ACCA - P5 Study text - Emile Woolf INT - 2010
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Chapter 10: Changes in business structure and management accounting
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New institutional theory and management accounting
Comparison of institutional theory and contingency theory
The nature of new institutional theory
New institutional theory and changes in management accounting practice
Criticisms of new institutional theory
2 New institutional theory and management accounting
2.1 Comparison of institutional theory and contingency theory
An institution, for the purpose of institutional theory, is something that gives
stability and meaning to social behaviour. It is an established way of behaving and
thinking. ‘Institution’ therefore has a meaning that relates to ‘something becoming
an established institution’ or ‘something becoming institutionalised’.
Contingency theory, as applied to management accounting, is based on the view
that the most effective or appropriate management accounting system depends
on the circumstances of the organisation.
Institutional theory, as applied to management accounting, takes a different
view. It starts by asking why so many organisations are similar in the way that
they structure their accounting systems, and the methods that they use.
Institutional theory also considers how systems might change as well as new
ways of doing things might become institutionalised. This might be relevant to
changes in management accounting systems.
2.2 The nature of new institutional theory
New institutional theory is an approach to the study of behaviour in organisations.
The theory is based on the view that the attitudes, habits and established views
within an organisation are influenced by its ‘institutional environment’.
Established rules, beliefs and practices within an organisation are formulated by
adopting the rules, beliefs and practices within other organisations. The way that an
organisation operates is therefore decided not so much by what is best for the
organisation, but by how things are done generally in all other similar
organisations. Institutional theorists promote the concepts of ‘isomorphism’
whereby organisations become similar to others in the industry and
institutionalised; they emerge as a common framework within the same field. These
accepted norms have found their way into modern management thinking.
New institutional theory has been described as follows: ‘People live in a socially
constructed world that is filled with taken-for-granted meanings and rules. Much of
their action is neither intentional nor conscious, for it is undertaken unconsciously
and as a matter of routine (Carruthers, 1995).
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DiMaggio and Powell are two leading exponents of new institutional theory. They
suggested that organisations operating in similar environments are subject to the
influence of established views about what is generally regarded as ‘acceptable’
behaviour’. As a result, all these organisations tend to have similar structures and
processes. Quitesimply,thetheoryisthatallorganisationsbecomeinstitutionalised.
They adopt the common practices of other organisations in the industry, and the
sameattitudes.
This institutionalisation extends to management accounting systems, as well as to
other aspects of organisational behaviour. Thisiswhyitisusualtofindthatcertain
management accounting methods are used in particular industries and not in
others. The
re is a tendency for all organisations to use the same management
accounting techniques because they are generally established and widely accepted,
not because they are techniques that are necessarily useful and relevant to the
organisation itself.
Powell and diMaggio identified three factors that make organisations copy the
practices and processes of other organisations:
pressures imposed on organisations to behave in a particular way by
government, regulations and possibly by supplier relationships
attitudes that are adopted when an organisation faces uncertainty and, in
response to this uncertainty, it copies the practices of another organisation that it
considers to be more successful or ‘legitimate’
attitudes of professionalism and the view that it is necessary to conform to a set
of norms or rules developed by a professional body or group. Management
accountants, for example, tend to conform to practices established by their
professional bodies.
2.3 New institutional theory and changes in management accounting
practice
A theory about changes in management accounting systems and practice is as
follows.
Accounting is a social and institutional practice that inter-reacts with social relations
within an organisation. When social relations within an organisation change,
accounting systems will also change. For example, consider a situation in which a
large company acquires control over a new subsidiary.
The board of directors of the company will require information about the new
subsidiary in order to monitor its performance.
To meet the requirements of the new owner, practices and procedures in the
subsidiary will change. The management accounting reporting system will also
have to change, in response to the changes in practices and procedures.
New accounting practices will be introduced.
The new accounting procedures and practices will then be reproduced by other
individuals who are responsible for introducing the new reporting system.
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The new accounting practices might gain widespread acceptance, so that they
come to be regarded as essential. In other words, they become institutionalised
within the organisation.
