Copyrighted material Part 1 The contemporary business world 1

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1 v Contents About the authors Foreword Preface List of figures List of case studies List of abbreviations ix x xi xiv xvi xvii Part 1 The contemporary business world 1 Chapter 1 The nature of business organisations and organisational management 3 The purpose of this book 3 The nature of business organisations 4 Organisational design 6 The main departments/functions of a business organisation 16 The structure and content of this book 19 Conclusion 20 Chapter 2 The evolution of the contemporary business world 21 Introduction 21 The drivers of change in relation to business 22 Political drivers 22 Economic drivers 23 Societal drivers 25 Technological drivers 26 Legislative drivers 28 Environmental drivers 29 Impact on the business sector 30 Business configuration 30 Business location internationalisation/globalisation 31 Business operations and management 33 Key issues for management accounting 36 Conclusion 36

2 vi Contents Chapter 3 The nature of management accounting in business organisations 37 Introduction 37 The nature of accounting in business organisations 38 The basic accounting divide in organisations 38 The nature of management accounting 40 The roles of management accounting in business organisations 41 Dimensions of organisational management and management accounting 42 The role of the management accountant in contemporary business 43 Conclusion 48 Part 2 Tactical and operational management accounting in the contemporary business world 49 Chapter 4 The basic principles of cost information and cost management 51 Introduction 51 The emergence of cost accounting: the need for product (or service) cost information 51 Cost concepts 53 Traditional costing approaches 55 The shortcomings of the traditional approach and the emergence of activity based costing (ABC) 58 The use of marginal costing 66 The various costing approaches in practice 69 Conclusion 70 Chapter 5 Contemporary business costing issues 71 Introduction 71 Costing under traditional production systems 71 Alternative costing approaches in contemporary production environments 74 Contemporary costing problems 79 Other contemporary costing developments 84 Conclusion 89 Chapter 6 Contemporary business tactical/operational planning and decision-making 91 Introduction 91 The distinction between the long run and short run in business planning and decision-making 91 The use of C-V-P analysis as a decision tool 93

3 Contents vii Marginal costing and contribution analysis for short-term decision-making 99 The principle of relevant costs for decision-making 103 The nature of capital expenditure decisions 107 The role (and limitations) of management accounting techniques 117 Conclusion 118 Chapter 7 Part 3 Contemporary business management accounting for tactical and operational control 119 Introduction 119 The nature of accounting control 119 The role and function of budgeting systems in business 120 Different approaches to budgeting 125 Budgeting systems and human behaviour and motivation 130 Working capital management 131 Standard costing and its relevance in today s business environment 133 Responsibility accounting 133 Divisional control and performance management 137 Conclusion 140 Strategic management accounting in the contemporary business world 141 Chapter 8 The nature of strategic management accounting 143 The development of strategic management accounting 143 The nature of strategic management accounting (SMA) 144 A framework for strategic management accounting (SMA) 146 Conclusion 149 Chapter 9 Internal and external analysis of the business and its environment 151 Introduction 151 External analysis of the business environment 151 Industry analysis 152 Competitor analysis 155 Benchmarking 157 Internal analysis of the business 158 Profitability analysis 160 Strategic cost analysis (SCA) 165 Getting comparator information 170 Conclusions 172

4 viii Contents Chapter 10 Strategy development and implementation 173 Introduction 173 The nature and composition of business strategies 173 Business models 176 Business integration 181 Competitive advantage 184 Conclusions 186 Chapter 11 The application of SMA to the development and implementation of business strategies 187 Introduction 187 Strategic cost improvement 187 Pricing strategy 191 Strategic capital investment appraisal 194 Strategic options analysis 200 Financial forecasting 201 Financial modelling 203 The role of budgeting systems in strategy implementation 208 Conclusion 209 Chapter 12 Strategy and Risk Management 211 The relevance of risk/uncertainty to strategy 211 The distinction between risk and uncertainty 212 Risk and strategic planning 212 Management accounting tools for supporting decisionmaking under conditions of risk and uncertainty 215 Conclusion 219 Chapter 13 Management control and performance management the strategic dimension 221 Introduction 221 The nature and purpose of management control systems 221 Linking management control to strategy 222 Approaches to strategic management control 223 Financial aspects of strategic management control 224 Strategic performance management 229 Conclusions 233 References 235 Index 239

