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Management Accounting and Control Summary
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Summary of the course Management Accounting and control at Radboud University year 3
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Management Accounting and Control – summaryLecture 1; introdution
Accounting is the overarching name for all calculative practices used to manage organizations.
- For everybody that is interested in economics and management, it is crucial to understand the roles of financial
information to measure and manage organizational performance.
- Good management accounting is crucial to avoid the lack of financial literacy and cost consciousness.
Financial accounting Management accounting
Prepare reports that are generally based on past Collate information such as revenue, cashflows and outstanding debts to produce
performance timely trend reports and statistics to inform management and business decisions
External reporting Internal reporting / internal accounting
Past performance Forward-looking & future-oriented
Produce the required financial information for use Combine financial information with non-financial information to paint a complete
by other functions within the business picture of a business
Financial information Financial & non-financial information
Management accountants have to balance between providing information to other managers for decision-making and providing
monitoring information used to control behaviour of lower-level managers.
- They report to chief financial officer (CFO), they do budgetplanning, they control financial data collection and reporting
and they administer internal and external accounting.
- The accounting information which is relevant, reliable, timely and accurate, can be used by managers in deciding upon
which option is best.
Lecture 2; organizational architecture
Agency theory
- Players: agents and principals, who want the agents to act on their behalf, to reach certain goals.
o This creates a principal-agent relationship
Theory of the firm (Jensen and Meckling); agency relationships exist everywhere.
- Two differences between principals and agents
o Information asymmetry: principals cannot observe all of their agents all of the time and know everything their
agents know
o Goal incongruence: principals want agents to help them achieve their goals and agents have their own,
perhaps different, goals
! these differences can potentially (not necessarily) lead to two agency problems for the principal.
o Adverse selection
o Moral hazard
Adverse selection; there is hidden information before the agent is hired.
Potential agents have better information than the principal. The principal wants to hire the best candidate. If an agent lies to
get the job, the principal ends up hiring the wrong employee.
- (Accounting) solutions: pre-contract investigation, post-contract penalties
When can this potential Before principal enters into agency relationship with agent
problem arise? Principal wants to choose an agent from amongst many
What is it? Potential agents have private information about their skills, motivations, etc. It is difficult for the principal to
determine which agent is best. The principal risks making a poor choice that results in a loss if potential agents
lie about their skills and motivation
Moral Hazard; principal cannot monitor agents 100% of the time, so there is a hidden action during the principal-agent
relationship. Agents want to be lazy or increase their personal wealth instead of the principals wealth. When the agent takes
advantage of the information asymmetry to pursue own personal goal, then there is moral hazard.
- (Accounting) solutions: inspecting, monitoring, target setting etc.
When can this potential During the agency relationship
problem arise?
What is it? Agent’s wilful misconduct (through action or inaction) that redistributes wealth from principal to agent
Example horizon problem; the tendency to extrapolate whatever is going on recently into the indefinite future, and
making decisions accordingly.
- Managers can have a short-term horizon for maximizing their own utility, while the company has a
long-term horizon of maximizing revenue. This difference in time horizon leads to agency problems.
- Myopic behaviour = focussing on the short-term
Accounting sllutions; long-term compensation such as stocks (equity compensation)
We can mitigate agency problems by making use of the organisational architecture; all the systems and processes that are
installed to mitigate and solve agency problems.
,The organizational architecture consists of three main pilars that need to be coordinated with each other;
- Measure performance; reduces the information asymmetry between the principal and the agent.
o Performance measures are used to determine whether the company is reaching its strategic objectives.
Objective measures; production rate, sales, meeting budgets and schedules
Subjective measures; helping others, innovation, improving team spirit
Financial measures, projects, costs, reveneus (information is available in internal accounting system)
Non-financial measures; quality defects, customer satisfaction, employee turnover, on-time delivery
o Issues;
You have to determine relative weight for each measure
There is a cost associated with collecting and analysing the measures
Performance measures should be linked to strategic goals
- Reward and punishment performance; incentivizing performance by rewarding good performance and punishing bad
performance, in order to reduce goal incongruency between principal and agent.
o Types;
Pecuniary (financial) rewards; salary, bonuses, retirement benefits, equity, etc.
Non-pecuniary (non-financial) rewards; job titles, better office location, reserved parking place, etc.
Punishment; reprimands, ridicule (spot), demotion (degradatie), termination, etc.
o Issues;
Is linked to performance measures
Is influenced by the external job market
Is limited by employment laws and tax laws
- Partition (verdelen) decision rights; the rights to take decisions about economic resources or assets
o Types;
Centralized decision rights; to top executives
Decentralized decision rights; to lower levels
o Issues;
A person should not be assigned decision rights if the exercise of these rights cannot be measures and
rewarded.
Knowledge means power, however knowledge is costly to acquire, store and process. There are
different types of knowledge available at different levels in the organization.
An alienable right is the right to sell a resource and capture the proceeds. Only owners of a resource can have the rights.
- A person with alienable rights (the owner) can delegate decision rights to someone else, but without also delegating
the alienable rights.