This view perceives organisations needing legitimacy to survive. The organisation
then adopts structures, job roles and policies e.g. Health and Safety, Equal
Opportunities to appease outsiders. Unfortunately for the firm these do not increase
efficiency or profitability.
2.4 Criticisms of new institutional theory
There are some criticisms of new institutional theory, as a method of explaining
behaviour and processes within organisations.
It ignores the fact that behaviour within an organisation may be decided by the
interests and views of powerful individuals or groups, rather than by generally-
accepted practice. Practices may become established because they are actually
appropriate for the requirements of the organisation rather than because they
are generally-accepted and widely-used.
The theory does not satisfactorily explain how change occurs in established
practices and views. It is more concerned with how practices become established
than with how they change.
However, institutional theory might help to explain why some organisations use
management accounting techniques and reporting systems that are not actually the
most appropriate for the information requirements of the organisation’s managers.
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The relevance of traditional management accounting systems:
‘relevance lost’
The purpose of management accounting systems
Are traditional management accounting methods still relevant?
Kaplan: ‘relevance lost’
Making management accounting relevant
Trends in management accounting
3 The relevance of traditional management accounting
systems: ‘relevance lost’
3.1 The purpose of management accounting systems
A management accounting system is a part of the management information system
within an organisation. The purpose of management accounting is to provide
information to managers that can be used to help them with making decisions.
Traditionally, management accounting systems have provided financial or
accounting information, obtained from accounting records and other data within
the organisation. Commonly-used management accounting techniques have
included absorption costing, marginal costing and cost-volume-profit analysis,
budgeting, standard costing and budgetary control and variance analysis.
For various reasons, questions have been raised about the relevance of traditional
management accounting to the needs of management in the modern business
environment.
Traditional management accounting techniques such as standard costing and
variance analysis do not provide all the information that managers need in
manufacturing companies where Total Quality Management or Just in Time
management approaches are used.
Traditional absorption costing is probably of limited value in a manufacturing
environment where production processes are highly automated, and production
overhead costs is a much more significant element of cost than direct labour.
Traditional management accounting focuses on manufacturing costs, whereas
many companies (and other organisations) operate in service industries and
provide services rather than manufactured products.
The traditional focus of management accounting has been on cost control or cost
reduction. Lower costs mean that lower prices can be charged to customers, or
higher profits can be made. However, many companies now seek to increase
customer satisfaction and meet customer needs. To meet customer needs, other
factors in addition to cost can be important – particularly product (or service)
quality. Traditional management accounting ignores factors such as quality,
reliability or speed of service.
Many traditional management accounting techniques have a short-term focus.
There are exceptions. Discounted cash flow, for example, is used to evaluate
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long-term capital projects. However, traditional management accounting
systems do not provide senior managers with the information they need for
making strategy decisions. Strategic decision-making needs information about
competitors, customers, developments in technology and other environmental
(external) factors.
Management information systems should be capable of providing the information
that managers need. For the management accounting system to be the main
management information system within an organisation, it must be able to provide
the necessary variety of information – financial and non-financial, long-term as well
as short-term – using suitable techniques of analysis.
3.2 Are traditional management accounting methods still relevant?
Many businesses compete with each other on the basis of:
product or service quality and price
delivery
reliability
after-sales service
customer satisfaction – meeting customer needs.
These are critical variables in competitive markets and industries. Business
organisations, faced with an increasingly competitive global market environment,
must be able to deliver what the customer wants more successfully than their rivals.
This means making sure that they provide quality for the price, and customer
satisfaction, including the delivery, reliability and after-sales service that customers
want or expect.
3.3 Kaplan: ‘relevance lost’
Some years ago, Robert Kaplan put forward an argument that management
accounting systems had lost their relevance and did not provide the information
that managers need to make their decisions.
When these ideas were first published, they were ground‐breaking because they
challengedthevalueand‘relevance ’ofmanagementaccountingmethodsthatwere
inwidespreaduseatthetime.
He suggested that the information needs of management had changed, but the
information provided by management accountants had not.There was a danger
thatm
anagementaccountingwouldloseitsrelevance–andvalue–entirely.
