Accounting is a Strategic Business Tool

Strategic Management Accounting

The strategic use of accounting at times of organisational change does not mean that organisations should adopt new accounting systems, like for example Activity Based Costing or Throughput Costing. Kaplan and Norton engaged in trenchant criticism of existing management accounting tools and techniques in the 1980s. They warned that these tools didn’t satisfy the needs of senior managers in the formulation and development of a strategy and in the creation and sustenance of competitive advantage (Drury, 2012).

Whilst cost and management accounting in the past tended to be based upon historical figures and inward-looking, a movement developed from the 1980s onward, advocating the use of accounting for strategic purposes, especially for the development, monitoring and enhancement of business strategy (Lord, 1996). Kaplan and Norton (1992), engaged in extremely sharp criticism of existing cost and management accounting tools and techniques, stating that they had not changed for several decades and were clearly outdated and unable to meet the needs of contemporary business organisations. They called upon management accounting professionals to develop new, efficient and imaginative cost and management accounting tools and techniques. This movement resulted in the development of several strategic management accounting techniques, including target costing, lifecycle costing, strategic cost analysis, activity-based costing, activity-based management, and strategic performance measurement systems (Yalcin, 2012). These costing techniques were very different from historical costing and management accounting methods.

Traditional management accounting control techniques tended to stress on cost containment, whereas strategic management techniques focus on cost reduction (Bowhill& Lee, 2002). Target costing involve the determination of the target price and the target profit, which in turn can identify the target costs and the method required for driving down the actual cost to the target cost (Tillmann& Goddard, 2008). Lifecycle costing constitutes the process of estimation of the money that could be spent on an asset or a project over its complete life and thus helps in a considerably superior prediction of costs (Lord, 1996). Activity-based costing is a managerial accounting method that traces overhead costs to various activities and thereafter assigns them to objects (Turney, 2010). It helps in the allocation of overhead expenses to jobs and products on the basis of the number of activities required to produce the product, rather than the simple estimation of the utilisation of each job (Yalcin, 2012). The proper assignment of indirect cost helps management in taking better informed decisions (Stratton et al., 2009).

Organisational managements can use strategic management accounting during times of organisational change to enhance organisational performance (Adler, 2000). Strategy makers can use target costing during the introduction of a new product (Drury, 2012). Its use includes the projection of lifetime sales volume, the targeted selling price of the product and the targeted profit margin (Ansari et al., 2007). The estimated/projected cost can thereafter be examined and analysed from various perspectives in order to bring it down to the target cost and ensure the achievement of target profits (Axet al., 2008).

The use of lifecycle costing helps in the estimation of both revenues and costs of a product over its entire life, commencing from the period of original research and development through sales to the time when customer support is not offered for the product any longer (Adamany& Gonsalves, 1994). It includes non-production costs, the development period for research development and design and other predicted costs and helps the management in understanding and analysing the total cost implications of a product or project (Bhimani& Bromwich, 2010).

The use of such strategic management accounting tools and techniques during times of organisational change does not call for the total rejection of historical and well-established cost and management accounting tools and techniques. Such costing tools and techniques, especially tools like standard costing, marginal costing and budgeting can continue to be used by organisations in their routine day-to-day activity. The examination of available literature has, in fact, revealed that whilst strategic management accounting tools have been developed and introduced for quite some years now, numerous organisations continue to use historical and traditional cost accounting tools because they continue to find them useful and effective for decision-making purposes. Standard costing continues to be widely used on account of its utility in enhancement of cost control, simplification of stock valuation and enhancement of product costing and pricing. It can be applied to jobs and processes both in manufacturing and service industries. It helps organisations in comparing actual with planned results, evaluating performance and taking corrective action. It also helps managements in the development of cost awareness and consciousness.

Several firms continue to make use of marginal and variable costing on account of its utility in fixation of products, taking of make or buy decisions, selection of optimal product mix, deciding upon alternative production methods and assessing the impact of changes in selling prices. Organisations continue to make use of budgeting and budgetary control. The use of budgets helps in planning, communication, setting of responsibility, appraisal, monitoring, motivation of people and allocation of resources. Many small organisations furthermore do not have organisational capabilities in terms of abilities and expertise for the implementation of strategic management accounting tools and they continue to effectively use them for organisational purposes. The use of strategic management and cost accounting can thus very well exist side by side with historical cost accounting tools and techniques.

