There are limitations, but financial and management accounting perform a fundamental role in the measurement of performance within an organization. Critically evaluate this statement.
Both financial and management accounting are useful and essential management concepts and tools in the modern business management world. Both of them play different and important roles in any organization, which include to document the activities occurred in an organization, to allocate costs to different activities and department, to assist in internal as well as external profit reporting, to capture essential information pertaining to the operations of a business, to collect and present data for managerial decision making process, to provide guidance for managerial planning, controlling and management process as well as for performance measurement and appraisal purposes (Merchant, 2006). This article will focus on the roles of financial and management accounting in measurement of performance within an organization, and the contemporary issues related to the usage of management accounting in measuring performance in an organization. The article is arranged as follow. Firstly, the roles of management accounting in performance measurement will be discussed. Then, the limitations, difficulties as well as the potential challenges in using financial and management accounting in performance measurement of a firm will also be presented. The article conclude that although there are limitations to the usage of management accounting in performance measurement of a firm, the framework and concepts from financial and management accounting are nonetheless playing fundamental role in performance measurement in modern organizations today.
Both financial and management accounting plays various crucial roles in modern organization today. The application of financial and management accounting can be generally separated into two distinctive perspectives, firstly, application within the organization, while secondly, applications with external parties such as shareholders and government outside the organization. This article will focus on the performance measurement within an organization. In this section, the roles of management accounting in performance measurement within an organization will be discussed. We shall see that both financial and management accounting play significant and fundamental roles in performance measurement within an organization, although there is also other relevant field of knowledge that should be used for more accurate and effective measurement of organizational performance for a firm in the dynamic business landscape today.
As we had discussed before, one of the vital roles of management accounting is to provide relevant and timely information for management in terms of control, planning, execution and finally performance evaluation within an organization (Weetman, 2006). As it is widely known, managers will often require a lot of data and information for decision making purposes in today competitive business environment. From the perspective within an organization, all these data and information is gathered, presented and compiled through the management accounting system or methods. Thus, management accounting plays very fundamental roles in assisting management in analyzing and measuring the performance of the organization from various perspectives. For instances, the management accounting will provide feedback to managers if the previous strategies is executed successfully, if the cost cutting program is satisfactory, if the efficiency and effectiveness of the production or operational work flow had increased, or if any corrective actions is necessary to further improve the operations of a company (Bushman & Smith, 2001). Not only that, the various measures obtained from management accounting, such as the cost, revenue, profit margin, collection period, growth in sales, return on capital, return on equity and many others are the key performance indicators widely used to gauge if a business is thriving or suffering by management. All these are numerical concepts presented by management accounting that is used to indicate the relative performance of a company or operation within an organization. Through these, management accounting essentially provide management the relevant information to measure the performance of various departments, activities, process flow, work flows and plans in an organization, so that these activities can be controlled, further improved or managed (Hoque, 2005; Demski et. al., 2008).
There are various methods in which management accounting can be used to measure the performance within an organization. In fact, scholars such as Taticchi et. al., (2010) have been tracking the evolution of financial and management accounting methods in performance measurement in companies. It is noted that the field is evolving fast, since the 1980 as different management accounting concepts and frameworks are used to measure organizational performances in the literature and corporate world. Although the field is still evolving, it is also noted that most of the frameworks or methods used to measure organizational performance are indeed based its fundamental concepts in management accounting, whereby the used of accounting data and variables are apparently a common theme for all of these performance measurement techniques or methods. According to Taticchi et. al., (2010), the main performance measurement of company performance before 1980s are mainly the ROI, ROE and ROCE measurement methods. After that, the Economic Value Added (EVA) technique is becoming more famous, and in 1988, this is taken over by the Activity based Costing (ABC) method. Since then, more and more theoretical frameworks on the context of performance measurement emerge. Those new methods emerge in the past decades include The Strategic Measurement Analysis and Reporting Technique (SMART) in 1988, the Customer Value Analysis (CVA) in 1990, The Balance Scorecard in 1992, The Cambridge Performance Measurement Framework (CPMF) in 1996, the Business Excellent Model (BEM) in 1999, the Performance Planning Value Chain (PPVC) in 2004 until the recent Unused Capacity Decomposition Framework (UCDF) in 2007. It is worthy to note that each of these framework try to overcome the limitations of the previous methods, and most of them, to a certain extent are relying on the concepts of management accounting in the measurement process.