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Kaplan made the following criticisms of traditional management accounting
systems:
Traditional overhead costing systems, where overheads were absorbed into costs
at a rate per direct labour hour, were irrelevant. (Activity based costing has been
developed as just one alternative for overhead cost analysis.)
Standard costing systems are largely irrelevant, because in many markets
customers do not want to buy standard products. They want product
differentiation.
Traditional management accounting systems fail to provide information about
aspects of performance that matter – product and service quality (and price),
delivery, reliability, after-sales service and customer satisfaction.
He argued that in today’s competitive market environment ‘traditional cost
accounting systems based on an assumption of long production runs of a standard
product, with unchanging characteristics and specifications, [are not] relevant in
this new environment.’
The need for a change of focus in providing information to management
Traditional management accounting systems focus on reducing costs and budgetary
control of costs. Kaplan argued that the focus was wrong:
In modern production systems, products are often designed and manufactured
to specific customer demands and often have a short life cycle. Their design is
often sophisticated, and they are overhead-intensive. Traditional management
accounting systems, in contrast, assume standard products whose manufacture
is directly labour-intensive.
Machinery used in production is often flexible, and can be switched between
different uses and purposes. Traditional manufacturing systems assume that
standard tasks require particular types of machine. Although they may focus on
minimising the machine time per product manufactured, these systems do not
provide information to help with optimising the use of available multi-purpose
machinery.
3.4 Making management accounting relevant
If it is accepted that traditional management accounting systems are no longer
relevant to the information needs of managers in a competitive business world, the
obvious next question is what has to be done to make them relevant?
The suggested answer is that management accounting systems need to recognise the
factors that are critical for business success, and that management need to know
about. These factors may be:
non-financial, as well as financial
longer-term (strategic) in nature, as well as short-term
strategic (concerned with objectives and strategies), as well as tactical (concerned
with day-to-day management control)
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related to factors in the business environment as well as to factors within the
business entity itself (in other words, making use of external as well as internal
information).
3.5 Trends in management accounting
New techniques have been developed in management accounting, in response to
changes in the business environment. Examples of techniques that have been
developed include activity based costing and activity based management, backflush
accounting, throughput accounting, target costing, life cycle costing, environmental
management accounting and the balanced scorecard approach to performance
measurement.
Some of these techniques have been developed in response to changes in
manufacturing methods and systems.
Evaluating a management accounting technique
If the contingency theory of management accounting is valid, it should be expected
that the management accounting techniques used in practice will vary with the
particular information needs of the organisation.
For your examination, you may be required to give your views about whether a
particular management accounting technique is appropriate for the specific
requirements of a particular organisation.
The management accounting techniques used within an organisation must provide
information that management need and will use. The key questions to ask, when
assessing the usefulness of a management accounting system, are as follows:
The information needs of management
What decisions do managers need to make?
What are they key factors that will affect their decisions?
What are the critical items of information they need for their decisions?
The information provided by the management accounting system
Is the information provided:
- relevant to the decision-making needs of the managers?
- sufficiently comprehensive for these needs?
- reliable?
- available when needed?
Is the information provided in a clear and understandable form?
Are key items of information drawn to the attention of the manager, such as
issues relating to controllability, trend or materiality?
Does the benefit of having the information justify the cost of providing it?
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The relevance of standard costing and variance analysis
Problems with standard costing and variances
The continuing relevance of standard costing systems
4 The relevance of standard costing and variance
analysis
4.1 Problems with standard costing and variances
Writers such as Kaplan and Johnson have argued that standard costing and
standard cost variances should not be used in a modern manufacturing
environment for either:
cost control, or
performance measurement.
They argue that standard costs are no longer relevant in a modern manufacturing
environment. Standard costing is used for standard products and the focus is on
keeping production costs under control.
Kaplan and Johnson argued that using variance analysis to control costs and
measure performance is inconsistent with a focus on the objectives of quality,
time and innovation, which are now key factors in successful manufacturing
operations.
