they would, of course, distort unit costs. The objective of ABC is the measurement of more accurate product cost by careful consideration of activities that are not driven by (related to) conventional volume measures such as direct labor hours, machine hours, material dollars, or weights. A simple example in the appendix illustrates activity costing and shows the distortions in reported costs resulting from purely volume based traditional systems. Summarizing, we can say that obsolete cost systems may lead to dysfunctional decisions (Holzer and Norreklit). Symptoms that sys-

10 tems have become obsolete include the following : - line managers lose faith in the cost figures produced by the cost systems and use their own cost estimates ; - competition's prices for some product are below your reported costs, and reported profit margins are hard to explain. We have said that the introduction of AT is one of the environmental factors that affect cost functions and therefore lead to changes in costing systems. Other external factors include increased competition brought about by the globalization of markets and domestic deregulation. 2. Life Cycle Costing Because of the shortened life cycle for many products, and the increased importance of design and development costs, more attention is now paid to shifting cost patterns over the life of a product. Today, product life cycle management attempts to integrate marketing and engineering perspectives of a product's life cycle. From a marketing perspective, the product life cycle comprises the shifts in the product revenue curve. From an engineering perspective, the product life cycle incorporates the types of activities that constitute a product's life cycle, i.e., production engineering, design, production, and distribution. In life cycle costing, cost is measured at each stage of the product's life cycle, and it is also accumulated by stages over development and production. Product design and development, process analysis, programming and prototyping constitute the cost of the first stages. They are followed by procurement, manufacturing, and distribution. Life cycle costing is used to establish pricing policy and for controlling product contribution margins during different stages. Especially in the early stages of product design and engineering, commitments are made with regard to materials, product specifications, and manufacturing equipment and processes. These commitments largely determine cost during the production and distribution stage of a product (see Figure 2). Cost and revenue factors will also determine the length of a product's life cyclc. G. Strategic Cost Analysis Although Anthony (1965)), more than 25 years ago, clearly defined and described management accounting's role in the strategic planning

11 process, interest in the strategic aspects of management has recently beer: rekindled, proba b 1. j fn-., +b- L, *a~-.,,,.-e. asons that led to the need for changes in costing systems. Global competition and rapid technological developments made the need for strategic planning more obvious. Strategic cost analysis implies the use of cost information in developing strategies. The widely published ideas of M. Porter (Porter (1979), (1985)), especially his analysis of competitive forces, have been very influential in the academic world, as well as in practice. According to Porter, competitive advantage can be achieved either through lower costs or through product differentiation. To achieve or maintain a competitive cost advantage, a firm must have a good understanding not only of its own cost, but also of the costs of its suppliers, customers and competitors (Jones (1988)). To diagnose any firm's competitive advantage, one must take a disaggregated view of the firm, which Porter calls the value chain. Figure 4 shows the main activities of the value chain. For a more comprehensive analysis of a firm, its activities may be disaggregated even further so that all activities affecting products' values can be analyzed. "...Profit results if the value created through performing the required activities exceeds the collective cost of performing them." (Porter (1986)). FIGURE 4 Value Chain (Porter (1985)). FIRM INFRASTRUCTURE I HUM!AN RESOURC~ MANAGE~ENT I I l TE~CHNOLOGY D'EVELOPME~T INBOUND OPERATIONS OUTBOUND MARKETING SERVICE LOGISTIC LOGISTIC SALES Strategic Cost Analysis may involve the following steps (Shank, Govindarajan and Spiegel (1990), (Govindarajan and Shank (1990), Shank and Govindarajan (1989), McGaughey and Starly (1990)): - define the firm's existing value chain and assign costs and assets to

