C PERFORMANCE MEASUREMENT SYSTEMS AND DESIGN

1. Management Accounting and Information systems

a). Identify the accounting information requirements for strategic planning, management control and operational control and decision-making. [2]Focus notes:

- Include extract of strategic position statement from BP, Shell, Nokia, etc.

1. Strategic planning is concerned with deciding the future direction of the organisation and the ways in which it should compete and sustain itself in a changing environment so as to continue to meet the expectations of stakeholders. Strategic planning takes place in three stages which are interdependent and interactive: strategic position, strategic choice and strategic action. The accounting requirements of each are discussed in the table below.

Strategic Planning Accounting Information Requirements

Explanations

Strategic positionHow is the firm positioned relative to competitors? Assess critical factors that determine competitive position: cost, market share, product mix

Relative levels and trends in costs, volumes, prices, market share - time series.Strategic variance analysisCost of innovation and new product launchesLifecycle costing and product profitability analysisForecast balance sheet and Cash flow

How is the firm positioned relative to customers?

Customer profitability analysis

How is the firm positioned relative to the external environment? Assess the strategic costs of PESTEL factors and include benefits appropriately.

Information about environmental costs associated with strategic decisions e .g. decommissioning costsInformation about technology costs and benefits associated with strategic decisionsAny other costs associated with PESTEL factors

How is the firm positioned relative to other stakeholders?How is the firm positioned relative to its culture and history?

Strategic choiceSet out criteria of choice from an accounting perspectiveInformation that allows choices to be made at all levelsBusiness level: various options in terms of how to compete need to be appraised. Cost and differentiation are the key issues.

Pricing informationCost of innovation and (focused) differentiationProduct Lifecycle costs segregated into committed and actual costs incurred

Corporate level: concerned with scope and breadth, the separate parts of the business, parenting and adding value, congruence. Options regarding diversification in business and products need to be appraised.

Transfer pricingSBU investment requirements

International: diversification beyond borders; ways of extending product life cycle. Concerned with licences, cost of production, investment, mode of

Labour and other country costsDirect investment costsCost of acquisitionCost of merger

entry: acquisition, merger, direct investment.

Forecast sales

Strategic ActionResourcingProcesses Assess the relative cost and efficiency of process options

Operational efficiency costs

OrganisingChangingPractice

Management Control

Operational control

2.

b). Discuss, with reference to performance management, ways in which the information requirements of a management structure are affected by the features of the structure. [2]

Focus notes:- purpose determines requirements: feature and function- structure is determined by purpose- hence the structure determines the information requirements- types of structure: group structure and SBUs; functional hierarchy, matrix- Functions of structure: delivery, accountability and control.

3. Management structure is the accountability relationship designed to ensure the objectives of the organisation are met. Resources are allocated, information flows, controls are exercised in accordance with the structure. This is the basis of responsibility accounting. Since structures are designed for specific purposes information requirements necessarily vary depending on the function of the structure and the purposes to be fulfilled. Certain information requirements are adhoc and therefore do not necessarily reflect structural features. For example, information on certain small projects can be accommodated within existing structures.

4. However, where efficiency and innovation are envisaged structural design needs to reflect the requirements of the business model to ensure fast delivery of strategic objectives. Flat structures, with minimum levels within the management hierarchy, suit this scenario. Decision making is close to the delivery of service or manufacture of goods or design of products. The information requirements would predominantly be operational details showing what progress is being made towards achieving objectives at frequent intervals. Senior management monitor frequently and are kept involved. For example, in a build or innovative organization performance of new product launches and progress on development of new products needs to be monitored frequently and necessary control action taken.