Standard cost variances ignore quality issues and ignore quality costs. However,
in a competitive market quality is a key success factor.
Manufacturing companies might have a system of Total Quality Management
(TQM) in place, or something similar. An aim of TQM is to continue to find
ways of achieving quality improvements, including cost reductions. With
continuous improvement, there should be continual (small) reductions in costs.
Standard costs – which are a fixed cost per unit – are inconsistent with the TQM
objective of continuous improvement and cost reductions.
Another aim of the TQM approach is to eliminate waste from operations. Kaplan
and Johnson argued that achieving standard costs is inconsistent with this TQM
objective of eliminating waste. If waste is gradually eliminated, there should be
continual reductions in costs.
When a company relies for success on innovation and new product design,
many of its resources are committed to product design and development, and so
many of its costs are incurred at this early stage of the product’s life. Cost control
should therefore focus on design and development costs, whereas standard
costing provides information about production costs for products that have
already been developed and are now in production.
When product design and innovation are important, product life cycles will be
short. It may therefore be appropriate to look at all the costs of a product over its
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full life cycle (including its design and development stages, and including
marketing costs as well as production costs).
Standard costing variance analysis is restricted to monitoring the manufacturing
costs of products during just a part of their life cycle.
Standard costs are only likely to apply in a stable and non-changing business
environment. In many industries, the environment is continually changing, and
products are adapted to meet the changing circumstances and conditions.
4.2 The continuing relevance of standard costing systems
However, there are still some advantages to be obtained from using a standard
costing system.
Standard costs can be a useful aid for budgeting even in a Total Quality
Management environment. Standard costs can be established for making
products within the budget period to a target level of quality. If the TQM goals
of continuous improvement and elimination of waste are achieved, the standard
costs can be adjusted down for the next budget period.
Managers need short-term (‘real time’) feedback on costs. They need to know
whether costs are under control, and they also need to understand the financial
consequences of their decisions and actions. Variance analysis is a useful method
of providing ‘real time’ feedback on costs.
Cost control is still an important aspect of management control. Quality, time
and innovation may be critical factors, but so too is cost control. Standard
costing and variance analysis provides a system for controlling costs in the short
term.
Standard costs for existing products can provide a useful starting point for
planning the cost for new products.
Standard costs can also be useful for target costing. The difference between the
target cost for a product and its current standard cost is a ‘cost gap’. Standard
costs can be used to measure the size of the cost gap. In order to achieve the
target cost, managers can focus on this cost gap and consider ways in which it
can be closed.
Overhead variances can provide useful information for cost control when many
overhead costs are volume-driven.
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Activity based management (ABM)
Changes in business structure
The features of activity based management (ABM)
Adopting ABM
ABM: value-added activities and non-value added activities
Uses of ABM
5 Activity based management (ABM)
5.1 Changes in business structure
Many entities operate in a rapidly-changing business environment. In response to
the changes in their environment, they undergo changes themselves. Changes in
business structures and processes are necessary in order to remain competitive.
When business circumstances change significantly, it might be necessary to make
big changes to organisation structures and processes.
Two techniques for introducing changes in business organisations are:
Activity based management (ABM), and
Business process re-engineering (BPR).
For each of these methods of managing change, information is needed to assist
management. Much of this information should be provided by the management
accounting system.
5.2 The features of activity based management (ABM)
In the past thirty years or so, there have been developments in management
approaches to the re-design of activities, in order to improve the efficiency and
effectiveness of activities and to reduce costs. The growing interest in activity
management was due largely to the increase in overhead costs relative to other costs
in an organisation. The ‘traditional’ focus of manufacturing companies on the
control of direct costs was inadequate for controlling the much more significant
costs of overhead activities.
Definitions
Activity based management (ABM) is the process of '... focusing on the management
of activities to improve the value received by the customer and the profit achieved
by providing this value' (CAM-I Glossary of Activity Based Management).
Activity based management (ABM) is ‘the management processes that use the
information provided by an activity-based cost analysis to improve organisational
profitability. [ABM] includes performing activities more efficiently, eliminating the
need to perform … activities that do not add value for customers, improving the