12 value activities ; - identify the cost and prices of all important c~mpetiters' value chains ; - determine who the buyers are, what needs they have, and what the impact of the firms' products and activities on those buyers is. Identify the diverse strategic positions of different products. In the process, look for and evaluate cost differences, value differences, industry and market evolution and changes; - investigate the cost drivers regulating each value activity and what changes can make the buyer's cost lower andlor enhance the buyers's satisfaction. Examine possibilities to build sustainable competitive advantage either by controlling cost drivers or by reconfiguring the value chain. Strategic cost analysis uses the principles of ABC when allocating costs to value creating activities. It tries to link costs to the value added for customers in each of the activities a company performs and compares it with competitor performance. It focuses on reduction of activity costs by controlling, changing or removing cost drivers. The focus is on finding the right price and segment in the product's value chain. Although Functional Analysis or Value Analysis is a very old technique, it is quite similar to Strategic Cost Analysis. In functional analysis, which is widely used in Japan, the cost of different product functions is established and compared to the value of the function for the customer : "Value analysis is a systematic interdisciplinary examination of factors affecting the cost of a product or service in order to devise means of achieving the specified purpose most economically at the required standard of quality and reliability." (Yoshikawa, Innes and Mitchell (1990)). Target costing is a tool for reducing the overall cost of a product over its entire life cycle with the help of the production, engineering, R&D, marketing, and accounting departments. The idea is to manufacture a product to a specific price. Cost becomes the output of the pricing decision, not the input to it. Target costing is used in the planning and design stage. Value engineering is central for target costing. It is "an activity to design a product from different angles at a lower cost by reviewing the functions needed by customers." (Sakurai (1990)).

13 H. Capital Irlvestment Analysis Justifying investments required for CIM and FMS is often difficult when conventional tools for analysis are used. Investments in CIM lead to a fall in R01 in the short run, but a rise in long run. When R01 goals are important performance measures, there are no shortrun incentives to invest in CIM and FMS: "R01 time spans are typically set at three to five years. CIM projects usually take two to three years to implement, so positive cash flows may be excluded from the analysis. However, CIM benefits may continue for up to ten years. Time horizons of ten to twelve years are required to compare CIM with long term alternatives." (Nobel (1990)). However, the long term consequences imply that payback is an inappropriate judgment criterion. Instead, expected net present value should be used. In this context, many writers question the use of high discount rates for this kind of investment analysis : "Hurdle rates for R01 can be anywhere from percent to allow for risk and ensure that investments yield a high return. However, the real cost of capital is estimated to be about 8 percent. Due to compounding, hurdle rates severely discount benefits received in later years." (Nobel (1990)). The discount factor should be the weighted average of the cost of equity and the cost of debt capital. The cost of debt capital should use the nominal cost of long and short term debt after tax. The cost of equity capital should be the opportunity cost of capital for the investors : "One can estimate the cost of equity capital in either of two ways : use the historical nominal return on corporate stocks of between 12 and 13% per year or use the real return (net of inflation) of about 8% to 9% and add the expected future inflation rate over the life of the project. Either method is reasonable and would be a dramatic improvement over the practice of some firms using rates in excess of 20%. " (Icaplan and Atkinson (1989)). Discount factors should not be adjusted for risk, because the discount rate usually uses a geometrical compounding, and the risk effect will also be treated as geometrical. Kaplan and Atkinson (1989) claim that riskiness of a project is considerably reduced after a high tech project's early years. Instead of including risk in the discount rate, he suggests the use of sensitivity analysis.

14 FIGURE 5 Valzle Added Activities Value Added Activities Center (Includes Direct 8c All Support Activities Related to the Shop Area) Value Added Activities Machine. Fabricate, Assemble. Non value Added Activities Sorting, Checking, Analyzing, Troubleshooting, Repairing, Expediting, Storing; Counting. Accumulating, Auditing, Inspecting, Recording, Reporting, Moving, Supervision Another major problem when evaluating investments in CIM or FMS is measurement of the benefits. Looking only at cost savings understates the benefit from higher quality products and improved customer satisfaction. These benefits are real and should be quantified. The lost benefits of not investing must also be taken into consideration because not investing may mean loss of market share and may even threaten survival of the firm. Three steps are recommended when evaluating investment in new technology : - strategic justification ; - cost justification ; - benefit analysis. The investment must be appraised with regard to its impact on markets and customers, competitors, and the internal organization. I. Pe$ormance Measurement A brief examination of the objectives of the JIT philosophy will show that such traditional performance measures as labor efficiency, material and budget variances are of limited use. The long-run goals of JIT are reduction or elimination of inventories and enhancement of total quality. JIT also suggests that non-value-added activities should be minimized. Non-value-added activities include moving the product, storing it, and inspecting it (see Figure 5). The goals of zero inventory and total quality are mutually reinforcing. Elimination of inventories is possible only when there are zero defects, because defects

