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Tijdschrift voor Economie en Management

Vol.

XXXVI, 3,

1991

Management ccounting

and Control Systems

by H.P. HOLZER4' and H. NORREKLIT' '

I. INTRODUCTION

Management accounting in the US and elsewhere has recently recei-

ved more publicity than usual. Outdated management accounting sys-

tems were found to produce misleading cost numbers and performan-

ce measures. Radical changes in manufacturing technology and phi-

losophy, 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 en-

vironment.

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

2

years. The need for cost accounting and tools for planning, coor-

dinating, 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.

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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 bet-

ween 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 in-

ventories, are viewed as a liability that should be minimized as much

as possible. In addition to lower inventories, the advantages of ap-

plying the JIT philosophy to a manufacturing process include reduc-

tion 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 vie-

wed as a company-wide continuous effort to improve productivity and

quality, not limited to the factory.

B

dvanced 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 compu-

terized methods for coordinating detailed production plans in multi-

stage 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 sys-

tems, the time of production is determined by a production schedule,

and in that sense it can also be viewed as a push system. MRP sys-

tems have been widely used, although there are far fewer applications

of MRP 11.

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Soon after the introduction of computerized MRP systems in ma-

nufacturing, use of the computer in the design of products (Computer

Assisted Design--CAD) and in the engineering of production proces-

ses (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. Com-

bining or closely linking the two functions permits simulation of pro-

cess 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 ma-

nufacturing 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 diffe-

rent jobs, and because they can switch from one job to another in a

very short time, they significantly reduce setup costs. Other advan-

tages are improved quality and reduction in direct labor hours.

C. lexible

anufacturing

Systems

Flexible Manufacturing Systems comprise all the techniques that fa-

cilitate flexibility by reduction of setup time in order to reduce inven-

tories. Three techniques are usually discussed under this heading

Just in Time (JIT), Islands of Automation (IA) and Computer Inte-

grated 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, ap-

plies 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

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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 ul-

timate form, CIM will provide computerized links from product de-

sign, to production engineering, to the actual manufacture of a pro-

duct. 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 organi-

zation 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 delive-

ries with an ideal of zero defectives.

AT

must also aim at improving customer service through signifi-

cantly 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 pro-

duct'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 phy-

sical exhaustion.

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FIGUR

Conseq~ler~cesf Developments Man ~~fnctz~rirzg

Features

Functions

Process

Facilities

Hardware

Control

Product

esign

Financial

Control

Tradit ional

Manufacturing

Many Dedicated Machi-

nes

Multiple Setups

Large Warehouses

Lal-ge W P Areas

Mainframe

Mini

MicroIPC

Constant Demand Fluc-

tuation

Frequent Rescheduling

Many Engineering Chan-

ges

Weekly Planning

Long Lead Times

Large Lot Sizes

Vendor Difficulties

Life Cycle Declining

Many Engineering Chan-

ges

Many Complex

Cornpo-

nents

Quality Improvement

over Cycle

Infinite Options

Labor Efficiency

Little Emphasis on

Investment

Shop O rientation

Focus on Variable Cost

overhead Spreading

Cost Measurement

Functional Interfaces

Long Lead Times

Hierarchical

Modern Advanced

Technology

Flexible Machine Centers

Zero Setups

No

W are l~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

Vendor Synergies

Life Cycle Much Shorter

Few Engineering Change

Few Complex Compo-

nents

Zero Defects

Limited Options

Product Profitability

Full Stream

Investment Intensive

Product Cost is Incurred

Minimum Variable Cost

Beyond Material

Zero Direct Labor

Cost Flexibility De-

pendability and

Quality Measures

Product Teams

Flexible and Rapid

Decision Making

Fewer Levels

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FIGURE

2

L Cyc e TT, Crrrh F ~ O K Irid Matched

Co.~t

Berliner and Brimson

1988)).

Changes in cost functions as we move from traditional to AT ma-

nufacturing 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 la-

bor has been widely used as one of the bases for the allocation of over-

head 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 re-

placement 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. Ow-

ning and operating

AT

facilities therefore leaves us only with mate-

rials 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 evalua-

tion.

