Managerial Accounting in Complex Organizations

Introduction to Managerial Accounting

Management accounting involves activities such as budgeting, costing, and much more, all focused on achieving organizational planning and control. Management accounting systems include both financial and non-financial measures that can assist organizations in achieving their goals through measures and reports that help evaluate and motivate managerial efforts to enhance quality and decision-making (Drury, 2005; Bhimani, 2006, p. 41). The information provided by managerial accounting systems includes budgets, performance reports, information regarding the costs of a company's products and services, and other reports such as data on sales backlogs, demands on capacity resources, unit quantities, and revenues from a company's products and services.

The basic difference between financial accounting and managerial accounting is that managerial accounting offers information to the key people responsible for controlling and directing operations within an organization, whereas financial accounting provides information to stockholders, creditors, and others outside the organization (Geense, n.d.).

The traditional approaches to management accounting have undergone significant changes in recent years, and most of the current debate concerns maintaining its relevance in steering a company toward achieving its overall mission in a resource-conscious manner. Experts have called for management accountants to adopt increasingly strategic types of cost analysis involving supplier- and customer-linked adjacencies in addition to internal processes and activities, and to place planning and control within the framework of the organization's value chain. Arguments put forward in favor of abandoning traditional budgeting have been contradicted by others who have demanded that traditional budgeting be rejuvenated by implementing continuous forecasting and performance evaluation regimes, and rolling budgets (Drury, 2005, p. 442; Bhimani, 2006, p. 42).

Limitations of Traditional Approaches

One component of management accounting that has not changed much in the last seventy years is the nature of cost allocation. Cost allocation comprises tracking and assigning costs to particular cost objects to aid internal reporting and support decision-making within the organization. The criterion for these allocations is generally a cause-and-effect relationship between variations in activity level and their associated costs (Riahi-Belkaoui, 2001, p. 2).

Considering the rapid changes taking place in business environments — including technological advances and globalization — organizations can no longer afford to remain fixed on traditional costing techniques. Every product has a life cycle, and costing techniques must incorporate a life-cycle costing approach to ensure that costs over the product's entire life cycle are taken into account (Drury, 2005, p. 447). Traditional managerial accounting systems were basically designed to gauge the efficacy of a firm's internal processes. However, several new approaches have emerged to produce more innovative methods. A standardized and highly structured cost accounting system may be considered ideal only for line-manufacturing or production industries, but the marketing and services industries — which require timely and flexible decision-making — need new accounting practices. Such innovative practices include bottleneck accounting, the balanced scorecard, and activity-based costing (Geense, n.d.; Lewis, 1995, p. 3).

Using direct labor as the basis for allocating factory overhead has been found to be unsuitable, since it reduces the share of overall manufacturing costs proportionally attributed to overhead-intensive activities. Direct labor is not always proportionate with output and accounts for a large percentage of overhead in comparison to other activity factors. As the ratio between machine hours and direct labor increases, fixed costs are not likely to disappear. Thus, activity-based costing removes the emphasis from raw materials or direct labor as cost drivers and shifts focus to activities as cost drivers. This gives key decision-makers a clear picture of the nature of cost drivers and the measures available to reduce such costs (Geense, n.d.; Lewis, 1995, p. 4).

Activity-Based Costing and Modern Costing Techniques

An activity-based costing system identifies the chief activities taking place in an organization and categorizes them into batch-level activities, unit-level activities, facility-sustaining level activities, and product-sustaining level activities. The basic aim of activity-based costing is to identify the causes behind the incurrence of indirect activity costs in an organization and their connection with the production of particular products. The diversity of cost drivers that an organization can choose from gives this technique considerable flexibility (Geense, n.d.; Lewis, 1995, p. 7).

Other new costing techniques include target costing and lifetime costing (Epstein, 2004, p. 290). Target costing is a management accounting tool used to lower the life-cycle costs of new products. An assessment of revenues and costs throughout the life cycle of a product is called lifetime costing (Smith, 2005, p. 87). Together, these techniques reflect the broader shift toward costing approaches that account for value across the full lifespan of a product rather than focusing narrowly on production-period expenses.

Earlier, the chief performance report used by management accountants was variance analysis, which refers to the systematic approach to examining the difference between budgeted and actual expenditures and revenues within a particular production period. Many firms have now begun using new techniques such as the balanced scorecard in conjunction with variance analysis. A balanced scorecard can be defined as a group of operational and financial measures used to gauge a company's internal workings, improvement and innovative activities, and customer satisfaction. This performance measurement system can respond to the increasing complexity of a firm's activities and environment.

Balanced Scorecard and Performance Measurement

The balanced scorecard provides insight into the relationship between expected activities and expected financial outcomes through performance indicators and critical success factors, giving organizations the means to control performance. It combines many disparate perspectives into a single report. These perspectives may include improving quality, reducing response time, becoming more customer-centric, emphasizing teamwork, and so on (Drury, 2005, p. 451; Geense, n.d.; Epstein, 2004, p. 296).

The balanced scorecard combines both financial and non-financial measures to provide a balanced view of overall performance (Smith, 2005, p. 93). Using non-financial measures to gauge and improve a company's performance enhances the competitive position of the company. Targeting non-financial measures is more like keeping an eye on the ball — which is obviously more important — than keeping an eye solely on the scoreboard (Davis, Lukomnik, and Pitt-Watson, 2006, p. 152).