5 3 1 The nature of business organisations and organisational management In this chapter, we will outline: The purpose of this book The nature of business organisations Organisational designs The main departments/functions of a business The structure and content of this book The purpose of this book The purpose of this book is to provide readers with a review of the state of the art of management accounting in business for the 21st century. In order to do so, we consider some of the important changes which have occurred in the business environment in the 20th century and how management accounting approaches may need to evolve further to accommodate these changes. Accounting historians differ with regard to the timeline of management accounting s evolution. Johnson and Kaplan (1987) argue that most of the management accounting tools comprising the conventional wisdom were formed by Bhimani and Bromwich (2010) contest this, arguing that the majority of tools now used were in place by the mid-1970s. Even if this later timeline is accepted, however, a number of major developments have occurred in the business environment since then that have implications for the relevance and applicability of management accounting. These developments include the following: Developments in technology have resulted in a changed cost structure for many organisations, with a majority of costs now being fixed, indirect or joint costs which are not attributable to individual products. This has created significant problems for traditional costing and costmanagement approaches. Technology changes not only the organisation itself but also the way in which organisations use technology to service the activity of accounting, which is now fundamentally different. Thus,

6 4 Management Accounting in the Contemporary Business World the development of data-processing systems has automated what used to be manual accounting functions. The dominance of service businesses (over manufacturing) in many developed economies, including the UK, with their distinctive characteristics, have implications for the application of a number of traditional management accounting tools such as product costing. The increase in uncertainty concerning the future has implications for some conventional decision-support tools and planning tools such as conventional budgets. The increasing importance of strategy has resulted from increased instability and complexity in the business environment, giving rise to the need for management accounting to adopt a more strategic orientation in comparison with its traditional emphasis on serving tactical and operational management. These developments call for new management accounting approaches in business organisations, which are considered in later chapters of this book. We also recognise, however, that many businesses still operate traditional business models for which traditional management accounting tools are relevant. We therefore consider both old and new management accounting tools in order to provide a comprehensive coverage of the field of management accounting. In order to understand the role that management accounting plays in organisations, it is necessary to understand the nature of organisations and their environment. Therefore, in order to provide the background and context to our study of management accounting, we will first look at the nature of organisations. The nature of business organisations The objectives and purpose of an organisation its reason for existence determine management s information needs and the management processes used. For example, the management of a business organisation whose primary objective is profit maximisation requires information on how efficiently resources are being used, what the financial costs and benefits of alternative possible courses of action are, which products or services and business segments are profitable and which are not. Consequently, in this section we will consider the nature, purpose and objectives of organisations in relation to the questions of: What is an organisation? Why do organisations exist? What types of organisation are there?

7 The nature of business organisations and organisational management 5 What is an organisation? An organisation is any group of individuals working to achieve a common objective or objectives. It consists of individuals and groups of individuals with collective goals; but it exists independently of its members, who may leave or join without affecting the nature of the organisation (Lucas, 2011). Mintzberg (1979: p. 24) considered all organisations to be made up of five components. These were the Strategic Apex, which would include the Chief Executive Officer (CEO) and other senior officers; the Middle Line, which is a group of managers who operationalise the objectives and broad plans of the senior management; a Technostructure, concerned with optimising procedures and quality control; a Support Staff, who perform administrative functions and provide legal advice, public relations, human resource functions etc.; and lastly, the Operating Core, which consists of the people who do the basic work of the organisation, either production or provision of services. Mintzberg s organisational model shows the separation of direction and management. Senior managers establish long-term objectives and policies to achieve the organisation s goals. Middle managers are responsible for turning these into detailed action plans, specifying managerial responsibilities and resource allocation for each task. They are also responsible for monitoring activities to ensure that resources are used efficiently and effectively, and that the organisation s objectives are being met (Lucas, 2011). Why do organisations exist? Organisations exist because groups of people working together can achieve more than they could achieve separately. For example, one person might struggle all day to move a load of furniture into a house, whereas a group of four people working together may do it in less than a quarter of the time of the individual because of the cooperative effort. However, such cooperation is only beneficial if individuals pull in the same directions, otherwise the results are counter-productive. Thus coordination is necessary and this is one of the fundamental roles of organisational management. Organisations may also exist to share certain transaction costs, since working cooperatively can then be cheaper than working as an individual. In crude terms, it may be cheaper to make or do something as a group because this cuts out the time-consuming process of negotiating terms and renegotiating them every time your requirements change (Lucas, 2011). What types of organisation are there? Broadly speaking, organisations may be classified into two types: for-profit and not-for-profit. For-profit organisations some of the profits earned by a for-profit organisation may be retained within the organisation for re-investment.