15 would cause inventories ; having no inventories to fall back on forces you to do it right the first time. Performance measures should therefore be designed to motivate people to move in the direction of no inventory and total quality. In the JIT environment, controls must move from periodic control to on-line measurements. Cost control will be done primarily by the personnel on the factory floor through SPC (statistical process control) and observation of other non-financial variables. Garrison (1991) distinguishes five areas for performance measurement : quality control measures, material control measures, inventory control measures, machine performance measurement, and delivery control measurement. Quality control measurements include : number of warranty claims, number of customer complaints, number of defects, and cost of rework. Material control measurements include : material as a percentage of total cost, lead time, scrap as a percentage of good pieces, scrap as a percentage of total cost, and actual scrap loss. Inventory control measurements include : inventory turnover of raw materials and finished goods, and number of inventory items. Machine performance measurements include : percentage of machine availability, percentage of machine downtime, setup time, machine stops, preventative maintenance, and use as a percentage of availability. Delivery performance measurements include : percentage of ontime deliveries, delivery cycle time, throughput time or velocity, manufacturing cycle efficiency, order backlog, and total throughput time. With the goal of continuous improvement, these measures should not be viewed as static standards but as evidence of a trend toward the ultimate goal of perfect quality and no inventory. We also need performance measures for important and indirect functions such as engineering. Some of these may include: - lead time from a product's conception to the start of production. - percentage of product that meets target objectives after a given period of production, average number of engineering change notices in the initial period of production, average days to process an engineering change notice from request to production implementation, and so forth. Product costing will be done outside the production cost control system.

16 IV. SCHOLARLY RESEARCH In our discussion of scholarly research in management accounting we will first describe the more practice oriented approach of mainly Harvard Scholars. We will then touch upon efforts dealing with the behavioral aspects of management accounting followed by some analytical modelling approaches. A. Management Control Merchant's research follows the practice-oriented research of such Harvard scholars as Anthony, Dearden and Vancil. In Control in Business Organizations (Merchant (1985)), he develops new concepts in management controls as a step toward the integration of different control concepts into a control theory. Merchant classifies control according to the object to be controlled, and distinguishes : result controls, action controls, and personnel controls. Establishing result controls requires : - knowledge of the result desired ; - controllability of the desired result ; - measurability of the controllable result. Result controls are used in decentralized organizations for rewarding individuals for accomplishing particular results or outcomes. At the management level result controls are established for example through the ROI as a performance indicator. At that level it should be possible for management to control sales, costs, and assets. At lower levels result controls can be established through targets or standards. At that level it should be possible to control either sales or expenses. Result controls may be effective in motivating employees to work toward stated targets. Action controls are used to ensure that individuals perform in a certain way. Action controls can take four basic forms: - behavioral constraints ; - preaction reviews ; - action accountability ; - redundancy. Behavioral constraints aim to make it more difficult for people to do something unauthorized or undesirable. This can be accomplished with passwords, identification, card readers, centralization or separation of duties. Preaction reviews include an examination of work or