Not only that, according to a research by Sabounchi and Roper (2008) on performance measurement system, they found that most of the performance measurement system rely on the quantitative or financial measures in gauging the performance of an organization. They summarized the various popular performance measurement systems into nine methods, and found that performance measurement methods such as DuPont Scheme, Activity-based Costing (ABC), Balance Scorecard, Competitive Benchmarking, Statistical Process Control (SPC), Work-flow based Monitoring, and Process Performance Measurement System are indeed relying on quantitative or financial measures in measuring the performance of an organization. Only two out of nine performance measurement techniques are relying solely on behavioral measures for performance measurement purposes. The findings from the scholars are presented in Table 1 below. As the vast majority of the performance measurement techniques are relying on quantitative and financial measures that are derived from financial or management accounting framework or theories, it is safe to conclude that the concepts of management and financial accounting are indeed playing fundamental roles in measuring organizational performance.
Table 1: Comparison of Different Performance measurement System
|Approach||Objects Measured||Types of Measures|
|Activity-based Costing (ABC)||Activities and Processes||Financial|
|Balance Scorecard||Enterprise or organizational units||Financial and non-financial, quantitative and qualitative|
|Self-Assessment (e.g., EFQM method)||Enterprise or organizational units||Mainly non-financial|
|Competitive Benchmarking||Processes||Mainly non-financial and quantitative|
|Statistical Process Control (SPC)||Processes||Mainly non-financial and quantitative|
|Work-flow based Monitoring||Processes||Mainly non-financial and quantitative|
|Capability Maturity Model (SW-CMM)||Software Processes||Non-financial|
|Process Performance Measurement System||Processes||Mainly non-financial and quantitative|
Source: Sabounchi and Roper (2008)
Thus, it is observed that apparently, the used of management accounting concepts and methods in performance measurement is indeed critical and required, as most of the literature are relying to a certain degree on the usage of management accounting on performance measurement. In fact, it is noted also that out of so many performance measurement method, the Balance Scorecard is the most widely used methods in performance measurement – as such method is holistic, comprehensive and practical. Under the Balance Scorecard, the organizational performance is viewed or analyzed from four perspectives, namely the customer perspective, internal business perspective, learning and growth perspectives, and financial perspectives. Such a method is one of the widely used strategic management technique in corporate world (Weetman, 2006). It is also widely taught in business school under the strategic management accounting subject. Thus, it is again shown that management accounting is indeed playing fundamental role in performance measurement of an organization.
In the past few decades, performance measurement using the concepts and tools of financial or management accounting is changing from a focus on financial perspectives to non-financial perspectives gradually (Taticchi et. al., 2010). As the business landscape becomes more competitive, dynamic and fast changing, it is no longer sufficient to measure company performance based on financial or numerical perspectives only. Companies now is required to measures more than what can be measured, and to take into account the various human or behavioral factors into consideration to ferret out or investigate the true performance of a company in the marketplace (Bushman & Smith, 2001).
We had discussed and showed many evidences on the importance of management and financial accounting concepts and theories in performance measurement of an organization in the section above, but it is also crucial to point out that the usage of management accounting in performance measurement is not without limitations or drawbacks. In this section, the various limitations of management accounting in performance measurement will be illustrated.
Firstly, most of the scholars widely acknowledge that a true performance measurement system should also consider the psychological or behavioral nature and picture in an organization. This is evidences from the fact that most of the famous and practical performance measurement systems use both financial and non-financial measures in assessing company performance. For example, management accounting does not measure employee motivation, employee commitment, retention intention, knowledge, growth and the workforce capability in an organization (Henri, 2004). However, the psychological and human behavioral issues, such as the leadership process, commitment, creativity and innovation, learning and growth issues, group work process and quality is the root cause and key contributors for top performing organization. These elements are essential to the ultimate performance or an organization and should never be neglected as well. Thus, for a proper and accurate performance measurement system, such behavioral factors should be captured and considered as well (Demski et. al., 2001).