8 6 Management Accounting in the Contemporary Business World However, the essence of a for-profit organisation is that the bulk of the profits will accrue to the owner(s) of the organisation, whether that be a sole trader, a partnership or a company. Not-for-profit organisations the name suggests that such organisations do not make profits, but this is not necessarily the case. A not-forprofit organisation, while it may be profit-making, is a type of organisation that does not earn profits for distribution to owners. All of the money earned by or donated to a not-for-profit organisation is used in pursuing the organisation s objectives. Such organisations include: charities, clubs, cooperative firms, social enterprises, some commercial organisations and public sector organisations which are owned, funded and run by central or local government. Examples of public sector organisations are hospitals, the armed forces, schools and government departments that provide goods or services which are considered undesirable (or impossible) for for-profit organisations to provide. Commercial organisations, charities and social enterprises have to generate sufficient funds from their activities to sustain themselves, whereas public sector organisations are largely funded by government. However, constraints on government expenditure mean that resources are limited, so that nearly all organisations need to be run as economically, effectively and efficiently as possible. Therefore, many of the same management principles are employed by both the for-profit and the not-for-profit sectors with the result that extensive use of management accounting is required. Nowadays the distinction between sectors is becoming increasingly blurred. Commercial organisations now commonly demonstrate social responsibility in order to satisfy their various stakeholders, and many not-for-profit organisations adopt commercial criteria to ensure sound financial management of scarce resources (Lucas, 2011). In this book we will be primarily concerned with business organisations, but it is important for readers to be aware that much of the management accounting we discuss is also relevant to not-for-profit organisations, even though their raison d être may be different. Organisational design The design of an organisation determines who needs what accounting information, in other words, the management accounting system (MAS) design. For example, in a decentralised organisation consisting of a number of separate responsibility centres (e.g. profit centres, cost centres and so on): Individual responsibility centre managers will need information tailored to their specific needs to help them make decisions relevant to their particular area of operations;

9 The nature of business organisations and organisational management 7 Senior management will require regular feedback information on how well various responsibility centres are performing in pursuit of organisational objectives. In highly decentralised organisations, for example, authority for decisionmaking is delegated to relatively junior managers. It follows, therefore, that a major function of the organisation s MAS will be to monitor the outcomes and provide feedback to senior managers about the performance of those with delegated authority to make decisions. This is not necessary in a highly centralised organisation where senior managers make all the important decisions; but in such organisations those senior managers still need meaningful management accounting information as the basis for their decisions. Under the heading of organisational design we cover the following themes: Organisational structures Organisational processes Organisational cultures Specific aspects of organisational design The organisational environment. Organisational structures Organisational structure is the relationship between the different functions and positions in an organisation. The structure determines who has authority and responsibility for particular tasks and activities. It also specifies the channels of communication between different parts of the organisation. It therefore has important implications for the design of an MAS (Lucas, 2011). With the emergence of large industrial enterprises in the 19th century, management theorists began to consider how organisations could best be designed and managed. Henri Fayol (1949) attempted to derive universal prescriptions for the optimal design of organisations. More recently, theorists have realised that differences are created by size, production technology, stability of the organisation s business environment and so on. These variables make a difference as to whether organisations are tall or flat, centralised or decentralised etc. (Lucas, 2011). Ultimately, organisational structure is a means of influencing and controlling the behaviour of the individuals who work in that organisation. It assigns authority and responsibility to individuals who may be held accountable for the achievement of specific tasks or objectives (Emmanuel et al., 1990: p. 38). Management accounting is very important in organisations, because it provides managers with the information they need to carry out the various

