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Martin, J. R. 1994. A controversial issues approach to enhance management accounting education. Journal of Accounting Education 12(1): 59-75

Summary by James R. Martin, Ph.D., CMA
Professor Emeritus, University of South Florida

Controversial Issues Main Page | Graduate MA Course Main Page


1. Whether traditional cost allocation systems should be replaced with activity based cost systems.

Issue number one can be treated as a narrow issue of whether an ABC system should replace the company's traditional general ledger system, or serve as a separate stand alone system for management decisions. However, this issue is broader if one argues that firms should convert to JIT production systems, since this conversion would automatically produce more accurate product costs without ABC. Then the question becomes whether ABC systems are needed when the factory is organized into cells that are focused on producing a single or similar products and support services are decentralized.

In addressing the narrow version of the issue, it is convenient for everyone to accept the notion that, under certain conditions, ABC systems provide more accurate information for management decisions than traditional cost systems. Then the question is whether the external reporting system should be combined with the internal decision system. CAM-I's single data base approach seems to provide the strongest support for a single combined system. On the other hand, the strongest argument against replacing general ledger systems with ABC systems is that all the detail associated with ABC is simply not needed on a continuous basis since stockholders and creditors do not need to know which products and customers are profitable. Thus, stand alone ABC systems can be used to produce more accurate product costs as needed for management decisions without overloading the general ledger system with unnecessary detail. A counter argument is that traditional cost allocations can also distort overall profitability where inventory levels are different for different types of products. For example, if inventory levels were high for high volume products (which tend to be overcosted in traditional systems) and low for low volume products, (that tend to be undercosted by traditional systems) then overall net income would tend to be overstated relative to the more accurate net income based on ABC. In such cases, ABC would be needed to provide accurate information for both internal and external users. The broader issue of whether ABC is needed, or even compatible with JIT is discussed below as issue number 7.

2. Whether a company should use multiple cost systems rather than a single cost system.

The second issue of whether a company should use multiple or single cost systems is related to the first issue, but includes the idea that information is also needed to control processes as well as to value inventory and provide direction for management decisions concerning pricing, make versus buy and product introduction and discontinuance. The question is whether any kind of accounting system can provide adequate information for process control because of the inevitable aggregation of data and lack of timeliness in reporting results. The main arguments for multiple systems are provided by Johnson and Kaplan (1987, Chapter. 10). Briefly, the information needed for process control, financial reporting and product decisions is required by three different audiences that have different requirements concerning such things as the timeliness of reporting, degree of cost traceability and whether the users decisions are process oriented or results oriented. Thus, it would be difficult, if not impossible to develop a single system that could satisfy all these diverse requirements. The other side of this issue seems to depend on the idea that a data base system can serve all users and that multiple systems tend to create too much redundancy and confusion where the different systems produce different answers for the same question. The technology is available to handle a multipurpose system, thus it is just a matter of developing the needed software. (See the Martin 98 summary).

3. Whether activity based cost systems will improve a company's competitive position.

Issue number three concerning the efficacy of ABC to improve profits leads to the controversy over bottom-up versus top-down approaches to management. The key question is, if ABC is simply grafted on to an otherwise traditional top-down accounting control system, will the firm's competitive position improve? Critics contend that although generating inaccurate product costs presents a problem, it is not the main problem facing American industry. A more important problem is the top-down, short term, financial results oriented mentality that is so pervasive in the American system. Critics of the notion that ABC will provide a solution to a company's competitive problems, argue that becoming globally competitive requires system optimization, which in turn requires managing a company so that it's components cooperate rather than compete (See Deming 93 and Johnson 92a and Johnson 92b). This type of leadership is based on an understanding of the company's overall system and knowledge about the variation within the system. Accounting models cannot tell a company if it's customers are satisfied or if it's processes are in control. Thus, although the ABC model may provide more accurate costs, it does not provide the needed mind-set change from a financial orientation to a process orientation and it does not provide the tools needed to manage processes rather than financial results. (See Palmer & Vied 98).

On the other side of this issue, defenders of activity based cost management admit that ABC models are not capable of providing real time feedback on process variation and improvements, but point out that techniques used to measure process variability on a real time basis, (e.g., statistical control charts) are not capable of measuring the economic consequences of that variability. It is not appropriate to criticize a technique for not doing what it was not designed to do. ABC models are designed to provide information about the cost of activities, products, product lines, distribution channels, vendors and customers. ABC models can be used to provide feedback on whether process improvements have lowered costs and increased throughput. In addition, ABC systems can be used to provide information about the trade-offs of alternative product designs. This is particularly important when one considers that over ninety percent of a product's life cycle costs are locked in prior to the production stage. ABC models can also provide information about which vendors are the real low cost suppliers by capturing all of the costs of ordering, receiving, inspecting, moving, storing, scheduling and reworking along with the purchase price for each vendor. Although ABC cannot tell a company if a customer is satisfied, it can indicate if the customer can be satisfied profitably. ABC is not magic, but it is a powerful management tool. (See Kaplan 92).

