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The role of management accounting in the development of a manufacturing strategy.


The primary role of management accountants in manufacturing organizations is to provide a financial analysis of management decisions and activities. As such, the reports generated by the management accounting system are to be used by organizations internally. In essence, management accountants prepare the report card by which operations managers are evaluated[1]. One recent criticism of many management accounting systems is that they are too closely connected to the financial accounting system[2]. Financial accounting collects, classifies, and reports financially based transactions subject to numerous disclosure requirements. The reports provided by the financial accounting system are to be used by sources external to the organization such as shareholders, investors, creditors, financial analysts, the IRS, etc. Linking the management accounting system to the financial accounting system strongly encourages operations managers to emphasize plant financial performance rather than other, perhaps more meaningful, performance criteria. And since the primary financial accounting report, the income statement, is normally generated, monthly operations managers are encouraged to focus on short-term financial performance rather than on a longer time period. Indeed, in a recent study by the Industrial Research Institute[3], operations managers identified the two major threats to US competitiveness as external financial pressures and short-term management focus.

Compared to financial accounting, management accounting is fairly new having evolved from simple cost accounting systems. Two primary purposes of the cost accounting system were to value inventory and to determine cost of goods sold (CGS) for the plant income statement, each of which is a requirement of the financial accounting system[4,5]. The use of cost accounting data for decision making and performance evaluation has recently gained importance. Given that managerial accounting evolved from simple cost accounting where the primary function is to supply information required by financial accounting, it is easy to understand why management accounting systems have been criticized for being too strongly linked to financial accounting.

In addition to the fact that management accounting reports are the score-card of an operation manager's performance, another reason for the sometime overemphasis by these managers on financial accounting reports is the short-term nature of US capital markets. Wall Street investors are required by numerous regulatory bodies to keep a "hands-off" relationship with the companies they own. Further, institutional investors such as pension funds, mutual funds, etc., are required by law to seek a maximum rate of return on their investment. Since a majority of stock ownership in US companies is held by these institutional investors, stocks are often traded like commodities as investors seek maximum return[3]. Given this hands-off relationship between investors and the companies they own, and the short duration for which many stocks are held, it is necessary for investors to rely almost exclusively on short-term financial reports to gauge the success of their investment. This further encourages managers to emphasize short-term financial performance.

Standard cost accounting systems

Perhaps the best example of the link between managerial and financial accounting is the standard cost accounting system. In a standard cost accounting system, budget variances, representing the management accounting system, are subtracted from, or added to, gross income to provide net income on the income statement. Despite the numerous criticisms of standard cost systems[2,4-7], they continue to be the predominant accounting used in US manufacturing companies[6,8].

In theory, a standard cost system is applicable in a very limited number of environments. Specifically, standard cost systems are most applicable when direct costs, specifically direct labour costs, represent a large per cent of total manufacturing costs[6]. In addition, standard cost systems are most applicable when a stable production process is used to manufacture high volumes of fairly similar products that compete in the marketplace based on product price[6]. Conversely, a standard cost system may not be appropriate when overhead costs (fixed and variable) are a large percentage of total costs or when labour costs are relatively small. Such systems are also not appropriate for a manufacturer that produces a wide variety of products at low volumes that compete in the market on such factors as quality or delivery.

The importance of a manufacturing strategy

A manufacturing strategy is the link between the marketplace and the manufacturing process. To establish a proper manufacturing strategy, those criteria that the market considers most important when placing orders, called order-winning criteria, must be determined[9]. Once these order-winners have been identified, it becomes the responsibility of manufacturing to provide a product that can compete in the market on that particular criterion. For example, if reliable delivery to customers is identified as the primary order-winning criterion, manufacturing efforts should be centred on providing the best delivery possible. Since delivery, in this case, represents the primary order-winning criterion, providing the best delivery performance in the market will increase the number of orders received from customers, thereby increasing revenue.

An effective manufacturing strategy requires a proper match between the process technology and the present and expected future order-winning criteria, as well as a match between the manufacturing infrastructure and order-winning criteria. As suggested by Hill[9], most companies share access to the same processes and technologies; thus they are not inherently different in companies in similar industries and markets. Quite often it is the manufacturing infrastructure that varies tremendously between companies. The manufacturing infrastructure encompasses the procedures, systems, controls, compensation systems, and organizational issues that ultimately determine how well manufacturing will be operated. Basically, the infrastructure represents the necessary software needed to run the hardware (process technology) in a manner dictated by the order-winning criteria. Given the importance of the management accounting system in measuring the performance of operations managers, it represents one of the key systems in the manufacturing infrastructure. It is vital that the management accounting system supports and encourages the management behaviour necessary to satisfy the order-winning criteria. As well, the management accounting system must be consistent with the manufacturing planning and control systems needed to run the plant.

