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Evolution of Cost and Management Accounting

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131 views3 pages

Evolution of Cost and Management Accounting

Uploaded by

houryaslm
Copyright
© All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd

Evolution of Cost and Management

Accounting
Evolution of Cost Accounting
Cost accounting seeks to establish the costs of each product produced or service
provided by an organization through systematic recording and analysis of
expenses. By knowing the costs of each product or service, the company’s
management will be able to reduce costs, fix prices, and maximize profits.

Accounting has existed since the dawn of civilization. The process by which
economic information is identified, measured, recorded, and communicated in
terms of money. The utility of accounting information resides in its ability to reduce
uncertainty. Relevant, verifiable, quantifiable and biased information must be
presented.

Businesses were traditionally small and market exchanges between individuals


and organizations characterized them before the industrial revolution. At that time,
there was a need for accurate bookkeeping, but not so much cost accounting. As
a result of the industrial revolution in the 18th century, large industries were
formed to perform single activities (e.g. textiles, railways etc.). There were no
markets for intermediary products during this time, so cost information became a
valuable tool to measure the efficiency of different processes. But the concept of
prime cost was used by some industrialists around 1875. Between 1880 AD and
1925 AD, complex product designs emerged and multi-activity diversified
corporations such as Du Pont, General Motors, and others rose to prominence.

Science-based management was developed at this time, which led accountants to


transform physical standards into cost standards, the latter of which is used for
variance analysis and control. The book “Cost Accounting Theory and Practice”
was published in New York in 1913 by J.L. Nicholson.

During World War I and II, the growing defense budgets of the United States
increased the importance of cost accounting. Many countries resorted to cost-plus
contracts to purchase the supplies needed for war in the absence of competitive
markets, under which the government would pay the price of production plus profit.
After World War II, the parties to defence contracts continued to rely on cost
information. The government continues to use a cost-plus method when awarding
contracts.

Evolution of Management Accounting


As described above, the development of management accounting is due to the
use of additional techniques that changes the concept from simple into
sophisticated. The adoption of new and innovative techniques is possible due to
the subjective and liquid nature of management accounting concepts.
Nevertheless, the core purpose of facilitating decision making for planning, control,
evaluation and communication within organizations remain. The following will
describe how management accounting developed since the 20 century.

Stage I – Before 1950


Management accounting in this stage was considered in its original form, where
technical activities that were required to keep track of business were the only
components of management accounting. Management accounting was simply
activities of determining product costs. This was quite easy due to the fact that
production technology was relatively simple at the time. After defining the labor
and material costs, managers can determine overhead simply by relying on direct
labor hours. At this stage, there were less competition and fewer challenges in the
form of regulation, etc. Products were easier to sell and little innovation was
required. Hence, people focused on cost effectiveness and productivity. The use
of budgets and basic cost accounting were already popular and important, but the
distribution of information for managerial decision making was still at a poor stage.
Managers are still eager and vary much allowed to make decisions based on
intuition and personal experiences.

Stage II 1950-1965
In the second stage of management accounting development, the concept
developed to involve more than just technical costing activities. By this time, it has
included planning and controlling activities. Experts believed that by this time,
management accounting
has shifted into a managerial rather than technical work, but it remains on the staff
level. In other words, management controls were limited in manufacturing and
administration rather than thinking about strategic directions. Therefore,
management accounting remained reactive. Actions are taken only when problems
are discovered through deviation analysis.

Stage III 1965-1985


The third stage was noted to represent a significant change in the practice of
management accounting. Corporate leaders and managers are joined in common
interest to reduce waste in corporate processes by making the most effective and
efficient decision. This significantly enhances the need for a better management
accounting techniques and practices.

The management accounting department can no longer afford to become reactive


and passive. Aggressive cost reduction plan and efficiency management
performed by many companies drives management accountant to be sharper and
more creative in providing
information that will support managers in decision making.

Researchers believed that such a change occurred because of the oil crisis of
1970. This pulled the world into a recession and even threatened the already
established and stable Western markets. Competition enhanced and the need to
have a better financial
management strategy rose. Others, however, believed that it was the rapid
development of new production technologies that increased competition and
generated new opportunities to enhance management accounting practices. With
the new computer technologies, there was a new challenge to meet the global
competition by better managing information for decision-making.
Stage IV 1985-1995
In this stage, the development of management accounting was boosted mainly by
the presence of new computer and communication technology like the World Wide
Web and E-Commerce. Competition enhanced, however the name of the game is
no longer reducing waste or resource efficiency management, but rather to
generate value through effective use of available resources. Since then,
management accounting professionals have been struggling to increase value
generation by providing better information for management teams who were
already having a clearer strategic focus.

Recent Issues in Management Accounting Evolution


Despite the rapid development of management accounting process we have
witnessed in the 20 century, we have also seen that in this first decade of the 21st
century there is quite a downturn. Companies starting to complain because their
management accounting department produces information that lacks accuracy,
timeliness, and relevance. Several writers and observers have stated that the
management accounting discipline of the 21st century requires quite a change to
fulfill the increasing need of managers for reliable and timely information.