5. In traditional hierarchical organizations responsibility accounting requirements dictate that information is produced to report budget performance against actuals and aggregated to meet the span of responsibility of various managers in the hierarchy. This allows performance to be evaluated in relation to specific criteria by product, business unit, division, subsidiary and for the group as a whole at appropriate intervals. This is appropriate for a business that is predominantly in harvest mode in a mature industry such as grocery retailer, publishers and car manufacturers.

c). Evaluate the compatibility of objectives of management accounting and management accounting information. [3]

Objectives of Management Accounting Management Accounting Information

Support strategic planning and decision making

What business should the organisation be in?

What products should be producing? How should it compete? Cost or

differentiation? Where should it do business? How should it make a difference? How should it be accountable? How should it raise funds? How should it manage risk?

Express the mission, vision and goals in financial terms. E.g. cost leadership means minimise costs organisation-wide, quantify minimum and maximum cost levels relative to competitors. Design and support cost efficiency oriented strategies.Forecasts and decision support information for strategic planning, budgeting and resource allocation. Over multiple periods, for the organisation and SBUs, showing linkagesScenario analysis, sensitivity analysis and risk managementRelative competitive positionStrategic resources and competences

Support efficient and effective allocation of resources at the Strategic Business Unit

Information should be adequate to enable decisions to be made judiciously about allocating resources to meet needs of SBUs, operations and support services within the value chain showing direct linkage between mission, goals, strategy, objectives, plans and operations.

Information needed to achieve this should be reliable and specific as to its uses. This includes: forecasts, estimates, time series, variance analysis, sensitivity analysis.

Support short-run decisions e.g. pricing for competition, capacity utilisation, managing off-season and cyclical effects, dealing with one-off orders, managing the effects of the learning curve manage product lifecycle

In concert with analysts and researchers provide information about relative levels and trends in costs and prices, market share, volume and financial position to enable profitability management for the purpose of outperforming the competition.

Support performance evaluation and control to ensure targets are met and the firm achieves its financial objectives and goals

Produce information that allows direct comparison between planned and actual levels of activity and measure variances. Analyse variances so that management can learn about performance and make timely remedial action.

d). Discuss the integration of management accounting information within an overall information system, for example, the use of Enterprise resource Planning system [2]Focus notes:- Why is integration a good idea? Discuss the merits and purpose of the balanced score card- What to integrate with?- How?- At what stage?- Some benefits- Some examples from business: see Analytics

6. Performance needs to be planned, actioned and measured in an integrated way to reflect the complex and multi-faceted nature of the means used to exploit opportunities and overcome threats in order to meet stakeholder needs. The balanced scorecard expresses this interdependence and interactivity: the financial perspective blends with the customer, process, and learning and growth perspective to provide a rich and comprehensive picture of performance that allows effective monitoring and evaluation.

7. Integration needs to take place at all levels of performance management. This is facilitated by ERP systems. The following critical functions are examples of where management accounting information needs to be integrated with other information to produce fast, effective information for managing competitive position.

Benchmarking to copy best in class entails comparing relationships between the organisation’s costs and outputs (and in some cases outcomes) and those of best practice organisations. The customer cannot pay any price. The cost of best practice has to be affordable by the strategic customer. Hence it is essential to look across the entire value chain to assess whether more value will be added by the practice to be copied. This entails integrating cost accounting information with other value based information such as product quality and customer satisfaction levels to produce cost benefit analysis.

Strategic management information produced to maintain competitive performance in a hypercompetitive industry such as the hotel and catering industry combines management accounting information with information produced by researchers and analysts, sales, marketing, production and other specialists to support decision-making, monitoring and evaluation of performance relative to competitors.

Value chain analysis recommended by Professor Porter requires integration of information about the performance of interrelated functions within the value chain. The concept of linkages is the main driver of efficiency and competitive advantage within the value chain. A linkage is the effect that a procedure or function has on functions performed subsequently in the value chain. For example, a well designed car has less need for after sales service and repairs. Integration of management information with the value adding performance indicators can reveal where investment in design has resulted in savings in service ands help explain possible adverse design budget variances.