F.

Product Costing

The change from direct to indirect and variable to fixed costs indi-

cates that many traditional costing systems may be producing cost

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FIGURE

Clzangng Cost ehavior Patterns

W

V

TECHNOLOGY

I

K

Q

ISLANDS OF

AUTOMATION MFG

numbers that are misleading if used for decision making. Many sys-

tems 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 evalua-

tion. 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.

n multi-product situations in AT en-

vironments, 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 A c t iv i t y B a s e d C o s t i n g A B C )

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.

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The initial focus of ABC is on the activities performed to produce

a product. Costs of these activities are identified and traced via a so-

called 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 activi-

ties 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 in-

dustries 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 inter-

nally 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 dis-

tortion 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 manufac-

turing 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 pro-

ducts 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 pro-

duct 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. simple example in the

appendix illustrates activity costing and shows the distortions in re-

ported 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-

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tems have become obsolete include the following

line managers lose faith in the cost figures produced by the cost sys-

tems 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 environ-

mental factors that affect cost functions and therefore lead to changes

in costing systems. Other external factors include increased compe-

tition brought about by the globalization of markets and domestic de-

regulation.

2 .

L i f e C y c l e C o s t i n g

Because of the shortened life cycle for many products, and the increa-

sed 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 mar-

keting 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 pro-

duct life cycle incorporates the types of activities that constitute a pro-

duct 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, pro-

gramming 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 con-

trolling product contribution margins during different stages. Espe-

cially

in

the early stages of product design and engineering, commit-

ments 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 pro-

duct (see Figure

2).

Cost and revenue factors will also determine the

length of a product s life cyclc.

G.

Strategic Cost

nalysis

Although Anthony 1965)), more than 25 years ago, clearly defined

and described management accounting s role in the strategic planning

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process, interest in the strategic aspects of management has recently

beer: rekindled, proba b1

fn

+b- * a ~ --e sons that led to the need

for changes in costing systems. Global competition and rapid tech-

nological 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. Ac-

cording 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 un-

derstanding not only of its own cost, but also of the costs of its sup-

pliers, 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 ac-

tivities 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 hain

(Porter

1985)).

FIRM INFRASTRUCTURE

HUM AN R E S O U R C ~MANAGE~ENT

I

l

TE~CHNOLOGYD EVELOPME~T

INBOUND OPERA TIONS 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

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H .

Capital Irlvestment nalysis

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 R 0 1 in th e short run , but a rise in long run. When

R 0 1 goals are important performance m easures, there are no short-

run incentives to invest in CIM and F M S :

R 0 1 time spans a re typically set at t hre e to five years. CIM pro-

jects usually take two to three years to implement, so positive cash

flows may be excluded fro m t he analysis. However, C IM benefits may

continu e for up to te n years. Time horizons of ten to twelve years are

required to compare C IM with long term alternatives. (Nobel

(1990)).

However, the long term consequences imply that payback is an

inappropriate judgment criterion. Instea d, expected net present value

should be us ed. I n this context, many writers question th e use of high

discount rates for this kind of investment analysis :

Hurd le rates for R 0 1 can be anywhere from

15-40

percent to al-

low for risk an d en sur e that investments yield a high return. However,

the real cost of capital is estimated to be a bout 8 percent. D ue to com-

pounding, hurdle rates severely discount benefits received in later

years. (N obel (1990)).

T h e discount factor should be th e 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 eq uity capital should be th e op portun ity cost of ca pital for the in-

vestors :

O n e can estim ate th e cost of eq uity capital in eithe r 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% an d ad d th e expected futu re inflation rate over the life of

the project. Eithe r m ethod is reasonable an d would be a dram atic im-

provement over the practice of some firms using rates in excess of

20%. (Icaplan an d Atkinson (1989)).