10 8 Management Accounting in the Contemporary Business World activities for which they are responsible. It is also an important part of performance management, to ensure that the organisation is on course to achieve its objectives (Lucas, 2011). The vast majority of organisations (of any significant size) employ the following principles. Specialisation Particular individuals or sections concentrate on specific tasks or activities. This enables the application of specialised knowledge, which improves organisational efficiency and effectiveness. Coordination It is necessary to ensure that the different areas and operations of an organisation are coordinated, so that the actions of individuals are consistent with each other and working towards the same organisational objectives. The management hierarchy or chain of command coordinates the various departments/functions and their activities. Management principles of the hierarchy of authority Management theorists have developed principles concerning the hierarchy of authority for coordinating activities (Lucas, 2011). Some of the most important are as follows: Unity of command each person should receive orders from and be accountable to one superior only, in order to avoid conflict and confusion. However, this general principle is not necessarily followed in situations where a matrix organisational structure requires the practice of managing individuals with more than one reporting line. The scalar chain there should be a clear line of authority from top to bottom of an organisation, so that all managers at all levels are linked. The responsibility and authority principle if a member of an organisation is allocated responsibility, they should also be given the authority necessary to carry out the tasks involved. They should also be held accountable for the outcome. Span of control the number of subordinates reporting directly to a manager or superior should be determined by: the nature of tasks, the similarity of tasks or functions which they undertake, the proximity of the tasks to each other and to the supervisor, and the complexity of the tasks. Tall versus flat organisations Organisations with a large number of levels of management are said to be tall. These tend to have narrow spans of control with a few people reporting directly to each manager. Organisations with a small number

11 The nature of business organisations and organisational management 9 of levels in the management hierarchy are said to be flat. These usually have wide spans of control with many people reporting to each level of management. In the last few years there has been a trend towards delayering, with tall organisations becoming flat by removing various levels in the management hierarchy. Information technology has reduced the need for many middle management jobs which were largely concerned with processing information to facilitate control within the organisation. Also, the management philosophy of empowerment has resulted in people at lower levels being allowed to make decisions which would previously have been taken by middle managers. The advantages of delayering are: Significant cost savings on middle managers salaries. Increased motivation, as people are given more discretion to make their own decisions. This is likely to result in improved performance. Improved communication between senior management and operational levels, which is increasingly important in a fast-changing, uncertain and highly competitive external environment. The main disadvantage of delayering is a possible loss of control. Middle managers are often needed to translate the broad general plans of senior management into operational plans. Senior managers have only a vague understanding of what is going on at the operational level. A great deal is therefore entrusted to relatively junior staff (Lucas, 2011). Forms of organisational structure The six main forms of organisational structure are (Lucas, 2011): functional structure matrix structure project teams product or service structure geographical structure hybrid structures. A functional structure is where people are grouped according to the type of job they do. This structure may be appropriate when people within functional departments need to communicate regularly with each other. For example, in a marketing department, the marketing director will coordinate the activities of marketing specialists in fields such as promotion, advertising, product design, market research and packaging. Although there is a need for communication with all the other departments, most of the information exchange and communication will be within the functional areas, so it makes sense to group these people together.

12 10 Management Accounting in the Contemporary Business World There can be disadvantages to functional structure, however. Since career paths tend to develop through functions, managers may not be aware of other issues facing the organisation. The organisation will not develop many generalists, and, consequently, managers will not have an overview of its operations. This could expose the organisation to significant risks. Staff will tend to work for the benefit of their department and not for the organisation as a whole. In addition, many members of staff may never meet an external customer and may not, therefore, understand the importance of customer service. In a product or service structure, members of staff are grouped along product or service lines. This is quite common in larger organisations where, for example, a big accountancy firm may group staff by the industry served or an education department may group staff according to the age or group of children they deal with (e.g. pre-school, primary, secondary or special needs). Each group will have its own production, service, accounting and human resources staff. This type of structure can be more responsive to customer needs and better at motivating staff. However, there is a danger of creating independent units which can be difficult to manage. It can also mean that professional expertise becomes fragmented. For example, if each product line has its own small accounting team, this may reduce career opportunities for specialists. A third variation is to group staff by geographical location, for example by region, country or continent. This has advantages for international organisations because there are likely to be big differences in markets, languages and cultures. National issues are usually best identified locally. However, there are several disadvantages to structuring by location. Information flows between staff in different locations can be costly and problematic. There may be duplication of activities, typically support functions such as accounting, human resources and information technology. It may be difficult to achieve integrated strategies across a number of different countries. A matrix structure is an attempt to overcome the disadvantages of the three structures discussed so far. Each person has two reporting lines, firstly to the functional head and secondly to a project, product, service or regional manager. These dual reporting lines are permanent. Advocates of matrix structures believe that they combine the advantages of functional and product or service structures. There are, however, problems associated with a matrix structure. Firstly, heads of reporting lines may need to meet regularly to decide how to apportion their time. Secondly, there may be differences of opinion between heads of reporting lines, while staff, on the other hand, may feel uncomfortable with the change and uncertainty inherent in having two bosses in a matrix structure. In practice, matrix structures can be very difficult to manage. Dual reporting may lead to conflict, confusion and overlapping responsibilities. This can then result in a loss of accountability.