Lifecycle costing and product portfolio management. Integrating product lifecycle costs with information

about relative levels and trends in possible substitutes, sales volumes, market share, innovation break through and other relevant industry information can help managers in deciding the best mix of products.

In strategic variance analysis and reporting integrating non financial performance information with financial information enhances the usefulness of the report to users. For example, if fifty percent of the budget has been spent has at least fifty percent of the work been done? Non financial information is needed to answer this question.

8. The organisation needs to update its MIS systems regularly to ensure it is efficient, adequate and relevant to user needs at all levels and that it incorporates the latest technology capability. This is an essential strategic capability in a competitive and changing environment. ERP systems support integration and confer distinct competitive advantages over those who do not integrate.

ADOPTING ANALYTICS9.

Adopting Analytics10.e) Evaluate i) whether the management information systems are lean and ii) the value of

the information that they provideFocus notes:- What is lean thinking?- What is lean management information?

Lean thinking & management techniques11. Lean thinking is an application of the ideas of zero-based budgeting extended throughout the performance

management chain. The features of Lean techniques are: i) Define value as perceived by the customer (e.g. no frills, low price, hybrid, differentiation, focused

differentiation)ii) Identify the activities (or steps) that will deliver value to the customer (e.g. special features of a military

aircraft, or a luxury cruise liner)iii) Map those activities to the value defined by the customer (e.g. design, produce and test a car, plan to

provide customer services in a hotel using capabilities in the value networks). The mapping to the value creates a value stream. Eliminate wasteful activities.

iv) Make the value creating activities occur in tight sequence so that the product or service will flow to the customer (design and execute consistently and reliably: six sigma methodology (DMAIC) enables manages to achieve product quality standards consistently. Your brand of beer tastes the same always). This creates flow (customer expectations will rise – remember local customer demand conditions in Porter’s Diamond?) Remember Porter’s Diamond seeks to explain why certain companies from certain countries are globally more competitive than others.

v) Once flow begins the customer will pull value from the next upstream activity. In other words, customer expectations will rise. Customers want better mobile phones that can allow them to shop, navigate, take pictures, etc. (convergence); after that they want the phone to do something else and this expectation continuously rises. Hence the need to innovate continuously.

vi) As value is specified, value streams are refined, extended and standardised, wasted steps are removed, and flow and pull are consolidated (think about all those queues waiting for the next apple phone or ipad); begin the process again and continue it until a state of perfection is reached in which perfect value is created with no waste. Think about kaizen costing, budgeting and Fitzgerald & Moon Building Blocks (performance optimisation model).

You may find it useful to apply this to your own approach to studying and preparing for exams.

Application to Management Accounting and Information systems12. Lean Accounting provides accurate, timely and understandable information that can be used by managers, sales people, operations

leaders, accountants, lean improvement teams and others. The information gives clear insight into the company's performance; both operational and financial. The Lean Accounting reporting motivates people in the organization to move lean improvement forward. It is often stated that "what you measure is what will be improved." Lean accounting measures the right things for a company that wants to drive forward with lean transformation.

13. Lean Accounting is itself lean. The information, reports, and measurements can be provided quickly and easily because of the relentless focus on efficiency driven by the customer’s perception of value, and the organisations need to compete with others to provide that value, as reflected in the price that the customer is willing to pay (implies target costing). It does not require the complex systems and wasteful data input traditions of manufacturing companies. The simplicity of Lean Accounting frees up the time of the financial people and the operational people so that they can become more proactive in creating value and moving the company

forward towards its strategic goals. The role of the financial professional advances from provider of feedback information about what has happened to that of provider of prospective information in support of strategic decisions and business management collaboratively with others.

14. In accordance with McKinsey 7S Lean Accounting matches the cultural goals of a lean organization (shared values). The simple and timely information empowers people at all levels of the organization because it is understandable and impels action. The financial and performance measurement information is organized around value streams and thereby reflects the lean principle of value stream management for value. Thus Lean Accounting has an important role to play in embedding a lean culture within an organization.