Discount factors should not be adjusted for risk, because the dis-

coun t rate usually uses a geom etrical compou nding, and t he risk effect

will also be trea ted as geometrical. Kaplan an d Atkinson (1989) claim

that riskiness of a project is considerably reduced after

a

high tech

project's early years. Instead of including risk in th e discount rate , he

suggests the use of sensitivity analysis.

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FIGUR 5

Valzle

dded

Activities

Value Added Activi t ies Center

Includes Direct

8c

All Support Activities

Rela ted to the Shop Area)

Value Added Activi t ies

Machine.

Fabricate,

Assemble.

Non value Added Activi t ies

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 un-

derstates the benefit from higher quality products and improved cus-

tomer satisfaction. These benefits are real and should be quantified.

The lost benefits of not investing must also be taken into considera-

tion 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 mar-

kets 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, ma-

terial 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 pro-

duct, storing it, and inspecting it see Figure

5 ) .

The goals of zero in-

ventory and total quality are mutually reinforcing. Elimination of in-

ventories is possible only when there are zero defects, because defects

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would cause inventories having no inventories to fall back on forces

you to do it right the first time. Performance measures should there-

fore 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 con-

trol) and observation of other non-financial variables.

Garrison

1991) distinguishes five areas for performance measu-

rement : quality control measures, material control measures, inven-

tory control measures, machine performance measurement, and de-

livery control measurement.

Quality control measurements include number of warranty claims,

number of customer complaints, number of defects, and cost of re-

work.

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 ma-

chine availability, percentage of machine downtime, setup time, ma-

chine stops, preventative maintenance, and use as a percentage of

availability.

Delivery performance measurements include

:

percentage of on-

time deliveries, delivery cycle time, throughput time or velocity, ma-

nufacturing 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 product s conception to the start of production.

percentage of product that meets target objectives after a given pe-

riod of production, average number of engineering change notices

in the initial period of production, average days to process an en-

gineering change notice from request to production implementation,

and so forth.

Product costing will be done outside the production cost control

system.

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IV. SCHOLARLY RESEARCH

In our discussion of scholarly research in management accounting we

will first describe the more practice oriented approach of mainly Har-

vard Scholars. We will then touch upon efforts dealing with the be-

havioral aspects of management accounting followed by some analy-

tical modelling approaches.

A. Management ontrol

Merchant s research follows the practice-oriented research of such

Harvard scholars as Anthony, Dearden and Vancil. In

ontrol in

Bu-

siness 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 ac-

cording to the object to be controlled, and distinguishes

:

result con-

trols, 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 rewar-

ding 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 lo-

wer levels result controls can be established through targets or stan-

dards. At that level it should be possible to control either sales or ex-

penses. 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 sepa-

ration of duties. Preaction reviews include an examination of work or

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plans with the individuals doing it before their work is done. Action

acceuntability requires defining what actions

re

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. Person-

nel controls work by encouraging and facilitating positive forces

through selection and placement, training, cultural control, group-

based 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 re-

sults 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 po-

sitive 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 pos-

sible 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

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(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 per-

sonal interviews with profit

center managers and corporate execu-

tives, of twelve companies over a number of years. The study com-

pared the ideal motivational contract for profit center managers de-

veloped by the author with the actual contracts in use in the compa-

nies 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 contri-

butions to results 3. the desirability of using some motivational con-

tract 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 desig-

ners 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 mea-

sures that consist exclusively of factors controllable by the profit cen-

ter manager. Accounting and other performance measures are usually

distorted by non-controllable factors and contract designers will en-

deavor to neutralize or minimize them.

Constraint reflects the fact that there are contract elements that

have little to do with motivation but serve other organizational pur-

poses such as retention of qualified managers or corporate risk re-

duction.

The author tabulates and analyzes his findings within this con-

straintsltrade-off framework. This work is an important contribution

to the managenlent accounting literature and an important step to-

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ward a comprehensive management control theory that is based on

pr ,p'r;,alr findings.