In summary, management accounting systems often provide the key criteria by which an operations manager is evaluated. Since many management accounting systems, especially standard cost systems, are strongly related to financial reporting, these same operations managers overemphasize plant financial performance. In doing so, other criteria that may be more indicative of order-winning criteria are often ignored. The end result is an inconsistency between the management accounting system and the manufacturing strategy necessary for continued competitiveness. Indeed, it is our contention that many management accounting systems are not consistent with either the manufacturing environment or the manufacturing strategy of many companies. Further, it is a lack of understanding of the management accounting system and the management behaviour they encourage, that promotes this inconsistency.

A survey of manufacturing companies

In order to investigate the two assertions made above regarding the inconsistency between many management accounting systems and a company's manufacturing strategy and environment, as well as the lack of understanding of the management accounting system and the behaviour it encourages, we conducted a survey of 85 US manufacturing companies. The chief operations officer (COO) from each company was asked to complete the survey. An initial survey instrument was developed with the help of several local manufacturing companies. The initial survey was sent to ten manufacturing companies as a pre-test. Based on their responses and suggestions, the survey completed by the 85 companies was developed. Each COO was asked to complete the survey based on one particular plant since different plants in the same company could manufacture different products on different processes.

Survey results

In Figure 1, we provide a set of questions included on the survey that were answered by each COO. In Figure 2, we provide a summary of results by three company types: non-users of standard cost systems; users of standard cost systems that allocate fixed and variable overhead costs by direct labour; and users of standard cost systems that do not use direct labour to allocate overhead costs. The remainder of this discussion will address in turn each of the two assertions discussed earlier.

The inconsistency between management accounting systems and the manufacturing environment

As we suggested earlier, standard cost systems continue to be the most widely used system in industry despite being applicable in a fairly limited range of environments[6,8]. Standard cost systems are most applicable when a limited range of products is produced in relatively high volumes; when the plant produces a product line with similar process characteristics that compete in the market based on price; and when direct labour costs are relatively high compared to overhead costs.

In question 1, we asked each COO if their plant uses a standard cost system and if so, how are overhead costs (fixed and variable) allocated to each product. Of the 85 companies included in this survey, 63 use a standard cost system while the remaining 22 do not. Of the 63 standard cost users, 46 indicated that overhead costs, both fixed and variable, are allocated by direct labour while 17 indicated another basis or method of allocation. This is consistent with the study by Price Waterhouse[8] which reported that 80 per cent of companies surveyed used a standard cost system and 80 per cent of those allocated overhead by direct labour. In our study, 74 per cent use a standard cost system and 73 per cent of the user companies allocate overhead by direct labour.

Responses to question 2, parts (a) and (b), and question 3 allow us to determine the manufacturing environment and type of production process employed by each plant, as well as the breakdown of total costs. After identifying the environment and process, we can then determine if, and to what degree, standard cost systems are being used in plants where they may not be applicable. To do this analysis, we classify the 85 companies included in this survey as non-users of standard costs, users of standard cost that allocate overhead costs by direct labour, and users that do not allocate by direct labour. We then calculate a simple Spearman correlation coefficient to determine if the use of standard cost systems is correlated with the production orientation of each plant. The resulting correlation coefficient indicates no relationship between the production environment and the use of standard costing. This lack [TABULAR DATA FOR FIGURE 1 OMITTED] [TABULAR DATA FOR FIGURE 2 OMITTED] of correlation suggests that many companies are using a standard cost system in an environment that may not be applicable. In addition, no correlation was evident between the use of standard cost or allocation base and the relative percentages of direct labour costs, direct material costs or overhead costs. This further suggests that standard cost systems are being used despite the ratio of direct labour and direct materials costs to overhead costs. This further strengthens our assertion that many management accounting systems in use today are not consistent with the production environment or the cost structure in which they are being used.

The inconsistency between management accounting systems and manufacturing strategy

We have stated earlier that the management accounting system is a major component of the manufacturing infrastructure in a company. Further, the manufacturing infrastructure must be designed so that products delivered to the market will satisfy current order-winning criteria. In question 4, each COO was asked to identify and rank, by order of importance, current order-winning criteria for his plant. Responses to question 5 will help identify the factors that are necessary for the long-term success of the company. It is the current order-winning criteria and these long-term success factors that ultimately determine the proper design of the manufacturing infrastructure. The average ranking of four order-winning criteria for each of the three classes of companies as well as the average ranked importance for each long-term success factor is shown in Figure 2.