4. Whether the concept of contribution margin is an effective tool rather than a treacherous device that promotes failure.

Critics of direct costing argue that the costs traditionally defined as fixed costs have been increasing faster than the costs traditionally defined as variable costs. Thus, the direct costing model does not reflect the cost structure of complex, multiproduct organizations. Although direct costing may be useful for some short term forecasting and optimization decisions, it is misleading for decisions such as product introduction, product pricing, product mix and make versus buy. The so-called fixed costs are not explained by output volume, but by the diversity and complexity of the company's products, customers, distribution channels and product lines.

Defenders of direct costing argue that the concepts of contribution margin and related techniques such as incremental analysis are useful for performing a variety of special relevant cost studies. Although production volume is not the only cost driver, it is still the major cost driver. Thus, production volume based systems such as direct costing still provide reasonably accurate information for a fraction of the cost of elaborate ABC systems and they are much easier for managers to understand than either traditional full cost or ABC statements. In addition, direct costing reduces the full cost behavioral bias towards over production by eliminating the production volume variance and the inventory change effect that increases net income when production exceeds sales.

The critics of direct costing refute these arguments by pointing out that the incremental cost studies presented in textbooks are not realistic. Even for a small company with as few as one hundred products and product components, the number of combinations of relevant cost studies that would be needed renders incremental analysis infeasible. A practical alternative is to extend the contribution margin approach by using Cooper's levels of cost variability. Thus, combining ABC with contribution margin analysis could reveal contributions at the unit, batch, product, distribution and customer levels. This type of information would indicate which products, distribution channels and customers really are profitable and avoid the trap set by the contribution margin logic that keeps companies from ever dropping anything. (See Ali 94 for more on this idea).

5. Whether the standard cost control methodology helps improve performance rather than creating a bias towards dysfunctional behavior.

The usual arguments against standard costing are that cost variances promote building excess inventory, too many vendors, low quality, spending the minimum on training and maintenance, and discouraging cooperation between operating departments. However, perhaps a more important indictment is that the standard cost control methodology is not a legitimate control device in the first place. Examining this part of the issue leads to the statistical control chart bottom-up alternative mentioned in the discussion of issue number 3 (See Deming 93 and Reeve 89). Briefly, the argument is that legitimate control requires an understanding of the variability within a system so that the variation resulting from common or random causes (i.e., variation caused by the system) can be distinguished from the variation resulting from special causes (e.g., the people working in the system). Statistical control charts provide this information at the operator level. Since standard cost systems do not capture the time order of the data, they are virtually useless for accurate prediction and adequate control. Thus, according to critics, the term standard cost control is a misnomer.

Anthony's control hierarchy (i.e., strategic planning, management control and operational control) provides a basis for defending the standard cost methodology. One can argue that if standard cost variances were only used at the middle management level for monitoring overall performance, rather than rolled down to the operating level, the dysfunctional behavior mentioned above would not tend to occur. The standard cost technique is not the problem. The problem is the manner in which standard costing is presented in textbooks and frequently used in practice. Standard cost based budgeting systems, if used correctly can provide substantial benefits in the areas of planning, forecasting and monitoring overall performance (See Anthony 64).

6. Whether traditional responsibility accounting is an appropriate method for evaluating managers rather than a way to destroy teamwork and goal congruence.

Issue number six extends the previous issue and touches on the broader question of whether evaluating individual performance, or subsystem performance, prevents people from cooperating to optimize the performance of the system. It introduces the question of whether the traditional concept of responsibility accounting is applicable to a team oriented organization where cross functional team members are jointly responsible for outcomes.

The arguments for responsibility accounting start with the idea that decentralization of supervision and decision making is needed to manage large complex organizations. Separating a company into responsibility centers (i.e., cost, revenue, profit and investment) is a logical way to assign authority and accountability. All activities and expenditures are assigned to the person who is in a position to authorize and control them. A responsibility accounting system allows for specialization which promotes faster and better decisions at the responsibility level than could be obtained in a centralized company. Although there are some potential problems with responsibility accounting systems, the motivational effects and other advantages far exceed the disadvantages.