These writers have not yet come up with a practical solution to jumpstart the
quality of management accounting practices in the 21 century, but they have
elaborated some of the reasons of such a downturn. The most important factor
that generates the
decreasing performance of management accounting is actually the increasing
importance of financial accounting. Stakeholders are more scrutiny in ensuring
that their companies are complying with every rules of financial accounting, which
are agreed by a trusted external accounting committee.

The result of this development is the increasing attention of managers and


corporate leaders over the practice of financial accounting rather than
management accounting. In theory, both of these functions can supposedly be
performed together in the same time, but recent reports indicated that in some
companies, due to the increasing demands over complying with the rules of
financial accounting, management accounting practices are left behind quite
significantly.

In some companies, management are left with no time but to ensure that financial
accounting practices are performed completely, that they are forced to make
decisions based on the information provided by the financial accounting process.
Ironically, due to the differences of information characteristics between financial
accounting and management accounting, this means that management are not
making decisions based on forward-looking and broadly-processed information,
but instead, a backward looking and inwardly-processed information.

Common questions

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Before the 1950s, management accounting primarily involved determining product costs, a task facilitated by the simplicity of production technology at that time. This simplicity meant that overhead could be estimated based on direct labor hours after defining labor and material costs, allowing businesses to focus on basic cost-effectiveness and productivity. As a result, there was less competitive pressure, and innovation in accounting methods was not as critical .

During the late 20th century, particularly in the period from 1965 to 1985, management accounting practices began to focus on efficiency and waste reduction due to increased global competition and economic challenges like the 1970s oil crisis. These pressures necessitated more effective and efficient corporate decision-making to maintain competitiveness. As new production technologies emerged, companies required sharper management accounting insights to optimize their processes and resource utilization .

Between 1965 and 1985, management accounting shifted from a reactive and passive function to one focused on active decision-making support, driven by global competitive pressures such as the oil crisis of 1970 and technological advancements. These events pushed companies to adopt better management accounting techniques to enhance efficiency and reduce waste, as international competition intensified and new production technologies emerged. The need for strategic financial management became more critical as businesses faced economic recessions and sought to maintain market stability .

The downturn in management accounting practices in the first decade of the 21st century is attributed to the increased emphasis on financial accounting compliance, which diverted attention and resources away from management accounting. As managers and corporate leaders focused more on meeting external regulatory demands, the management accounting function became less relevant, leading to delays and inaccuracies in the information provided. This shift challenged management's ability to make informed, forward-looking decisions, thus devaluating management accounting's role within companies .

Recent technological developments, especially in computing and communication, have augmented the strategic role of management accounting by enabling more precise and timely information delivery. Technologies like advanced data analytics and real-time reporting allow management accountants to provide more actionable insights, facilitating strategic planning and value creation. These advancements help overcome traditional constraints, aligning management accounting closer with strategic objectives and enhancing its relevance in decision-making processes .

Before the industrial revolution, businesses were typically small, and the need for precise cost accounting was minimal because business exchanges were simpler and mostly between individuals or small organizations. Accurate bookkeeping sufficed for such transactions. However, with the industrial revolution came the emergence of large industries and the complexity of operations increased. This shift necessitated the development of cost accounting to measure efficiency and control costs, as there were now multiple processes and products to manage .

In the 21st century, as the importance of financial accounting increased, management accounting practices faced significant challenges. Companies prioritized financial accounting to comply with stringent regulations, resulting in a shift of focus away from management accounting. Consequently, the timeliness, relevance, and accuracy of management accounting information diminished as resources and attention were diverted. Despite both functions theoretically being complementary, this shift meant that decision-making often relied on backward-looking financial data instead of the forward-looking, enhanced decision-supporting data typical of management accounting .

By the 1960s, management accounting evolved beyond technical cost activities to include planning and control functions, marking a shift towards managerial work. Despite this evolution, it remained mostly reactive and focused on manufacturing and administration, with limited influence on strategic direction. Management accounting practices during this period were still constrained to staff-level roles, leading to decisions being made largely in response to detected variances rather than proactively .

From 1985 to 1995, computer and communication technologies like the World Wide Web and E-Commerce transformed management accounting by enabling more strategic focus and resource value generation. This technological advancement allowed management accounting professionals to provide higher quality information, supporting management in their strategic decisions. Rather than focusing solely on cost reduction or efficiency, management accounting began emphasizing creating value through effective resource use, driven by the ability to analyze and disseminate information more quickly and accurately .

World War I and II had a significant impact on cost accounting in the United States due to the adoption of cost-plus contracts, where the government compensated production costs plus a profit margin. These contracts were crucial for supplying necessary wartime materials in the absence of competitive markets. Consequently, the importance of cost accounting rose as it provided a basis for governmental expenditure on defense supplies. The detailed cost analysis this period required led to enhancements in cost accounting techniques, which continued post-war .

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