B . Behaviol a1 Accountirzg and hz fo m at io rz Processing

Behavioral accounting research accounts for a major part of current

academic research in management accounting. Behavioral accoun-

ting concerns itself with human behavior as it relates to accounting

information problems. Its basic objective is to explain and predict hu-

man 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 for-

ces within the organization. We will briefly mention only the approa-

ches, which are most widely discussed in the literature.

1. C o n t i n g e n c y t h e o r y

Contingency theoiy assumes that there is a match between the design

of various components in accounting systems and specific contingen-

cies. Contingency theoretical studies have investigated how techno-

logy, organization structure, competitive environment, and other va-

riables 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 effecti-

veness of the relationship between contingency variables and accoun-

ting systems.

2

S l a c k

Slack concerns the excess resources that can be accumulated from su-

perior 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 or-

ganizations. 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

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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

P a r t i c i p a t i v e B u d g e t i n g

Empirical research in psychology supports a hypothesis that specific

hard goals produce better performance then medium, easy, do-your-

best, or no goals (Locke, Shaw, Saari and Latham (1981)). Other fac-

tors that influence the effects of goal setting are direction, efforts,

persistence, strategy, feedback on progress, rewards given for goal at-

tainment, 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 impro-

ves 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 per-

formance. Moderating effects on the participation effect are motiva-

tion, leadership style, task uncertainty, role ambiguity, reward struc-

ture, cognitive dissonance, authoritarianism, locus of control, and the

upward influence of a superior on his or her relationship with subor-

dinates.

Goal-setting research seeks additional variables that can mediate

the link between goal setting, participative budgeting, and task per-

formance. Research in this field continues. For an excellent discussion

and analysis of budgeting research see Birnberg, Shields and Young

(1990)~.

4 . H u m a n I n f o r m a t i o n P r o c e s s i n g

Accounting information is used for decision making. Human infor-

mation processing research tries to understand and improve the de-

cision process when it is based on accounting information. Psycholo-

gical accounting studies of professional experts' and managers' deci-

sion and judgment behavior show Macintosh (1985)):

experts tend to be surprisingly unreliable

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individual experts tend to b e consistent in their judgment over time ;

th

degree of consensus among experts tends to be low;

more information after a point does not improve expert judgment.

Stu dies of cognitive style %how individua l difference s influence

the way managers gather, process and utilize information in making

decisions

or, to put it another way, individuals with different cog-

nitive structures should prefer and work better with different types

of accounting and information system. (Macintosh (1985)). A re-

cently published book (Belkaoui (1989b)) provides an excellent over-

view 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

th e accounting context has been developed by Dem ski and Feltham ,

who prod uced a systematic cost benefit analysis for th e evaluation of

information and measurement alternatives.

The information-economics approach attempts to measure the

dem and for information, a dem and based on the value of the infor-

ma tion an d th e cost of supplying it, including th e perha ps higher cost

for m ore accurate or more timely information. (Kaplan and Atkinson

(1989)).

The accountant is the constructor, who has to take the utility of

th e mana ger into consideration. Fo r an excellent discussion of th e ear -

ly developments of information economics for management accoun-

ting see also Mattessich (1980).

D . Agency theory

T h e Agency Theory ap proach goes back to basic concepts presented

by Jensen and M eckling (1976). Agency theory studies the contrac tual

relationship between two parties

:

th e principal, who has a prop erty

an d th e agent, whom h e hires to m anage it. The principal delegates

som e decision making authority to th e agen t. Th e role of the principal

could be imputed to the owners, shareholders, superiors or insurers

of an agent. The agent may be th e manager, the departm ent head,

subo rdinate or the insu red of the principal. Accordingly, th e owners

or sh areh olders can be viewed as the principal hiring the top-manager

to be their a gent in managing the firm or the top-manager may be

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of information are processed by various levels of managers. Many

agency researchers believe that the design of management control sys-

tems is largely a problem of evaluating performance and using re-

wards so that risks are shared among managers and owners in the op-

timal way. Horngren also has his doubts concerning the realism of cur-

rent agency theory models. H e 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 be-

fore 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 trans-

action 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 relation-

ship 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 ma-

nagers and subordinates can be stated realistically in a mathematical

model. In the real world, the relationship depends on human perso-

nalities 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 or-

ganization 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 theo-

ry 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 asses-

ses 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.