- The decision rights and the alienable rights of a organization are located with…
o The same person in a sole proprietorship; the owner makes all decisions
o Different people in cases with shareholders; shareholders are the owners (alienbale right), but the managers
have the decision rights in the company.
Benefits and costs of organisational architecture choices
- Benefits; it reduces conflict and increases cooperation
o Measuring performance and allocating decision rights: employee learns what is important in the job
Employees have clearer roles and goals, less job tension
o Rewarding performance: employee is rewarded for increasing organizational success
- Costs (“agency costs”); all potential solutions are cosly to implement, may have negative unintended consequences are
the solutions may be imperfect (none will completely eliminate agency problems).
Lecture 3; performance measurement
Why should we measure performance?
- To reduce information asymmetry between principal and agent
- For evaluation purposes; are we on track/reaching goals or are there additional actions needed?
- For motivation purposes; giving incentives and elements for employees to focus on
Potential problems related to measuring performance
- Measurement error; no performance measure are able to catch the actual performance perfectly.
o It is the difference between measured quantity and the true value
- Failed measure management; when the agent manipulates the performance measurement system to pursue his own
goals instead of the principal’s.
Campbell’s Law: reporting systems that measure and incentivize performance typically also encourage
agents to distort performance
o Distortion: making decisions that increase reported performance more than true performance
o Surrogation; Acting as if the performance measure is more important than the actual performance.
, Agents forget that the performance measure only imperfectly capture performance.
oTwo requirements;
Motivation; agents are aware of the performance measures by which they are being evaluated, and
care about that evaluation.
Discretion = the ability to distort;
Real or operational measure management: agents manipulate the performance
measurement processes. E.g. a salesperson only gives the opportunity to happy customers to
fill out the customer satisfaction survey.
Opportunistic reporting: agents report the outcome of the performance measurement
processes opportunistically. E.g. the salesperson and the data analyst collude and report
false outcomes of the survey (so opportunistic behaviour
Responses to solve the problems;
- Measurement error: develop performance measures with less measurement error
- Measure management:
o Motivation: conceal measurement by ensuring that employees do not know they are measured
o Discretion: people cannot engage in measure management if they don’t have the ability to distort operating or
reporting decisions
In performance measurement, it is important to consider the following aspects;
- Performance measure (e.g. customer satisfaction)
- Performance goal (e.g. high customer satisfaction)
- How you measure it (e.g. survey with question are you happy with the services received)
- Result of measurement (e.g. percentage of customers that said yes)
EXAMPLE: EVALUATING TEACHERS ON STANDARDIZED TEST SCORE
Performance goal: Good education
Performance measure: Students’ standardized test scores
1. Measurement error: High test scores don’t necessarily represent good education
2. Measure management:
- Motivation: Test scores used for evaluation
- Discretion: Teachers might know questions and might be able to manipulate test scores
Operational measure management: Showing the test questions before the test
Opportunistic reporting: Reporting false test scores
EXAMPLE: WELLS FARGO
Employees opened fake bank accounts for friends/family in order to be able to go home early. They thus committed fraud. The goal of Wells Fargo
management was to get 8 accounts a day, but due to the high pressure to get this, employees frauded.
Performance goal; high sales, deep customer relationships (trust)
Performance measure; number of products sold per customer (e.g. bank accounts created, credit cards sold)
The problem was that there is no such thing as ‘just measuring’. Management wanted 8 accounts a day created, but from the moment they started
measuring, employees started to ‘manage the measure’ by creating false accounts.
1. Measurement error; also the length of the customer relationship is important; fake accounts are no ‘real sales’. They do not count as actual true
performance.
2. Measure management;
- Motivation; sales people received bonuses based on the number of products per customer and lost their job if they did not meet the sales targets.
- Discretion; apparently the control system was not strong enough to detect false customer accounts.
EXAMPLE: HOSPITALS
Performance goal: Hospital quality
Performance measure: Scores on health care report cards (length of stay, mortality rate)
1. Measurement error: there is nothing more difficult to measure than hospital quality
2. Measure management:
- Motivation: Surgeons can ask higher fees and see more patients if they do well, hospitals can lose their funding if they perform weak or attract high
risk patients
- Discretion: 63% of the surgeons admitted being reluctant to operate high-risk patients, 67% of the surgeons refused to treat at least 1 high-risk
patient/year (Arnold 2017)
EXAMPLE: UNIVERSITIES
Performance goal: Research quality
Performance measure: Number of top publications
1. Measurement error: there is nothing more difficult to measure than whether a paper generates new knowledge
2. Measure management:
- Motivation: career depends on the number of top publications schools are ranked based on the number of top publications
- Discretion: some academics falsify their data and/or don’t honestly report about the procedures they used
There is no real perfect appropriate performance measure, but principals must choose one that motives agents to take actions
consistent with the principal’s goal (goal congruence). Besides that, agents should be evaluated and rewarded/punished based
on a performance measure that are under their control (= controllability principle).
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