Value-based pricing (an application of lean accounting that can give a competitive advantage)15. The first of the five principles of lean thinking is value to the customer. The prices of products and services are set according to the

value created for the customers. Lean accounting includes methods for calculating the amount of value created by a company's products and services, and from that knowledge to establish prices. This approach is in stark contrast to many traditional companies that calculate their prices using the cost-plus method (resources consumed). The cost-plus method establishes prices by calculating a fully absorbed product cost and then adding on an acceptable profit margin. This cost-plus methods leads to serious errors in pricing because it creates a false linkage between price and cost (uncompetitive). The price of a product is unrelated to the cost of manufacturing and supplying that product. The price of a product or services is entirely determined by the amount of value created by the product in the eyes of the customers. Lean accounting methods enable value-based pricing (target pricing).

Evaluation of Lean Accounting and management Information systems

Criteria to use

16. The purpose of Lean Accounting is to fundamentally change the accounting, control, and measurement processes so they motivate lean change and improvement, provide information that is suitable for control and decision-making, provide an understanding of customer value, correctly assess the financial impact of lean improvement, and are themselves simple, visual, and low-waste. Lean Accounting does not require the traditional management accounting methods like standard costing, activity-based costing, variance reporting, cost-plus pricing, complex transactional control systems, and untimely and confusing financial reports. These are replaced by

lean-focused performance measurements

simple summary direct costing of the value streams decision-making and reporting using a box score financial reports that are timely and presented in "plain language" that everyone can understand radical simplification and elimination of transactional control systems by eliminating the need for them driving lean changes from a deep understanding of the value created for the customers eliminating traditional budgeting through monthly sales, operations, and financial planning processes (SOFP) value-based pricing (see below) correct understanding of the financial impact of lean change

As an organization becomes more mature with lean thinking and methods, they recognize that the combined methods of Lean Accounting in fact creates a Lean Management System (LMS) designed to provide the planning, the operational and financial reporting, and the motivation for change required to prosper the company's on-going lean transformation.The Strategy Clock http://www.innovationforgrowth.co.uk/Blog/?p=671 (analysed and explained in terms of operations and strategies,

costs and prices, profit and loss)Beyond Lean http://beyondlean.wordpress.com/tag/5s/Lean accounting http://www.pcb.org.za/upload/files/what-is-lean-accounting-maskell.pdfSOFP http://www.hitachiconsulting.com/files/pdfRepository/WP_SalesOperationsPlanning.pdf

f) Define and discuss the merits of, and potential problems with, open and closed systems with regard to the needs of performance management. [2]Focus notes:- define- show the control value of - insights from systems theory and cybernetics

Open system

17.An open system exchanges information and inputs with its environment, influences and is influenced by it. For example, an organization is influenced by its environment on which it depends for the factors of production and for its customers. It produces goods and services which the environment benefits from while at the same time could be a pollutant and source of other hazards.

18. The concept of open and closed systems derives from general systems theory which seeks to explain the way organisations work using an “organic analogy: the organization was viewed as a living organism that was open to its environment and that survived by the exchange of materials and information with its environment” p 47, Accounting for Management Control, Emmanuel et al

19. The value of the open system concept can be seen both internally and externally. Internally it provides guidance in identifying and integrating activities for the survival and prosperity of the organisation. For example, ERP systems are built on the open system approach, allowing integration of internal sub-systems to provide timely information for decision-making to exploit the opportunities and counter threats in the external environment.

20. Externally, the open system concept provides guidance in identifying value networks for supporting the organisation’s purposes. This is in keeping with Porter’s Value Framework which suggests that organisations should look beyond their own value chains and exploit cost saving and value creating opportunities in the wider environment. Organisations that are able to do this effectively and consistently can develop sustainable competitive advantages over their rivals.

