Management accounting: somecomments.

When I received the AAA Lifetime Contribution to Management Accounting Award, I was asked to talk for a few minutes. This paper contains those remarks plus some additions. Former articles have reflected on the changes in management accounting throughout my long university teaching career (Williams

1986; Horngren 1989, 1995). Moreover, some personal descriptions of my experiences are available (Horngren 1993). Therefore, this paper will not repeat those expositions of history. Instead, I will concentrate on a few core ideas.

As always, all of us are heavily influenced by our readings and our discussions with co-workers. This paper is a personal statement, but I claim no originality. Many writers, colleagues, students, and managers have affected my thoughts.

Why Do Management Accounting Systems Exist?

What I like best about the management accounting techniques or methods that have been receiving so much recent attention is their tendency to force managers to focus on the fundamentals of their organizations. For example, ABC-ABM, benchmarking, and reengineering have led to more efficient processes and activities. The more probing studies have learned not to bother calculating and reducing the cost per activity if the activity should not exist at all.

I have a McNamara framework for judgments in these areas. Many times I have urged my students to follow Robert McNamara's advice to his staffs at Ford and the U.S. Department of Defense: "Always start by looking at the grand total. Whatever problem you are studying, back off and look at it in large."

This framework is not unique. Concentrate on the basics: The focus of management accounting should be on decisions. How can various techniques, systems, and measurements induce and help the collective decision making throughout the organization? Never forget the fundamental aim: decision support.

Overarching Criterion

My classes have repeatedly emphasized that accounting and control systems, tools, and techniques are economic goods, just like milk or beer. Consumers buy enough milk or beer to satisfy their perceived wants--and no more. Similarly, managers buy enough management accounting methods and systems--and no more.

What system does a manager want to buy? The answer depends on the buyer's perceptions of the expected benefits in comparison to the related costs. The benefits are the expected improvements in the collective decisions throughout the organization. The costs are the familiar systems costs plus the costs of change and expensive management time.

The cost-benefit test is the overarching criterion that assists me in deciding whether a proposed System B is preferable to existing System A. Any system has two simultaneous missions:

* Transmission of information to help reach wise economic decisions

* Motivation of users to aim and strive for organizational objectives or goals

In short, management accounting and management control systems can best be understood by comparing costs and benefits coupled with a key awareness of the importance of behavioral effects.

Fundamental Thread: Cause And Effect

What fundamental thread has extended throughout management/cost accounting during the past century? It is the attempt to link causes and effects. Examples include the increasingly refined approaches toward allocations of indirect costs to products, services, and customers. For instance, in manufacturing companies, the procession has been from broadly averaged, plant-wide overhead rates, to departmental rates, to narrower, granulated rates based on activities within departments. Accordingly, the multiple rates are frequently tied to different cost drivers. Other examples include approaches to classifying costs by varieties of variable and fixed behavior patterns.

The history of developments in cost allocations includes movements toward variable costing in the 1950-1960s and toward full costing based on numerous cost allocation bases in the 1985-1990s. The latter, which acquired the ABC label, sparked much interest among practitioners and academicians.

Managers, accountants, and others have had some provocative disagreements regarding how to manage costs. For example, the advocates of variable costing and contribution reporting believe that keeping distinctions among variable, fixed, and semi-variable costs helps the focus on causal relationships. Moreover, the supporters of the theory of constraints believe in super-variable costing, which means that the sole variable cost is direct materials. To them, cost management consists primarily of searching for, finding, and reducing bottleneck resources.

In contrast, ABC-ABM adherents consistently maintain that their approach takes a longer-term outlook and that, in the long run, all costs are variable. I may be too picky here, but I prefer saying that all costs are avoidable, not variable, in the long run.

Regardless of these differing views, the continuing search has been for better pinpointing of causal relationships. Information technology has advanced so that details can be gathered more economically than ever. Consequently, demands for more accurate linking of causes and effects are satisfied more easily.

Nonfinancial Measures

Recent years have seen a growing interest in developing and using nonfinancial measures to evaluate performance. The Balanced Scorecard is one of several variations of attempts to integrate such measures in management control systems. It provides another illustration of cause and effect. The scorecard features the idea that management's strategies should give explicit attention to the causal relationships between leading indicators (causes) and lagging indicators (effects). Scorecard measurements help crystallize an organization's strategies, communicate them, and help align everyone toward common goals.

