History of Management Accounting: 150 Years of Evolution

Introduction: The Role of Management Accounting in History

This paper examines the role of management accounting over the years as a system for determining an organization's performance and profitability. It further analyzes the evolution of certain management accounting practices and their role in global competition and productivity. As Johnson and Kaplan observe, today's management accounting information — driven by procedures and the cycle of the organization's financial reporting system — is too late, too aggregated, and too distorted to be relevant for managers' planning and control decisions.

In attempting to understand the genesis and scope of modern cost and management accounting systems, accounting historians adopting what has been labeled a "Foucauldian" approach have been rewriting the history of key 18th- and 19th-century developments in the United Kingdom and the United States in three ways: through new evidence, new interpretation, and a refocusing of attention on familiar events whose significance has become obscured. According to K.W. Hoskin and R.H. Macve, "this new history is a 'disciplinary' history: the historical discontinuity between early attempts at costing and what may be seen as the modern managerial approach to, and a key source of the modern power of, accounting occurs when the focus shifts to applying expert knowledge to the construction of a new 'human accountability.' Accounting thereby shifts from objects and machines to men and new conceptions and writings of the organization of men and material."

Accounting is actually part of ancient history, with some modern methodologies based on accounting practices that are 10,000 years old. In the early days of civilization, with the formation of towns and villages, scribes developed record-keeping systems to track wealth, trade, and land usage fees. These early ancestors set the stage for what would become crucial skills and fundamental processes for management accounting in the 21st century.

Early accountants invented writing, developed money and banking, and innovated the double-entry bookkeeping system that fueled the Italian Renaissance. They were essential to the Industrial Revolution's inventors and helped develop the capital markets necessary for capitalism. Today, accountants are indispensable to the information revolution that is transforming the global economy.

Everyone from key corporate executives to Fortune 500 companies depends on financial reports to understand current business performance and predict the future potential of their organizations. That is where management accounting becomes important. Looking back in history, one can easily see how business practices and management accounting overlapped — for example, in the emergence of monopolies and billion-dollar companies, all of which depended on accounting information to shape their futures. The real users of management accounting information are internal users: the people who manage the business.

To understand the true value of management accounting, one must consider the importance that accounting has played throughout history. In some ways, accounting has not changed fundamentally since Luca Pacioli wrote the first textbook in 1494. On the other hand, accounting has helped lead the information revolution. Understanding the role of financial information today, as part of management accounting, requires an understanding of the past. It is the survival of firms that demands innovative accounting and accurate, useful information for management decisions.

Management accounting is essentially the branch of accounting that focuses on providing useful financial information for internal business decision-makers, generally senior executive management. Creditors and investors are not concerned with the same kind of information as managers. Managers use accounting information for three broad purposes:

To determine the cost of products and services. A company must know the cost of each product it produces and each service it provides. Companies need this information for planning and controlling business operations and for external reporting.

To plan and control business operations. This includes evaluating the performance of people and activities.

To report to external parties the company's financial position and results of operations.

Product Costing: From Ancient Practices to Modern Systems

In Relevance Lost, Johnson and Kaplan argue that "the management accounting system fails to provide accurate product costs. Costs are distributed to products by simplistic and arbitrary measures, usually direct-labor based, that do not represent the demands made by each product on the firm's resources."

Product costing is based on a fundamental accounting practice that dates back to ancient times. Yet, as Johnson and Kaplan suggest, many modern scholars feel there is need for improvement in the system. As Hsihui Chang has noted, "the case for improvements in the design of product costing systems is often motivated by appealing to the potential impact of costs on pricing decisions. However, there has been scant, if any, empirical evidence on whether, and to what extent, cost influences prices, and whether full as opposed to variable costs are associated with prices."

Companies have always needed information on the costs of their products and some form of measurability to estimate cost of goods and pricing policy. The renowned Code of Hammurabi, handed down during the first dynasty of Babylonia (2285–2242 BC), for example, required that an agent selling goods for a merchant give the merchant a price quotation under seal or face invalidation.

Product costs refer to the costs of producing products that will be sold. These costs include any labor, materials, overhead, and other costs associated with a product throughout the value chain. The value chain represents those additional activities that add value to the product or service.

Investment Analysis and the Rise of Big Business

Understanding financial information gives senior managers the ability to consider both short-term and long-term goals based on known expenditures and available funding for investments. Cash flow information has always been a key consideration for investment analysis.

Consider the early railroad industry and how it was tied into the Industrial Revolution and the development of capital markets to finance large business enterprises. The business people organizing the first railroads were ambitious thinkers, planning the use of technology that did not yet exist. Capital markets were expanded and new conceptual arrangements invented to finance railroad construction and operations. The businessmen of this era were out-of-the-box thinkers who initiated a logical plan of investment analysis. They had a vision and realized that the future of transportation — and specifically, the railroad — held great financial rewards.

Investment analysis also played a significant role for the inventors and entrepreneurs of the Industrial Revolution. The first massive monopoly was Standard Oil, organized as a holding company in 1870. Speculation and market manipulation became part of the big-business story.

It is clear that wise investing shaped the early rise of big business. Investment analysis continues to play a dominant part in management accounting. According to Gunther Friedl, "real-world investment decisions are generally made sequentially over time. The possibility of subsequent decisions — like suspending a project — must be considered when an initial investment decision is made. The impact of lags between an initial investment decision and the completion of a project based on the value of an investment have important implications for management accounting, such as the relationship between short-term production and long-term investment decisions."

Cash flow information, net income, and other financial statement data have always been critical to investment and credit analysis. To truly understand a company's overall cash and investment position, managers must have complete and accurate operational information.

Managers under pressure to meet short-term profit goals can, on occasion, achieve these goals by reducing their expenditures on discretionary investments. Thus, short-term profit pressures can lead to a decrease in long-term investment.

The massive market failure of 1929 and the Great Depression that followed illustrated how accounting practices and investment analysis could create both successes and failures for that era's visionaries. British and American cost accountants developed calculations and reporting techniques that allowed corporate executives to control vast business empires from headquarters. Part of this process involved buying out or destroying competitors.

Even now, businesses use investment analysis to determine their financial position when raising capital, funding growth, or acquiring a competitor. This information also allows investors to evaluate management's decisions, assess the company's ability to pay creditors and stockholders, and identify cash flow for future endeavors.

Conclusion: Management Accounting in a Global Economy

Throughout history, the management accounting system has played an integral role in achieving competitive advantage in the marketplace. After all, a company is only as good as the information it works with, and in today's business environment, information can be leveraged as part of a company's strategic plan.

Management accounting will continue to evolve as business becomes more complex, more global, and requires alternative strategies to remain successful. It remains clear that throughout history the value of management accounting has often been overshadowed by financial accounting. Recognizing that management accounting is not a static discipline will highlight the advantages that functional and activity-based concepts can bring to accounting applications.