Need to Increase Use of Strategic Management Accounting in Business

Langfield-Smith (2008) engaged in a review of strategic management accounting since it was first conceptualised in the early 1980s, wherein he stated that it had impacted practice, scholarship and accounting, but not in the way originally envisaged by the founders of SMA. Strategic Management Accounting (SMA) has been defined in different ways by various experts. Simmonds (1981) defined SMA as the delivery, examination and analysis of management accounting information about a business firm and its existing competition for utilisation in the formation and checking of organisational strategy. Bromwich (1990) on the other hand defined SMA as the delivery and investigation of financial data on an organisation’s markets for its products, costs of competitors, structures of costs and the evaluation of the strategies of organisations and their competitors over several periods. Langfield-Smith (2008) summed up these various definitions, stating that SMA entails a strategic orientation through the development, explanation and examination of management accounting data and information about competition.

Several experts, from the 1980s onward, focused on the importance of strategic management accounting and presented strong cases for its adoption. Apart from Simmonds (1981), other influential academics like Kaplan (1984), Cooper (1966) and Shank (1989) flayed the state of management accounting and urged management accountants and organisational managements to adopt strategic cost management techniques. Simmonds (1981), Shank (1989), Bromwich (1990) and Kaplan and Norton (1992) strongly advocated the adoption of SMA. Several SMA techniques were devised and formulated during that period, including activity-based costing, activity-based management, target costing, lifecycle costing, and strategic cost analysis (Cadez & Guilding, 2008). The development of these techniques led to the availability of a range of new approaches in the fields of costing, strategic control, strategic investment appraisal and performance management (Cinquini & Tenucci, 2010). They highlighted the potential for management accountants to play a greater role in competitor analysis and recommended an externally focused role for accountants when conventional cost and management accounting practice displayed an extremely internally focused orientation (Cadez & Guilding, 2008). Simmonds (1981) stated that SMA was spreading rapidly in practice and that management accountants were spending significant time and effort in the collection and estimation of cost, volume and price data on competition, as also the calculation of the relative strategic positions of firms and competitor for the formation of business strategy.The examination of literature, however, revealed that this was proved otherwise in later years.

Cravens and Guilding (2001) stated that one of the most important objectives of strategic management accounting was to alter the focus from the traditional concept of cost management to a more inclusive and broader concept of profitability management. This required dealing with profitability as the consequence of several drivers, understanding the ways in which drivers accept profitability and manage them with the help of suitable strategic management accounting techniques (Guilding et al., 2000). Research and surveys revealed that whilst strategic management has gained credence and acceptance over the years, several techniques like activity-based costing, attribute costing, lifecycle costing, quality costing, target costing, and value chain costing are not being used frequently by modern organisations (Van der Stede et al., 2005). The organisational uptake of these tools and techniques has by and large been intermittent and not widespread.

Management accounting information and techniques are used to support strategic decision making, especially in the information gathering and analysis stage; though mostly in connection with current performance (Heinen & Hoffjan, 2005). The most significant features of strategic decision making, wherein management accounting is perceived to deliver a considerable contribution is in the justification and corroboration of strategic decisions, specifically involving pricing, business and market development, new products development and mergers and acquisitions (Guildinget al., 2000). There is little evidence of the development of an external focus as suggested by several advocates of strategic management accounting, even though there is tracking of competitor position and pricing.

Strategic management accounting helps in decision making through financial analysis but the focus is on the assurance that strategic decisions have the potential to be viable (Cadez & Guilding, 2008). Several of the techniques packaged as SMA are used infrequently (Heinen & Hoffjan, 2005). The key techniques available for strategy formulation includ customer profitability analysis at the level of the contribution margin, benchmarking and investment appraisal. Sophisticated costing techniques are rarely used (Cinquini & Tenucci, 2010). Langfield-Smith (2008) lamented that SMA techniques, whilst strongly advocated, are not being widely adopted.

Whilst advocates of SMA have for years strongly advocated its use in the development and formulation of business and competitor strategy, it is yet to be widely used; especially the techniques that are more sophisticated. Notwithstanding this limitation, SMA tools and techniques have been accepted in some areas of the formulation of business strategy and the making of business decisions.

References

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