The designers of the balanced scorecard have described a strategy as a set of hypotheses about cause and effect (Kaplan and Norton 1996, 2004). An example is:

* If we have a 10 percent improvement in on-time delivery, then customer satisfaction will improve.

* If customer satisfaction improves, then our average margins and sales volumes will increase.

The causal linkages depicted by the balanced scorecard are only one of many. For example, there is a service profit chain that moves from employee satisfaction to customer loyalty to market share to financial performance. The basic appeal of these chains is their pushing of managers to keep their eye on the big picture. The use of such measures impels intensive and extensive executive interactions that help define strategies and enhance competitive advantages.

Why is there elevated attention to nonfinancial measures? There are at least two reasons. First, decision support. Financial measures focus on outcomes of decisions made under risk or uncertainty. For example, profitability measures may be the major objectives of an organization, but they are not necessarily subject to direct control, especially at lower levels of the organization. Furthermore, they are not the best predictors of future financial performance.

The adherents of heavier uses of nonfinancial measures assert that market share, product and service quality, customer satisfaction, innovation, and employee training are frequently more meaningful and controllable at various hierarchical levels. Most important, such measures are leading indicators. That is, decisions regarding these measures and their resulting improvements in performance signal forthcoming improvements in financial performance.

Second, attention to nonfinancial performance measures can reduce managers' excessive emphasis on the short term, such as quarterly earnings. Still, earnings remain as ultimate outcome measures. If a spotlight is placed on the correct nonfinancial performance measures (correct because such performance improvement causes progress toward strategic goals), then managers will be more likely to concentrate on the factors that will ensure excellent profitability in future years.

The chain of reasoning regarding linkages between nonfinanciai and financial measures is clear-cut. In assorted versions, including the best-known Balanced Scorecard, there is a huge amount of faith and plenty of intuitive appeal. But so far there is scanty empirical evidence of the causal linkage pattern. I am a follower of this faith, but the lack of much empirical evidence of the strength of the various linkages means that this work is in its infancy. Nevertheless, researchers admirably persist in examining potential cause-and-effect relationships (Ittner and Larcker 1998; Smith and Wright 2004).

Although now well entrenched, the Balanced Scorecard label is at best vacuous and at worst misleading. The word "balanced" carries the connotation of focusing on both short-term and long-term goals and juggling so that all aims of the scorecard are achieved. However, that focus is too fuzzy. A better name would be the linked scorecard or even the causal scorecard. Not all of the elements of the scorecard are equally important, and the validity and relative force of the abundant linkages remains speculative.

I support the balanced scorecard and similar devices that promote causal thinking. However, even if the cause-and-effect linkages are empirically convincing, corollary questions arise that involve cost-benefit and behavioral factors. Reconsider the earlier on-time delivery example. Few organizations can afford to enhance customer satisfaction for its own sake. On-time improvement may be a benefit, but how much will it cost? How long will it take for the impact to take hold? Other unanswered questions about the scorecard are:

* Are the most important variables included? Are the measures credible?

* Which nonfinancial variables are the most promising in ultimately improving financial performance? What is the relative force of the abundant linkages?

* If nonfinancial variables are to be included as determinants of total compensation, then how should they be weighted? That is, how is the appropriate balance to be set? As an observer said, "To measure many things but to pay on profits alone is to reduce all other measures to insignificance."

* Is there a linear relationship, or is there a trade-off relationship, among the various strategic goals and key result areas or critical variables of a company? For example, is there a straightforward link from quality to customer satisfaction to profitability? Or do managers satisfice? That is, do they aim for quality, customer satisfaction, or similar measures subject to the attainment of a budgeted profit?

In short, the Balanced Scorecard illustrates how causal, behavioral, and cost-benefit aspects weave together in making decisions about the design of management control systems.

Budgeting As a Research Topic

Earlier I mentioned that a management accounting system has two simultaneous missions: economic decisions and motivation. For years, I have welcomed and supported various types of research in management control and accounting. For example, budgeting has always fascinated me. Why? Because it manifests the essence of management accounting, the blending of accounting and management. No sub-part of management accounting better demonstrates how accounting integrates with management and why the behavioral sciences may rank abreast in importance with economics.