13 The nature of business organisations and organisational management 11 Matrix structures can suffer from low responsiveness, slow decision- making and high levels of internal political conflict. On the other hand, they can force people to work flexibly across functional boundaries, which may result in some productivity benefits to the organisation and thus outweigh the potential disadvantages. Project teams are often set up to react to changing circumstances and allow an organisation to respond quickly. They are organic structures rather than the mechanistic structures previously described. Project teams draw staff from across the organisation, seconded on a full- or part-time basis. Part-time secondment is often very stressful for an individual who effectively gets two jobs for the life of the project. It is similar in structure to a matrix system in that there are two reporting lines, but a very important difference is that it is not permanent. Since the project teams only last as long as the projects on which they are working, there can be problems of control; on the other hand, fast-moving changes can be implemented as a result of the flexibility and speed of response that this sort of structure can give. In practice, changes to the structure of organisations tend to occur as they evolve. A hybrid of functional and product or service structures is common and might include internal functional departments with the rest of the company organised on a product, service, geographic or project basis, as required to meet the needs of the customers (Lucas, 2011). Organisational processes Organisational processes are those flows of activity that must link together for the organisation to be successful. Many would argue it is organisational processes and not structures which are the fundamental building blocks of all organisations, and both process understanding and process improvement form the lifeblood of organisations. Subsequently, they would argue that the first stage in organisational design is not structure but the development of the various processes needed to get the organisation to function (e.g. procurement, distribution) and to then build the organisational structure around those processes. All such processes transform inputs, which can include actions, methods and operations, into outputs. Everything we do is a process, whether it is documented or not, and in each area or function of an organisation there are many processes taking place. These processes interact with other processes throughout an organisation, as outputs from one process form the inputs to another. Organisational cultures An important feature of organisations, with implications for management accounting, is organisational culture. The culture of an organisation consists of its customs, values and norms of expected behaviour i.e. the way

14 12 Management Accounting in the Contemporary Business World we do things around here (Lundy and Cowling, 1996). Different cultures will tend to result in different management styles and, consequently, in different approaches to management accounting. For example, many small businesses, with the feel of an extended family, rely on informal relationships. There is little formal structure, and the culture depends on trust and personal contact rather than formal controls (Emmanuel et al., 1990). In such organisations there is likely to be very limited use of management accounting particularly of management control tools such as budgets and performance measures (financial and non-financial). Many large, bureaucratic organisations, on the other hand, are characterised by what Handy (1985) called a role culture. In such a culture, the emphasis will be on formal procedures and accounting controls (such as budgeting and performance measurement systems). It should be noted, however, that size is not the only determinant of organisational culture; some large organisations are far more informally structured and flexibly managed than others and will tend to rely more on informal controls such as peer group pressure and trust rather than on formal procedures and accounting controls. The relative importance of management accounting in managing different organisations (and perhaps even different parts of the same organisation) will therefore vary. Specific aspects of organisational design In contemporary organisations, flexibility and speed of decision-making have become increasingly important, which has led to a number of developments (Lucas, 2011) discussed below. Flattening of structures removes levels in the organisational hierarchy. This shortens the chain of command and increases the speed of decision-making. Multifunctional project teams and an empowered, multiskilled workforce increases flexibility. A customer service orientation rather than an inward internal process orientation has developed. The flexible firm has emerged. Flexible firms consist of a small core of permanent staff which organises and directs the organisation s affairs, supplemented by various levels of contract workers to carry out the routine operations of the organisation. In an increasingly competitive environment, continuous reduction in costs is essential, so full-time, permanent, salaried staff have been replaced by temporary and parttime contract staff. This allows greater flexibility as labour can be hired or laid off as demand fluctuates. It also provides substantial savings in pension, health insurance and holiday pay.