17 plans with the individuals doing it before their work is done. Action acceuntability requires defining what actions are acceptable, tracking what happens, and rewarding or punishing deviations. Redundancy involves assigning more people or machines than necessary to a task, so that the probability that a task will be accomplished increases. Action controls are only feasible when knowledge exists about which actions are desirable/undesirable, and there is an ability to make sure that action occurs. Personnel controls develop employees who are self-directed. They may encourage either individual self-control or social control. Personnel controls work by encouraging and facilitating positive forces through selection and placement, training, cultural control, groupbased rewards, and provision of necessary resources. When a manager can rely on others or make them reliable (e.g. through training or socialization), then personnel control is feasible. If he can not, but knows the desired action and is able to make sure that the desirable action is taken, then action control is feasible. If neither of these is feasible, but the manager knows the desirable results and results are controllable and measurable, then result control is feasible. As we adopt the new manufacturing philosophy, practices will move more towards personnel control, although result and action control will continue to be important. Financial accountability control is a special form of results control, which holds managers accountable for financial figures, such as net income, earnings per share, or return on investment, assets, or equity. The advantages of financial accountability include the facts that positive financial results are one of a firm's most important objectives, and that they are inexpensive and effective when top management is unsure of what is right. On the other hand, financial accountability controls may induce non-goal-congruent behavior and management myopia. Several possible mechanisms minimizing the shortcomings are discussed. In the final chapter of this book, Merchant discusses the use of his control concepts in the design of control systems. Merchant's Rewarding Results --Motivating Profit Center Managers (Merchant (1989)) builds on his previous work and should be viewed as a significant theoretical contribution to Management Accounting, with great practical value. Vancil's foreword to the book views it as closing "...the loop on management control systems (Merchant (1989))" that began with Chandler's Strategy and Structure (Chandler

18 (1962)), and was extended by Anthony (1965), Vancil (1978) and others in the management control area. Merchant's book reports the empirical results of a field study, which used questionnaires and personal interviews with profit center managers and corporate executives, of twelve companies over a number of years. The study compared the ideal motivational contract for profit center managers developed by the author with the actual contracts in use in the companies studied. The ideal contract for most employees should have six primary characteristics : - performance measures that are congruent with the overall corporate goal of maximizing shareholder value ; - controllable results measures ; - accurate results measures ; - preset and challenging performance standards ; - rewards that are meaningful, but at minimum costs ; - and simplicity (Merchant (1989)). As one might expect, actual contracts in 54 profit centers studied by the author deviate from this ideal. Deviations from the ideal contract design are the result of three constraints : I. the inability to measure shareholders' value directly ; 2. the inability to isolate the profit center manager's unique contributions to results ; 3. the desirability of using some motivational contract elements for other than motivational purposes (Merchant (1989)). These constraints lead to trade-offs. Constraint 1, for example, leads to the use of short-term accounting earnings as a proxy for measuring shareholder value. Contract designers will, however, try to offset the inherent short-term bias, and try also to direct the manager's attention to long-term results. Constraint 2 is caused by the difficulty of finding performance measures that consist exclusively of factors controllable by the profit center manager. Accounting and other performance measures are usually distorted by non-controllable factors and contract designers will endeavor to neutralize or minimize them. Constraint 3 reflects the fact that there are contract elements that have little to do with motivation but serve other organizational purposes such as retention of qualified managers or corporate risk reduction. The author tabulates and analyzes his findings within this constraintsltrade-off framework. This work is an important contribution to the managenlent accounting literature and an important step to-

19 ward a comprehensive management control theory that is based on pro,.,p'r;,al l,r findings. B. Behaviol-a1 Accountirzg and hzfomatiorz Processing Behavioral accounting research accounts for a major part of current academic research in management accounting. "Behavioral accounting concerns itself with human behavior as it relates to accounting information problems. Its basic objective is to explain and predict human behavior in all possible accounting contexts." (Belkaoui (1989a)). The principal research approaches (Duncan and Morres (1989)) used as paradigms in behavioral accounting include contingency theory, functional and data fixation, slack, language, participative budgeting, human resource considerations, cultural determinism, and social forces within the organization. We will briefly mention only the approaches, which are most widely discussed in the literature. 1. Contingency theory Contingency theoiy assumes that there is a match between the design of various components in accounting systems and specific contingencies. Contingency theoretical studies have investigated how technology, organization structure, competitive environment, and other variables affect accounting systems. Despite numerous studies using this approach, no conclusive results of real practical significance have emerged. There is still a need for more research about the effectiveness of the relationship between contingency variables and accounting systems. 2. Slack Slack concerns the excess resources that can be accumulated from superior performance in one period, to be used to compensate in full or in part for inferior performance in the subsequent period. Two kinds of slack are mentioned: 1. organizational slack, which refers to a resource which is not used to its full capacity ; and 2. budgetary slack, an understatement of budgeted revenues and an overstatement of budgeted cost. Slack is a generally recognized phenomenon in organizations. Lewin and Wolf criticized the slack concept because it "explains" too much and "predicts" too little ; slack has to be better determined. "Further investigation into the potential determinants of