21. The interaction with the environment brings benefits as well as risks that must be proactively managed through strategic management.

Closed system

22. A closed system on the other hand does not exchange information, inputs or outputs with its environment. Such a system hardly exists and if it does it is bound to be inactive and incapable of performing tasks. An approximation of a closed economic and political system was the Communist system of the Soviet republics which failed because it could not grow and produce the goods and services needed by its own people due to excessive restrictions on production and ideas.

g) Highlight the ways in which contingent (internal and external) factors influence management accounting and its design and use.William Richard Scott describes contingency theory in the following manner: "The best way to organize depends on the nature of the environment to which the organization must relate".

Focus notes:- Review contingency theory in Wikipedia- Adopt value based-approach and argue its merits- Identify contingent factors inherent in strategic direction- Identify contingent factors incidental to strategy implementation-

23. Contingency theory suggests that the design and use of management accounting systems is influenced by situational factors that are specific to an organisation (internal environmental factors e.g. culture, stakeholder expectations, strategic capability, product mix, lifecycle of products) and environmental factors (external factors such as the strength of competition, industry structure, requirements of legislation, PESTEL factors). The success of the system depends on how well these factors are accommodated in its design and use.

24. The best way to study the impact of contingent factors on the design of management accounting systems is to study the ways in which the organization goes about creating value – the value based approach. In commercial organizations this is about generating cash; in not for profit organizations creating value means providing best value to clients e.g. as a social landlord this means providing best housing services to tenants. The following table shows the interaction between value-creating strategies contingent factors and the design of management accounting systems.

Contingent factor

Strategy Management Accounting Implications

Cost leadership JIT strategic goals:- focus on entire value chain; influence

or re-configure it to reduce costs by reducing inventories and waste and lead time

- emphasize continuous improvement- reduce inventory and WIP- reduce unused floor space- reduce idle and unused plant capacity

Lean accounting:- simplified product costing no need for ABC, little

need for overhead cost allocation when computing actual product costs by value stream;

- supports creating value for the customer by costing the entire value stream, not products or departments, thereby eliminating waste in the accounting process

Kaizen budgeting: build target reductions in costs into the budget and empower staff to achieve them, See Horngren p. 221-3

Focus on value streams: develop organizational structures (e.g. manufacturing cells in JIT systems that group together all the operations needed to make a given product or product line) and costing systems e.g. backflush costing p741-7Value Stream Assessment ProcessValue stream mapping - Wikipedia, the free encyclopediaSupply chain responsiveness matrix - Wikipedia, the free encyclopedia

Cost leadership Conventional management techniques - goals

- promote operational efficiency through standard costs and detailed variance analysis

-

Standard costing and variance analysis; structural cost driver analysisFlexible budgeting: resources allocated conventionally by functions without strategic grouping to reflect value engineering as in JITFeedback controlProduct costing and pricing

Inventory levels and cost are significant and a factor in profit determination

Differentiation

Culture

Structure

Competitive pressures

Strategic goals:- Maintain market share- Innovate to survive and increase value

to the customer through product enhancement and cost reduction

Strategic management accounting, producing outward and forward information that allows proactive management of profitability and capacity:

- Levels and trends in relative costs, market

share, volumes, innovative strategies and capabilities

- Strategic variance analysis- Management accounting information integrated

with other relevant information to produce a rich and composite picture of competitive position and how it is changing relative to competitors

- Explicit focus on value chain and value drivers to maximise value to the customer and manage costs. Examples: Merger of KLM and Air France; Walmart

Strategic status Harvest: mature and declining product, threatened by substitutes

- Strong focus on profit performance and cash flow.

- Control over discretionary expenditure; rein in costs to keep profits up while sales decline

- Budgets not a priority as control is focused on cost management and all costs are known and predictable

- Cost allocation not a significant issue- Pricing is cost based plus mark-up as all costs

must be covered to avoid a loss from which the firm cannot recover.