15 The nature of business organisations and organisational management 13 The organisational design of the company emphasises a strong degree of informality and flexibility, and the organisation may evolve frequently and easily in response to changing priorities and pressures. Such a culture will put a premium on such things as innovation at the expense of formality. Organisational boundaries have become increasingly blurred as a result of an increase in outsourcing. Ever-increasing competitive pressures have led to a continuous search for greater efficiency and reduced cost. Many businesses have responded by outsourcing non-core activities (such as Finance, Procurement, Marketing and so on) to specialist organisations with superior expertise and economies of scale (and hence lower costs). Successful outsourcing, however, usually requires working closely with the external vendor to develop and improve business processes, rather than just handing them over to a third party and letting them get on with it (CIMA, 2010). This trend has created an important new role for management accountants in: oo Cost analysis of the various non-core business processes, to identify those which might be performed at a lower cost by outsourcing rather than in-house; oo Inter-organisational cost management (IOCM), as part of the ongoing relationship once a business process has been outsourced to an external party. IOCM involves working closely with people in other organisations in order to plan and control the costs of activities that cross organisational boundaries. The internal structure of many organisations has changed significantly (in comparison with the traditional divisionalised organisation structure) as a result of the increased use of shared service centres (SSCs). In a traditional divisionalised organisation, each business unit has (in addition to its core operations) its own service departments (Finance, Purchasing, HR, IT and so on). SSCs are created by taking these out of the individual business units and creating a large, shared service function to serve all business units. So, for example, there will be a single organisation-wide Finance function, Procurement function and so on. The use of SSCs can achieve similar benefits to outsourcing in terms of specialised expertise, technology and economies of scale. Crucially, however, it (unlike outsourcing) allows management to retain complete control, where this is considered essential. A significant factor encouraging mergers and acquisitions (M&A) in recent years has been the perceived cost reductions resulting from the increased operating efficiency and avoidance of duplication provided by SSCs. Management accountants also have a role to play in cost analysis of the various service departments to identify potential candidates for consolidation into SSCs, in order to reduce costs and improve performance.

16 14 Management Accounting in the Contemporary Business World Decentralisation and centralisation Within business organisations, there is very often a tension between the pressures of centralisation and decentralisation of authority and decision-making. Centralisation is common in smaller businesses where the owner manager takes all the important decisions, but can also be found in some large organisations even though it can be difficult for large organisations to operate successfully in a fully centralised manner. Decentralisation is when authority to make decisions is delegated to people at lower levels of an organisation. Growth and increased complexity often lead to decentralisation. It is usually present to some degree in most organisations, and it has several advantages. Specialisation by managers should result in better quality decisions. Timelines are improved because junior managers can make decisions more quickly and senior managers have time for more important decisions affecting the whole organisation. Having authority to make decisions usually results in greater motivation and commitment, which leads to improved performance. Less experienced managers also have the chance to learn their trade without their mistakes jeopardising the whole organisation. Any misjudgements will only affect a limited aspect of the organisation s operations. Finally, if an organisation is divided into separate segments, it is easier to evaluate which areas are performing well and which are not. There can also be disadvantages of decentralisation, however. Managers may improve the performance of their organisational segment while damaging the organisation as a whole. For instance, a manager may keep costs down in his own department but provide a lower quality of service to other departments. There is a danger that senior management may lose control of the organisation as they become too far removed from the detail of underlying operations. Costly management information systems may also be needed to monitor the performance of lower management levels to ensure that delegated decision-making is in the best interests of the organisation. In many types of organisation there has been a strong tendency to adopt increasing amounts of decentralisation as an aid to management decisionmaking. However, the use of modern IT and communication systems has, in some cases, resulted in a resurgence for some degree of centralisation because of the economies of scale which can be realised. Responsibility Centres Decentralisation leads to the creation of separate responsibility centres: areas of the organisation s operations for which a particular manager is responsible. There are, in commercial organisations, four common types

17 The nature of business organisations and organisational management 15 of responsibility centre: cost centres, revenue centres, profit centres and investment centres. The manager of each cost centre will be judged according to how well costs are controlled. They will need regular information provided by the accounting system, such as budget variance reports and budgetary planning information including cost targets to be achieved. The manager of each revenue centre is expected to influence significantly the level of revenue earned and will be judged on this basis. Managers are responsible for generating income through meeting sales targets. They will need feedback on actual versus budgeted revenues. The manager of a profit centre is assumed to be able to influence costs and revenues and is judged on the basis of the level of profit generated. Managers, therefore, need information concerning both revenues and costs to determine which products or services are profitable. An investment centre is a type of profit centre where a manager also has significant influence on investment decisions. Such a manager would be judged not only by return on sales but also by return on investment. In addition to the information needed regarding profit centres, managers need detailed appraisals of potential investments and control information concerning the level of investment, for example, working capital levels (inventory, receivables, payables) at a particular point in time. The divisionalised organisation An organisation may be separated into a number of investment centres that operate almost as independent businesses, each with its own profit responsibility. The basis of divisionalisation may be the product, service or geographical area. Each division will usually have its own functional structure. Where authority and control are exercised from above and passed down through the hierarchy, the resulting relationships are known as line relationships. Staff relationships exist, on the other hand, when a manager gives or receives advice from another member of the organisation. For example, the Accounting and Finance manager will provide information and analysis to help the marketing and production managers make decisions and control their operations (Lucas, 2011). The organisational environment The information needs of an organisation s management will also be influenced by the (external) environment in which it operates. For example, as will be discussed in later chapters, economic factors (including government economic policy) and demographic trends will influence the demand for a business s products or services. Technology developments will influence the choice of the most efficient/economic production methods and perhaps also the choice of selling and distribution channels.