20 organizational and budgetary slack remains to be done. This effort is an important one, as the behavior of slack is highly relevant to the achievement of internal economic efficiency in organizations." (Lewin and Wolf (1976), Belkaoui (1989a))~. 3. Participative Budgeting Empirical research in psychology supports a hypothesis that specific hard goals produce better performance then medium, easy, do-yourbest, or no goals (Locke, Shaw, Saari and Latham (1981)). Other factors that influence the effects of goal setting are : direction, efforts, persistence, strategy, feedback on progress, rewards given for goal attainment, and participation in the setting of goals (Belkaoui (1989)). Accounting research has examined the relationships between high budgets, direct reward, and feedback on performance. Other studies examine the interaction between goal setting, task uncertainty and performance. Some research seems to indicate that budget participation improves performance, while other studies show only a weak association or even negative relationship. Other research shows that influence on decision making may influence performance positively, leading to the conclusion that budget participation is important for increasing performance. Moderating effects on the participation effect are motivation, leadership style, task uncertainty, role ambiguity, reward structure, cognitive dissonance, authoritarianism, locus of control, and the upward influence of a superior on his or her relationship with subordinates. Goal-setting research seeks additional variables that can mediate the link between goal setting, participative budgeting, and task performance. Research in this field continues. For an excellent discussion and analysis of budgeting research see Birnberg, Shields and Young (1990)~. 4. Human Information Processing Accounting information is used for decision making. Human information processing research tries to understand and improve the decision process when it is based on accounting information. Psychological accounting studies of professional experts' and managers' decision and judgment behavior show (Macintosh (1985)): - experts tend to be surprisingly unreliable ;

21 - individual experts tend to be consistent in their judgment over time ; - the degree of consensus among experts tends to be low; - more information after a point does not improve expert judgment. Studies of "cognitive style"%how "individual differences influence the way managers gather, process and utilize information in making decisions ; or, to put it another way, individuals with different cognitive structures should prefer and work better with different types of accounting and information system." (Macintosh (1985)). A recently published book (Belkaoui (1989b)) provides an excellent overview and summary of the published research in the field. C. Information Economics Information Economics treats information like any other economic commodity for which there is a demand. Information Economics in the accounting context has been developed by Demski and Feltham, who produced a systematic cost benefit analysis for the evaluation of information and measurement alternatives. "The information-economics approach attempts to measure the demand for information, a demand based on the value of the information and the cost of supplying it, including the perhaps higher cost for more accurate or more timely information." (Kaplan and Atkinson (1989)). The accountant is the constructor, who has to take the utility of the manager into consideration. For an excellent discussion of the early developments of information economics for management accounting see also Mattessich (1980). D. Agency theory The Agency Theory approach goes back to basic concepts presented by Jensen and Meckling (1976). Agency theory studies the contractual relationship between two parties : the principal, who has a property ; and the agent, whom he hires to manage it. The principal delegates some decision making authority to the agent. The role of the principal could be imputed to the owners, shareholders, superiors or insurers of an agent. The agent may be the manager, the department head, subordinate or the insured of the principal. Accordingly, the owners or shareholders can be viewed as the principal hiring the top-manager to be their agent in managing the firm ; or the top-manager may be