These results suggest that the primary order-winning criterion for users of standard cost systems is product quality. The primary order-winning criterion for non-users is product price/cost. No statistical difference between the responses of the three classes of companies for any of the long-term success factors is found. However, all three company types indicated that long-term success was highly dependent on improvements in product quality. These results are again somewhat contrary to the recommended use of standard cost systems. A standard cost system has been suggested to be most applicable when product price is the primary order-winner. Indeed, given its emphasis on controlling costs, it is understandable why this application is suggested. Yet the results below indicate that users of standard cost systems manufacture products that compete in the market on quality while non-users compete on price. The least important order-winning criterion for all three classes of companies was process flexibility.

The long-term success factors felt to be most important by all three classes of companies is product quality with product cost reductions being second. Since product quality is indicated to be the most important long-term success factor, it is necessary that the manufacturing infrastructure encourages management behaviour that will improve this factor. Given the short-term emphasis of standard cost systems on controlling production costs, it is often difficult to make changes in the process that will promote long-term quality. In other words, it is difficult to justify short-term costs and investment that will provide a long-term return. The two least important success factors are inventory reductions and direct labour cost reductions. This is interesting in that 98 per cent of all companies surveyed indicated in question 6 that they had tried within the last three years to significantly reduce inventory. Since inventory reduction was not felt to be important to long-term success, the justification for efforts at reducing inventory are unclear. Perhaps given the popularity of just-in-time, inventory reductions are the proper thing to do. No other rational is apparent.

The lack of understanding of management accounting systems

As we have stated, it is critical to the success of any manufacturer to have a manufacturing infrastructure that is consistent with current order-winning criteria. Results in this study indicate that a major inconsistency exists between the management accounting system which is a primary component of the manufacturing infrastructure and the order-winning criteria. Also, the management accounting system in many companies does not seem to be appropriate for the production process and orientation and cost structure present in that company. One possible explanation is a lack of understanding of the management accounting system and the behaviour it encourages by COOs that contributes to this mismatch. However, before we indict operations managers for their lack of understanding, we suggest that the management accountant must shoulder some of the blame. We will discuss this shortly.

Questions 7, 8, and 9, parts (a) and (b), are intended to: identify the types of information used by operations managers to run their plant; and to discuss the role of the management accountant in each class of company. In question 7, we asked each COO to indicate the importance of budget variances in making day to day operations decisions.

We see in Figure 2 that the emphasis given to budget variances to make operations decisions for non-users is 3.1, 3.6 for users without direct labour allocation, and 3.7 for users with direct labour allocation. This suggests that companies who use a standard cost system, regardless of overhead allocation methodology, place a greater emphasis on budget variances when making day-to-day operation decisions than non-users. In question 8, we provided a list of eight reports that managers frequently use to run their plant. This list included: direct labour efficiency or variance; other budget variances; scrap reports; cash-flow statement; machine utilization; plant P&L; shipment reports; and inventory reports. Each COO was asked to rank, by order of use, each of the reports. In Figure 2, we provide the average ranking for each report by each class of company.

Based on the results in Figure 2, several points are worth noting. Despite the type of accounting system used, great emphasis is given to financial reporting, i.e. the P&L or income statement. This fact by itself supports the argument that much emphasis is given to the financial performance of the plant as determined by the P&L rather than other, non-financial criteria that may be more closely related to order-winning criteria. Since the P&L is most commonly generated monthly or quarterly, this encourages a short-term focus by operations managers on financial indicators of performance.

The report ranked as the second most important depends on the accounting system being used. User companies indicated that labour efficiency or variances were almost as important as the plant P&L. This was true despite the overhead allocation basis. It bears repeating that direct labour costs in the three company classes was essentially equal. Non-user companies ranked shipment reports as equally important as the P&L in running the plant suggesting a greater emphasis on production throughput measures than do user companies.

Another interesting observation is the relative lack of importance given by user companies to other budget variances despite ranking direct labour variances very highly. One possible reason to help explain this observation for user companies that allocate by direct labour is that the amount of money that can be spent on each variance category, the earned dollar concept, is normally based on the production volume of direct labour. Operations managers, understanding that volume cures all ills, focus more on labour productivity than controlling other budgeted expenses. It is not clear why user companies that do not allocate by direct labour place great emphasis on labour variance but little emphasis on other budget variances. Perhaps, the management notion of maximizing direct labour productivity guides the use of these reports. Further study is warranted to explain this phenomenon.

One last point worth noting is the lack of importance given to the cash-flow statement. In 1987, Financial Accounting Standards Board rule number 95 made it mandatory that companies include a cash-flow statement in their financial reports. Since operations managers obviously place great emphasis on the income statement, which is also required for financial reporting, one would think that cash flows would be an important consideration in making operations decisions. The opposite appears to be true suggesting that profitability is still the primary driver of decision making.