18 16 Management Accounting in the Contemporary Business World The main departments/functions of a business organisation In order to provide managers with the relevant information to enable them to plan and control activities and make informed decisions, management accountants require a good understanding of what the main departments/functions do. This is particularly the case with the emergence, in recent years, of the concept of the management accountant as business partner. Traditionally, management accountants were based firmly in the Accounting and Finance department, providing generic financial information which they considered appropriate but which was often not meaningful or useful to other functional managers in running their departments. Increasingly, accountants have been coming out of their silos and working closely with other functional managers as part of their team. So, for example, one accountant would work closely with the Marketing function, another with the Operations function, another with HR, providing customised information and analysis for the respective functional needs. Acting in this way as a business partner requires accountants to have a detailed knowledge and understanding of the operations and technology of the various business functions. Consequently, in this section we will consider the activities of the main departments/functions of a business organisation. In order to understand the role of management accounting in an organisation, it is necessary to have an appreciation of the purpose and activities of the departments within it. Management accounting is concerned with providing managers with information to help them undertake their activities and monitor the impact of their activities on the organisation. Therefore, a well-designed MAS must be based on an understanding of what managers actually do (Lucas, 2011). A typical business organisation will consist of the following main departments or functions: Operations Research and Development (R&D) Procurement Marketing (including Sales) Human Resource Management (HRM) Accounting and Financial Management. The Operations function This is the part of the organisation that undertakes the activities necessary to provide the organisation s products or services. Service organisations such as banking, professional firms of accountants and solicitors have a number of distinctive features which have implications for how they are managed.

19 The nature of business organisations and organisational management 17 Services are less easy to standardise than manufactured products, so service quality tends to be more variable. This makes motivation of staff more critical. Services cannot always be precisely measured or assessed, which can make attracting customers more difficult, since it depends on promoting something intangible. Services cannot be stored but must be consumed as they are produced or wasted. This creates additional problems in matching productive capacity with demand. Although there may be differences in the nature of operations between a manufacturing and a service organisation, they are both fundamentally concerned with transforming various resource inputs (raw materials, people, technology, energy and so on) into a range of outputs products and services. The main responsibilities of the operations function are: Production/service planning and scheduling Control and supervision of the production/service workforce Managing product/service quality (including process control and monitoring) Maintenance of plant and equipment Control of inventory (in a manufacturing organisation) Deciding the best production methods and factory layout (in a manufacturing organisation). The Research and Development (R&D) function This is concerned with developing new products and processes and improving existing ones. R&D and Marketing must be closely coordinated to ensure that the organisation is providing exactly what customers want, efficiently, effectively and economically. The Procurement function This is concerned with acquiring goods and services for use by the organisation for its own internal functions or for the production and distribution of its products. The latter includes raw materials and components for manufacturing and production equipment. Procurement for internal functions involves buying for the whole organisation items such as office equipment, furniture, computer equipment and stationery. Procurement managers must take into account the purchasing mix : quantity, quality, price and delivery. Buying large quantities can attract price discounts and prevent inventory running out. On the other hand, there are substantial costs involved in carrying a high level of inventory. There will usually be a trade-off between price and quality, and decisions will have to be made in cooperation with other departments. Supplier reliability must also be taken into account in order to achieve best value. Lead time can also be critical for production planning and scheduling. The purchasing mix involves making sure that the