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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 trans-

action 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 theo-

ry's potential for future contributions to management accounting

theory and practice.

PPENDIX

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 pro-

ducts. 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 1 10 5 6 5 1 1

P2

100 50 6 50 3 1

P3 10 15 18 15 1 1

P4 100 150 18 150 3 1

220 220 8 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 y Cost per

No. Produced Hours

per Unit Product

Unit

P 10 5

6 287

28.73

P2 100

50 6 2,873 28.73

P3 10

15 18

862 86.18

P4 100

150 18

8,618 86.18

220 12,640

Conversion cost pr. direct labor hour:

10,000/220 = $45.45455

a : (10 X 6)+ (5 X 45.46)= 287.3

b 287,3110= 28.73

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ANALYSIS OF COST DRIVERS (ACTIVITIES) FOR CONVERSION COSTS:

Number Direct Machine Number Number Total

PI-oduct of Units Labor Hours of of part Conversion

No.

Produced Hours Setups Numbers Cost

P1 10 5 5 1 1

P2

100 50 50 3 1

P3 10 15 15 1 1

P4 100

150 150

1

220 220 220 8 4

Conversion

Cost of 2,500 3,300 2,200 2,000 10,000

Cost-drivers

Cost pr.

Cost- driver 11.36 15.00 275.00 500.00

Unit

PRODUCT COST ANALYSIS WITH ACTIVITY COSTING

No. of Mate- Direct Cost of Setup Cost of Total Cost

Pro. Units rial Labor Machine Cost Part Cost per

No. Prod. Usage Nos Unit

P1 10 60.00 56.82 75.00 275.00 500.00 966.82 96.68

P2 100 600.00 568.18 750.00 825.00 500.00 3243.18 32.43

P3 10 180.00 170.45 225.00 275.00 500.00 1350.45 135.05

P4 100 1800.00 1704.55 2250.00 825.00 500.00 7079.55 70.80

220 2640.00 2500.00 3300.00 2200.00 2000.00 12640.00

COMPARISON OF UNIT COSTS CONVENTIONAL vs. ACTIVITY COSTING:

Conven- Activity Differences

tional

Costing Amount Percent

28.73 96.68 67.95 236.51

28.73 32.43 12.88

86.18 135.05 48.87 56.71

86.18 70.80 (15.38) (17.85 )

NOT S

1.

The figure is adapted from C.J. McNair a.o., p.24-25.

2. See also our discussion on the value chain.

3. For detailed discussion see : Prentice Hall Editorial Staff (1983).

4 The reader who is interested in an overview of this kind of research is referred to Belkaoui

(1989a) en Ferris (1988).

5. For some recent research in the contingency area

Macintosh

and Daft (1987), Rockness

and Shields (1988), Simons (1987). Earlier work includes Watterhouse and Tiessen

(1987), Gordon and Miller (1976), Burns and Stalker (1961) and Burns and Watterhouse

(1975).

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6. The concept of slack is discussed by many authors. The interested reader is referred to

Cyert and March

(1963), Lewin and Wolf (1976) pp. 648-654, Bourgeois (1981) pp.29-39,

Schiff and Lewin (1970) April pp.259-268 and (1968) May pp.51-62, Merchant (1985)

May pp.201-210 ad Belkaoui (1985) Fall.

7. Recent research in Budget~ng articipation is Aranya (1990), Fall pp. 67-77

;

Hirst (1987),

October pp 774-784, Brownell P. and M. McInnes (1986) October and Chenhall and

Brownell (1988) pp.225-233. Earlier research is Hofstede (1968) Argyris (1952) and Hop-

wood (1972).

8. Cognitive style determines the way each individual processes, tranforlns and restruc-

tures the stimulus information from the environment to shape the resulting behavioral

response. Macintosh (1985) p.87.

9. For in depth treatment of this approach refer to Demski (1980) and Magee (1986).

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