Innovate: new products and services under development; new product launches

- Strong budget and performance management focus to track progress and take timely corrective action

- Flexible budgeting to reflect uncertainty of new product and research activity

- Flexible pricing to adapt to changing market conditions

- Standard costs predominantly for learning; adjustable to take account of progress on the learning curve

- Strong focus on cash flowDivest from industry - Similar to harvest

- Some investment to enhance product or service quality prior to sale

25.

h) Evaluate how anticipated human behaviour influences the design of a management accounting system [3]“…one of the aims of this book is to encourage students to think more diversely, to think of managerial accounting as being more than a set of technologies.” W&C, p9 To understand the purposes of the technology, the context in which the technology is developed and applied, the conflicts and risks attendant upon its application and the observed and anticipated defects and deficiencies.

Focus notes:- What is a) management accounting? b) What is it for?- What factors influence human behaviour in relation to budgets and performance management? Needs: Empowerment,

participation, control, accountability, influence, job satisfaction, avoidance of blame; Perceptions: how performance will be judged and rewarded or punished, budgets are a strait jacket;

- How do people actually behave?- How is human behaviour likely to affect performance management? Responsibility accounting- What is the relevant published research?

Budget planning and implementation

26. People tend to use budgets as sources of power and prestige: the more resources a manager has the more powerful he is perceived to be. Consequently, people tend to inflate their budgets and to use all of their allocated budgets regardless of need, to avoid cuts. To avoid the problem of slack one strategy used in the design of management accounting systems is to work out a relationship between inputs and outputs. Inputs being the resources needed to deliver certain outputs; and outputs are the products to be manufactured and the services to be delivered defined so that they can be measured. For example, outputs could be number of hours of teaching time, area of streets to be cleansed, etc.

27. The management accounting systems can then be used to monitor and evaluate performance to determine to what extent the actual input/output relationship matches the planned input/output relationship. Variance analysis provides an opportunity to learn about the level of resource allocation: whether it was adequate or excessive. The necessary adjustments can then be made through a variety of means including negotiation, standard costing and motivation.

Participation and motivation

28. People perceive budgets as a means of judging their performance and tend to develop negative attitudes towards budgets as a result. For example, a manager tasked with achieving budgeted sales would be satisfied with reaching the target and would not necessarily push to exceed targeted performance unless explicit rewards exist for doing so. Often managers would not be motivated to reach budget targets and may even challenge them, particularly when they involve stretching beyond their normal performance levels.

29. To overcome this limiting problem managers should be fully involved in setting budgets that they own and are committed to delivering. Because managers’ detailed knowledge and insights underpin the assumptions and estimates, budgets are more likely to be realistic, achievable and stretching. Achievement breeds job satisfaction; blame is avoided and employees feel empowered because they have a say in how their performance will be measured and evaluated.

30. Incentives should reflect the trade-off between creating incentives and imposing risk. This requires an assessment of the employees risk appetitive and designing adequate incentives to achieving desired levels of performance. The incentive mix tends to consist of basic salary and performance bonus. This strategy tends to work with both risk averse and risk preferred employees.

Responsibility and accountability

31. Ownership and control of budgets should be backed up by clearly defined responsibilities and accountabilities which are the basis of responsibility accounting. Stakeholders need assurances that people running the organisation are in control and discharging their fiduciary duties for the benefit of stakeholders and not for themselves. The system of accountability designed as part of the management accounting systems should be sensitive to this and incorporate appropriate checks and controls as well as performance indicators to demonstrate that stakeholder expectations are being met.

Standard costing

32. Standard costs are set based on the assumption that employees who have fully learnt a set of skills will remain in employment and carry out those tasks in future at the required level of expertise. If employees leave

standard costs need to be revised to reflect the new learning curve. Hence the incentives for employees to stay within the company should be built-into the management accounting system.

i) Discuss the impact of responsibility accounting on information requirements [2]33. See discussion in b