20 18 Management Accounting in the Contemporary Business World organisation has the right amount, of the right quality, at the right price, at the right time. The Marketing and Sales functions These two functions are distinct but related. Marketing is concerned with identifying and satisfying customers needs at the right price. It involves researching what customers want and analysing how the organisation can satisfy those wants. By contrast, selling involves persuading customers that your products or services provide the benefits that they are looking for. Marketing activities range from the (long-term) strategic, concerned with the choice of markets and how to compete in them for example on price or product differentiation, to the (day-to-day) operational, arranging sales promotions, producing product catalogues and brochures and placing advertisements in the appropriate media. Having invested so much in customer-focused marketing, the company must then sell the benefits of its products to customers. This involves advertising and promotion to communicate product benefits. It involves providing the appropriate support literature and direct selling to retail outlets that will stock the product. The sales force is effectively selling the benefits of the products. These benefits were developed as a result of market and product research. Marketing and sales therefore go hand in hand. The Human Resource Management (HRM) function Fundamentally, the HRM function has a key responsibility to ensure that the human capital of the business is suitable for the task. It is concerned with employee recruitment and selection; training and development; employee relations; grievance procedures and disciplinary matters; health and safety; and redundancy procedures. In recent years, the HRM function has become more important, as there is an increasing need to get the most from employees in terms of customer service for the benefit of the organisation. Increasingly, human capital is replacing physical capital (plant and machinery) as the primary source of customer value creation. The Accounting and Financial Management function At one level, this is concerned with financial record-keeping of transactions involving monetary inflows or outflows; preparing financial statements such as the income statement, balance sheet and cash flow statement; calculating tax due on business profits; payroll administration, including income tax and national insurance records. At another level it is concerned with preparing accounting information and analysis to help managers plan, control and make decisions in other words, management accounting.

21 The nature of business organisations and organisational management 19 The structure and content of this book This book is divided into three parts, as follows. Part 1 looks at the nature of organisations, the business environment in which they operate (including trends in that environment in recent years with implications for management accounting) and the nature and role of management accounting in organisations. In this chapter we have considered the nature of organisations and their environment, in order to provide the background and context for our study of management accounting in later chapters. The structure and content of the rest of the book are as follows. In Chapter 2 we look at the major trends in the contemporary business environment which have implications for the evolution of management accounting; these are reflected in a number of subsequent chapters where specific management accounting methods/techniques are considered. Chapter 3 considers the nature and role of management accounting in business organisations in the context of the role and functions of management. Part 2 considers management accounting tools for supporting tactical and operational management. It is sometimes thought, by some people, that management accounting in contemporary business just concerns strategic management accounting only. This is not the case; tactical and operational management accounting practices have also been altered by the changes discussed in Chapter 2. While many of the techniques are the same, their mode of practice and relevance have sometimes altered. In this part of the book we look at the practice of operational and tactical management accounting in the contemporary business environment. Chapters 4 and 5 are concerned with costing and cost management, and Chapter 6 considers management accounting tools for supporting tactical and operational planning and decision-making in contemporary business. Chapter 7 then discusses methods and techniques of tactical and operational management control such as budgeting. Part 3 considers management accounting tools for supporting strategic management. In order to do so, it discusses in some depth the nature of strategy and the processes involved in strategic analysis, strategy development and implementation, and strategic control. Chapter 8 considers the limitations of traditional management accounting for supporting strategic management and discusses the emergence of strategic management accounting. Chapters 9 to 13 then discuss various aspects of strategic management (strategic analysis, development and implementation of strategy, and strategic control) and consider some important management accounting tools which can support the strategic management process. Chapter 9 is concerned with

22 20 Management Accounting in the Contemporary Business World the strategic (internal and external) analysis of the business and its environment. Chapters 10 and 11 consider the process of strategy development and implementation and the contribution of strategic management accounting (SMA). Chapter 12 looks at the problems of risk and uncertainty in strategic planning and at some management accounting tools for dealing with risk and uncertainty. Finally, Chapter 13 discusses strategic management control and strategic performance management, including management accounting tools that can contribute to these processes. Conclusion This chapter has established one aspect of the context of this book, namely the role, nature and function of organisations and, in particular, business organisations. It has looked at various themes concerning organisations, including structures, processes and cultures as well as considering some specific aspects of organisational design. It has also considered the main departments/functions of a business organisation and the nature of the organisational environment. All of these matters (and especially recent trends concerning organisations, such as, for example delegation of authority) have relevance to the practice of management accounting. As well as introducing the book, this chapter has attempted to provide a reasonably comprehensive understanding of the nature of business organisations and the way they are designed. An understanding of the nature of organisational design and development is an essential pre-condition to understanding the nature of management accounting in business organisations and the ways in which the effectiveness of the management accounting function may be optimised. The chapter has also provided a guide to the remainder of the book. In the next chapter we discuss, at some length, the forces which have impacted on business over the last few decades and the implications for business and management accounting practices.