22 viewed as the principal hiring the department head as his agent in managing the department. Principals and agents act in their self-interest and try to maximize their profit andlor utility. It is assumed that the principal and the agent care about financial compensation and wealth, and the agent values prerequisites such as attractive working conditions and flexibility in hours worked. Because agents are thought to be lazy and more risk averse than the principal, they require monitoring and incentives to minimize these differences. Other assumptions deal with the existence of differences in the principal's and the agent's risk attitudes and their private information about the environment. Shareholders could simply tell managers to implement an optimal solution of a problem if they knew what the optimal action was and if monitoring the action were costless. Because the principal has limited information about the best action (the agent knows more about the environment) and the observability of the agent's action is limited and costly, owners give managers an incentive to take actions that are in the best interest of the shareholders. That is the contractual relationship. Agency theory focuses on the design of performance measures and rewards that will induce subordinates to act in the interests of the whole organization. The relationships and variables in the contract are expressed mathematically : "The appropriate form of this contract is said to be governed by the interaction of several variables, and these relationships are expressed in a mathematical model." (Anthony (1989)). "This analysis requires a formal specification of the economic agent's preferences and risk attitudes (as modeled by a utility function of wealth) and beliefs (as modeled by the agent's subjective probability distributions for random outcomes) as well as possible states of the world, actions and outcome functions." (Kaplan and Atkinson (1982)). Some view the agency theory as a natural extension of information economics. Information systems and signals play a key role in agency theory. Major research efforts have been based on this theory, and the enthusiasm with which many researchers continue to embrace it shows no signs of abatement. Horngren (1989) thinks that agency theory has reinforced the realworld phenomenon that different levels of managers bear different risks, that subordinates tend to be risk averse, and that different sets

23 of information are processed by various levels of managers. Many agency researchers believe that the design of management control systems is largely a problem of evaluating performance and using rewards so that risks are shared among managers and owners in the optimal way. Horngren also has his doubts concerning the realism of current agency theory models. He considers agency theory as an excellent conceptual framework but states, "One big challenge is to move from the simplified settings of agency theory to the complicated settings of real organizations." (Horngren (1989)). Much needs to be done before any practical results can be expected. Agency theory also has its detractors. The theory has its roots in neoclassical economics, inspired by Coase (1937), who saw the transaction as the analytical starting point instead of the marliet and the firm. "Indeed, in agency theory the firm can effectively disappear as a meaningful aspect of the analysis. Instead, the contractual relationship between parties takes its place, and the firm is reduced to the status of a phantom." (Puxty (1985)). Other critics has been more concerned about the theory's lack of realism. It is more rational than reasonable : "More importantly, I see no way that the relationship between managers and subordinates can be stated realistically in a mathematical model. In the real world, the relationship depends on human personalities and how human beings react to various incentives." (Anthony (1989)). "The aversion to work may not be a realistic assumption for senior members of organization. Usually these people have risen in the organization because of their demonstrated skills and their willingness to put extra effort into their work..." (Kaplan and Atkinson (1989)). "In spite of a great deal of published research, to date agency theory models have been so simplified that we do not see any practical use of them. However, some of the concepts may eventually lead to improvements in the real world management control systems." (Anthony, Dearden and Bedford (1989)). We would also claim that agency theory is in contradiction with the JIT philosophy, which stresses cooperation among workers and assesses an atmosphere of confidence and trust. Reduction of hierarchical levels under JIT not only reduces the number of supervisors, but also greatly diminishes their influence.

24 In a recent paper Baiman, a wellknown advocate of agency theory, surveys the recently published agency research rela-ted to manageria! accounting. In it he distinguishes three branches : The principal-agent literature (largely identical with what was discussed above), the transaction cost literature and what he calls the Rochester literature. The interested reader is referred to the Baiman paper which includes an excellent critical analysis of the agency theory literature and the theory's potential for future contributions to management accounting theory and practice. APPENDIX ACTIVITY COSTING - EXAMPLE (Cooper (1988)) The following information is available for costing the four products made in ARTWELL CO's factory. The four products differ in volume and size. P1 and P3 are low volume products. One of which is small and the other large, P2 and P4 are high volume products, again one is small and the other large. All products are manufactured on the same equipment by similarly processes. The total conversion cost (overhead and direct labor ) for all products is 10,000. ACTIVITY AND COST DRIVER INFORMATION : Number Direct Material Machine Number Number Product of Units Labor Cost Hours of of part No. Produced Hours per Unit Setups Numbers P P P P P 8 P 4 Conversion cost of 2,500 3,300 2,200 2,000 cost drivers CONVENTIONAL PRODUCT COSTING : Number Direct Material Total Product of Units Labor Cost Cost by Cost per No. Produced Hours per Unit Product Unit P l " 28.73" P , P P , ,640 Conversion cost pr. direct labor hour: 10,000/220 = $ a : (10 X 6) + (5 X 45.46) = b : 287,3110 = 28.73