If a research topic is both important and relevant, then it deserves attention. In my opinion, until recently accounting academicians and practitioners have not thought seriously about the weaknesses of budgeting concepts and applications. Encouraging signs have now appeared. For instance, the 2003 edition of this journal contains an entire forum on budgeting. Furthermore, empirical research on budgeting has grown. Some of this research spurs readers to think more deeply about how to run organizations.

All planning and budgeting systems can be improved. Budgets have their fans and their attackers. Nevertheless, everybody agrees that such planning tools are imperfect. Some researchers and managers believe that improvements can be made. Others believe that budgets should be abandoned altogether. The accompanying ferment in the literature and at conferences underscores that we all have much to learn about the fundamentals of management

Despite their countless weaknesses that have been documented for many years, budgets survive in various forms and practices. Budgets have often led to misguided and/or unethical decisions. Sometimes managers have erroneously picked the budget as the villain. But budgets are inanimate tools. They can be used wisely or stupidly. A better target is the administration of budgets or, more broadly, the entire management control system, including the culture of the organization.

Many of those who favor searching for improvements in budgeting favor an activity-based budgeting (ABB) approach (Hansen and Torok 2004). Their model explicitly emphasizes and links operational performance with financial results. The model encompasses the demand for products and services, related activity requirements, resource requirements, capacity requirements, and interrelationships. Particularly noteworthy is the weaving of capacity analysis and metrics into the model.

The ABB model focuses on cause-effect relationships, on identifying leading and lagging measures. To predict financial results more accurately, managers must be confident about their predictions of operational metrics. The ABB model offers an in-depth model for improving planning, budgeting, and general management.

A pair of British researchers, Jeremy Hope and Robin Fraser, has pursued a radical idea about budgeting: Simply abandon it. For the past seven years, they have conducted empirical research in Europe that examines the experiences of organizations that have abolished budgeting (Hope and Fraser 2003, Beyond Budgeting).

Numerous managers are extremely unhappy about budgeting, but few have really questioned its existence. Beyond Budgeting does. The book describes an alternative coherent management model attuned to today's economic conditions. It supplies a guiding framework for how organizations should be managed today and tomorrow.

Beyond Budgeting may be a provocative title for a book. But do not be misled. The book emphasizes the entire general management model, not simply the replacement of obsolete, horribly mismanaged budgeting processes. Beyond Budgeting is not merely a negative idea that assails budgeting. Rather, it is a positive idea that uses the jettisoning of budgeting as a trigger for improving the whole management control process. Budget extinction initiates broad and penetrating analysis of how entities should be managed.

Many of us may be skeptical of the proposed banning of budgeting. How would organizations be managed without budgets? The suggested answers are complex. Nevertheless, research like this is beneficial because it sparks deeper thinking by all of us.

This research is an illustration of a worthy effort regardless of the presence of any flaws. Management accounting research and education has advanced enormously since I entered the field, but it has far to go. It deserves concerted interest by all of us.

REFERENCES

Hanson, S. C., and R. Torok. 2004. The Closed Loop: Implementing Activity-Based Planning and Budgeting. Fort Worth, TX: CAM-I.

Hope, J., and R. Fraser. 2003. Beyond Budgeting. Boston, MA: Harvard Business School Press.

Horngren, C. T. 1989. Cost and management accounting: Yesterday and today. Journal of Management Accounting Research 1:21-32.

--. 1993. Hall of fame induction. The Accounting Historians Journal 17 (2): 125-134.

--. 1995. Management accounting: This century and beyond. Journal of Management Accounting Research 6:281-286.

Ittner, C. D., and D. P. Larcker. 1998. Are non-financial measures leading indicators of financial performance? An analysis of customer satisfaction. Journal of Accounting Research 36 (Supplement): 1-35.

Kaplan, R., and D. Norton. 1999. The Balanced Scorecard. Boston, MA: Harvard Business School Press.

--, and --. 2004. Strategy Maps. Boston, MA: Harvard Business School Press.

Smith, R. E., and W. F. Wright. 2004. Determinants of customer loyalty and financial performance. Journal of Management Accounting Research 16: 183-205.

Williams, L. 1986. Management accounting's renaissance man. Management Accounting 18(7):22-29.

Charles T. Horngren

Stanford University