In question 9, parts (a) and (b), we try to determine the role of the management accountant within each plant as well as the acceptance by COOs of the accountant's role. Obviously, a plant accountant who takes a more active role in the management of the plant by directly querying managers about variances will have the greatest potential for influencing the behaviour and types of decisions these managers make. Without question, a department manager will pay closer attention to a particular report if he is asked to explain his department's performance on that report by a plant accountant. Since as shown earlier, direct labour variance is a major report used in running the plant, it is highly likely that accountants in these companies routinely ask department managers about direct labour productivity. It is these active accountants who can have the greatest impact, positively or negatively, on the management of the company. If accountants question managers about reports that are not consistent with the manufacturing strategy of the plant, it is likely that the company will not be as successful as possible.

We see in Figure 2 that plant accountants take a much more active role in the management of the plant when a standard cost system is being used. Also, top-level operations managers in a company that uses a standard cost system indicate a higher level of acceptance of the legitimacy of this role by the management accountant than managers in non-user companies. It is clear from these results that accountants have greater responsibility and authority in a company that uses a standard cost system than in a company that uses another type of accounting system.

The need for proactive management accountants

Results from this study show that the use of a standard cost accounting system is often not consistent with:

* the production volume and product variety manufactured in many plants;

* the cost structure in many plants; and/or

* the manufacturing strategy of many plants.

As we suggested, manufacturing competitiveness requires a manufacturing infrastructure that is consistent with current order-winning criteria and long-term factors necessary for continued success. We further show that top-level operations managers, regardless of accounting system, are greatly concerned with the short-term financial performance of the plant as measured by the plant P&L or income statement. Last, top-level operations managers in companies that use a standard cost system accepted a more active role by plant accountants in the day-to-day running of the plant.

Given these findings, we suggest that the management accountant must take a broader role in the management of the plant. However, the kind of role that we are suggesting is entirely different from the generally accepted role. The management accountant can no longer afford to simply question managers about various reports generated by present accounting systems that do not support manufacturing strategies or are inconsistent with the manufacturing environment. Indeed, the management accountant must become proactive in the design, selection, and implementation of a management accounting system that does not suffer from the weaknesses discussed above. This requires the management accountant to be willing to discard the very system he has worked hard to maintain. He must, therefore, become an advocate for change as well as an educator within the plant. All levels of managers must be educated regarding the strengths and weaknesses of their present accounting system. In addition, the management accountant must also educate the managers about other alternative accounting systems that are more conducive to long-term competitiveness. This is a mandate to the accountant to become knowledgeable of the production process, product variety, and manufacturing strategy. Without such knowledge, the prospects for changing to the role we suggested are not favourable.


Manufacturing managers have been criticized for their over-reliance on financial reporting to run their plants. In this article, results from a survey of 85 chief operations managers support this criticism, as the primary information used to run their factories is the plant P&L. The over-reliance on financial performance is such that performance on other criteria is often not considered.

We have shown in this article that the use of standard cost accounting systems by many companies is not consistent with plant characteristics such as production volume, product variety, and/or cost structure and is often not supportive of the manufacturing strategy. Since the management accounting system is a major component of the manufacturing infrastructure, it is vital that the system supports this strategy. Also, the application of a standard cost system in a production environment ill-suited for such use leads to problems frequently cited in the published literature.

We suggest that the management accountant must take a proactive role in the selection of, or change to, a proper accounting system. As such, the accountant must become an educator to plant management regarding the proper use of alternative systems. He must also become a student of manufacturing in order to understand the manufacturing process, product requirements, as well as the manufacturing strategy of the company.


1. Edwards, J.B., "Are management accountants marching toward inevitable decline because of outmoded techniques?", Management Accounting, September 1985, pp. 45-50.

2. Kaplan, R.S., "Yesterday's accounting undermines production", Harvard Business Review, July-August 1984, pp. 95-101.

3. Jacobs, M., Short-term America: The Causes and Cures of Our Business Myopia, Harvard Business School Press, Boston, MA, 1991.

4. Johnson, H.T. and Kaplan, R.S., "The rise and fall of management accounting", Management Accounting, January 1987, pp. 22-30.

5. Johnson, H.T. and Kaplan, R.S., Relevance Lost - The Rise and Fall of Management Accounting, Harvard Business School Press, Boston, MA, 1987.

6. Hilton, R.W., Management Accounting, McGraw-Hill, New York, NY, 1994.

7. Fry, T., Karwan, K. and Baker, W., "Performance measurement systems and time-based manufacturing", Production Planning and Control, Vol. 4 No. 2, 1993, pp. 102-11.

8. Price Waterhouse, "Survey of the cost management practices of selected midwestern manufacturers", internal report, Price Waterhouse, New York, NY, 1989.

9. Hill, T., Manufacturing Strategy, Richard D. Irwin, Homewood, IL, 1994.
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Author:Fry, Timothy D.; Steele, Daniel C.; Saladin, Brooke A.
Publication:International Journal of Operations & Production Management
Date:Dec 1, 1995
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