Not only are that, apart from the behavioral factors that are critical to the performance of an organization, other non behavioral and non-financial issues also not being measured by financial or management accounting. For example, the impacts of organizational structure, such as decentralization effects to corporate performance, the task uncertainties affecting the workforce, the product life cycle and its impacts to the company, the efficiencies or the effectiveness of the value chain in the company, the organizational culture are also not being taken into account by the management accounting framework. All these issues however are critical and influential towards the success of an organization in the dynamic marketplace (Henri, 2004). Thus, it is important for manager to understand that the measures enabled by management or financial accounting are just reflective on certain or partial issues in the organization, and should not be treated as the comprehensive set of measured to be used for decision making process. There are more issues, mainly those qualitative issues to be observed and investigated by the management to truly gauge the effectiveness, performance and potential of a particular organization (Burney & Matherly, 2007; Hoque, 2005).
It should also be understood that accounting measures are largely a measure on the results, but not the root of a problem or success. For example, the measurement of ROE is measuring the financial profitability of the company, but is not a measure on the workforce commitment to serve the customers as good as possible and to beat the competition. Thus, to a large degree, the usage of management or financial accounting is not forward looking, and is not really predictive on the future performance. Thus, accountant should realize that the numbers obtained from the measurement process is at best providing useful hints to the management, but should not be treated as the ultimate guidance on the future performance of an organization. Many more should be done. For example, it is essential to anticipate changes in the marketplace, to adapt to the constantly evolving business landscape and to learn and growth in daily operations of the business. Those change elements and the growth stories are not being captured by management accounting measures, but are too important to be investigated and understood in measuring the true performance and business viability of a firm in today dynamic business landscape (Demski et. al., 2001).
Besides, there are also critiques that the measures presented by management accounting is too static, while in the competitive business environment, dynamic measures on the business process is more important. According to Fowler and Mason, the accounting measurement system is operating in the static point of view and never considers the true picture of the inter-dependencies in the real world, where everything is dynamic and inter-related. The accounting system is not able to consider the trade-off between various dimensions of performances in the real time. For example, some actions may enhance short term performance of an organization but may cause troubles in the longer term, and all these are not being captured in the accounting measurement system. This is one of the huge limitations of the accounting-based measurement system, as the dynamic business landscape requires managers to focus on the process of the business and to adapt and constantly improve to meet with the challenges daily (Sabouchi & Roper, 2008).
It is also argued by some researchers that when the numerical or quantitative measures are used as performance targets in measuring corporate performance, it is likely that people will focus in meeting those numerical targets instead on doing what is truly important – i.e., to satisfy the customer demand and requirements effectively. As such, when something is being measured, and it had become a target, it ceases to become a good measure. For example, when the cost of goods sold is being measure, supervisors may buy lower grade of materials in order to meet the numerical targets in terms of costs saving, rather than to focus on the process flow in cost cutting and saving purposes (Burney & Matherly, 2007). It is argued also that when people are being forced to meet a certain numerical target, they may not focus in doing what is right, and instead trying various way to game the target, which could means doing actions that is not in line with the long term benefits of the entire organization (Bushman & Smith, 2001).
Another valid comment on the potential limitations and difficulties in using management accounting related measures for performance measurement purposes is that it is hard to choose the correct measures. There are simply too many measures that can be used, and to choose the correct measures to be used in a parsimonious manner is highly challenging. If too many measures are used, people may lost focus and control, and the accountant will spent their time measuring, without really knowing if what is being measured counts (Weetman, 2006). On the other hand, if the measures used is not reflective of the true environment, the decision making process will be adversely affected, and that proper corrective actions will not be possibly taken to improve the organizational performance. Thus, management is facing with the difficulties in choosing the truly impactful and reflective measures to be included in the performance measurement system. The key performance indicators measured should also enhance self-regulation in the organization, and encourage improvement in the business or organization effectiveness ultimately (Hoque, 2005; Merchant, 2006).
Overall, it is shown that financial and management accounting is crucial in measuring corporate performance. In fact, financial and management accounting is firstly used as the key performance measurement indices prior to 1980s. The usage of ROI, ROE and ROCE are used widely in the past as the indicators to gauge company performance (Bushman & Smith, 2001). Up to date, it is also noticed that many of the modern performance measurement or even management system are relying heavily on the usage of management accounting concepts and frameworks in measuring organizational performance. It is observed that financial and management accounting is playing fundamental role in performance measurement system in modern organizations today. Nonetheless, it is also noted that other measures or field of knowledge, particularly those related to psychological or behavioral factors are also widely used in performance measurement in organizations. As the business environment is becoming more complex and dynamic, the usage of financial or quantitative measures as widely adopted in management accounting is no longer sufficient to provide effective and accurate measures on the company performance. Besides, it is also critical for accountant or manager to realize that the usage of management accounting in performance measurement system indeed has some limitations. The various limitations include the financial and management accounting does not consider the behavioral aspects in the organization, the accounting measures are too static, the reliance on accounting measures may cause workers to game their behaviors, and it is simply not easy to choose the truly meaningful and crucial elements to get measured in an organization. All of these limitations, drawbacks and well as difficulties in implementation of financial and management accounting framework in performance measurement of an organization should never be neglected by managers in order to derive an accurate and effective performance measurement system in any organization.
Overall, although the usage of financial and management accounting does indeed face some inherent limitations in performance measurement of an organization, it is still useful in providing sufficiently good measures on the firm. It is then the manager responsibility to realize the limitations of management accounting in the field of performance measurement and to rely on other methods in order to assess the corporate performance accurately. Quantitative measures are good pieces of evidences in an investigative case in an organization, but they are not the whole story.
Burney, L., & Matherly, M. (2007). Examining Performance Measurement from an Integrated Perspective. Journal of Information Systems, 21(2), 49-68.
Bushman, R., and Smith. A. (2001), Financial accounting information and corporate governance, Journal of Accounting and Economics, Volume 32, Issues 1-3, December 2001, Pages 237-333.
Catasús, B., Ersson, S., Gröjer, J. E., & Wallentin, F. Y. (2007). What gets measured gets … on indicating, mobilizing and acting. Accounting, Auditing & Accountability Journal, 20(4), 505-521.
Demski, J., Fellingham, J., & Lin, H. (2008). Useful Additional Evaluation Measures. Journal of Management Accounting Research: Special Issue, 20, 165-173.
Elliott, B., and Elliott, J. (2005), Financial Accounting and Reporting, ninth edition, published by Pearson Education Limited.
Flamholtz, E. G. (2009). Towards using organizational measurements to assess corporate performance. Journal of HRCA: Human Resource Costing & Accounting, 13(2), 105-117.
Gupta, K. M., & Gunasekaran, A. (2005). Costing in new enterprise environment: A challenge for managerial accounting researchers and practitioners. Managerial Auditing Journal, 20(4), 337-353.
Henri, J. F. (2004). Performance Measurement and Organizational Effectiveness: Bridging the Gap. Managerial Finance, 30(6), 93-123.
Hoque. Z, (2005), Linking environmental uncertainty to non-financial performance measures and performance: a research note, The British Accounting Review, Volume 37, Issue 4, December 2005, Pages 471-481.
Horngren.C, Datar. S and Foster. G, (2006), To accompany cost accounting-Topic 8, published by Pearson Education Limited.
Hussain, M. (2004). Management Accounting Performance Measures In Interest-free Financial Institutions: Need of Non-financial Performance Measurement. Managerial Finance, 30(11), 74.
Ittner. C and Larcker. D, (2001), Assessing empirical research in managerial accounting: a value-based management perspective, Journal of Accounting and Economics, Volume 32, Issues 1-3, December 2001, Pages 349-410.
Libby. R, Libby. P and Short. D, (2001), Financial Accounting, The McGraw-Hill Companies, Inc.
Merchant, K. A. (2006). Measuring general managers’ performances :Market, accounting and combination-of-measures systems. Accounting, Auditing & Accountability Journal, 19(6), 893-917.
Sabounchi, N., & Roper, M.. (1 January). Process Performance Measurement based on a Dynamic Approach. IIE Annual Conference. Proceedings,1784-1789.
Taticchi, P., Tonelli, F., & Cagnazzo, L. (2010). Performance measurement and management: a literature review and a research agenda. Measuring Business Excellence, 14(1), 4-18.
Tayles, M., Pike, R. H., & Sofian, S. (2007). Intellectual capital, management accounting practices and corporate performance :Perceptions of managers. Accounting, Auditing & Accountability Journal, 20(4), 522-548.
Van der Stede, W. A., Chow, C. W., & Lin, T. W. (2006). Strategy, Choice of Performance Measures, and Performance. Behavioral Research in Accounting, 18, 185-205.
Walters, L., & Pergola, T. (2007). A Performance Measurement Case for Managerial Accounting. Journal of Business Cases and Applications, 1, 7-17.
Weetman. P, (2006), Management Accounting, published by Pearson Education Limited.