Critics argue that traditional responsibility accounting has outlived it's usefulness. The concepts of specialization and responsibility produce an organization based on functional areas where performance and control measurements are exclusively vertical. This type of organizational structure ignores the interdependencies within the organization and promotes subsystem optimization. Responsibility accounting is based on the assumption that independence of activities is preferred because maximizing individual performance will maximize the performance of the system. To maintain independence and improve subsystem efficiency, buffers (e.g., extra inventory, workers, equipment and materials handling systems) are placed between work stations and responsibility centers. However, organizations that have embraced the newer concepts of JIT and continuous improvement have removed the buffers that create non-value added activities or waste. Linking activities and responsibility centers by removing the buffers reveals the interdependence within organizations and the enhanced need for cooperation. Traditional responsibility accounting supports a tree or stovepipe organizational structure that prevents the inter-functional cooperation needed to successfully implement the lean production concepts associated with JIT. What is needed is a network, or cross functional team structure that promotes group performance and continuous improvement through managing processes rather than promoting individual performance through managing financial results. (See McNair 90 and McNair & Carr 94).

7. Whether just-in-time production systems and activity based cost systems are compatible rather than conflicting concepts.

Critics of ABC contend that organizing, or reorganizing a factory into dedicated cells focused on producing one, or a few related products, eliminates the need for expensive ABC systems. Using ABC in this context is analogous to using a Rube Goldberg mechanism to complicate the completion of a very uncomplicated task. Simplified back flush systems will satisfy the accounting requirements, therefore using ABC with JIT is just another form of waste.

On the other hand, proponents of activity based management argue that the critics of ABC put too much faith in JIT continuous improvement systems and confuse the needs of external and internal reporting. A backflush system may be adequate for external reporting, but it is not a management decision support system. The concepts and practices associated with JIT (e.g., kaizen, kanban, jidoka, autonomation, statistical process control and plan-do-check-action wheels) are designed to control and improve processes, cycle time, quality and flexibility, but they do not replace, or eliminate the need for, management reporting and decision support systems. Activity based management supplies this need and provides the link between JIT and ABC. Thus, these concepts are not incompatible. Instead, they are both useful concepts that are designed for different purposes.

8. Whether constrained optimization techniques such cost/benefit analysis, EOQ and the economic conformance model for quality costs, are useful decision tools, rather than incompatible with the TQM continuous improvement initiative.

Issue number eight is fairly broad because many of the traditional American management practices are based on the concept of constrained optimization. Briefly, the controversy is based on the idea that management by constrained optimization techniques tends to view the environment as static, while management by continuous improvement views the environment as dynamic. For example, critics of the economic conformance model for optimizing quality costs argue that the technique is based on the belief that an optimum quality level exists. Thus, the model is inconsistent with the concept of continuous improvement because it places emphasis on finding the static optimum rather than continuously eliminating constraints. This controversy leads to the thought provoking question of whether the quality level for a company's products and services can be too high, where quality is defined as conformance to specifications.

Advocates of the various optimization models contend that the techniques are not intended to provide final, once and for all answers to questions concerning order quantities, product mix, production quantities and quality levels. Instead, these tools should be used to assist in the continuous improvement process by testing the sensitivity of optimum solutions as constraints are relaxed or eliminated. Used in this way, these quantitative models promote dynamic, rather than static optimization and are not at all inconsistent with the continuous improvement initiative.

9. Whether traditional capital budgeting techniques are still useful, rather than creating a bias against needed investments in JIT, FMS and CIM systems.

Issue number nine compares the traditional discounted cash flow (DCF) capital budgeting techniques with the newer investment management concepts. Critics argue that the DCF model ignores the synergistic linked benefits of investments that must be considered as a portfolio to achieve an integrated strategy. For example, a company may decide to pursue a proactive strategy in some areas in which the company competes, (i.e., attempt to become a technological leader), a responsive strategy in other areas (i.e., invest after the technology has been proven), and a reactive strategy in the remaining areas (i.e., buy technology off the shelf). By analyzing investments on an individual basis, an integrated strategy cannot be achieved. Another criticism is that the traditional capital budgeting approach is static in the sense that operating and competitive conditions are assumed to remain constant regardless of the investment decision. What is needed is a dynamic moving baseline approach that incorporates the effects of not investing into the analysis. For example, if a company chooses not to invest in a computer integrated manufacturing system, what will be the effect on the company's competitive position in terms of quality, reliability, flexibility, customer responsiveness and market share? Intangible factors are frequently more important than the identifiable cash flows.

Arguments for the defense of traditional capital budgeting are based on the idea that the technique is valid if it is used correctly. The approach is not based on the assumption that intangible, non-quantifiable factors should be ignored in the investment process. The traditional capital budgeting approach includes the recommendation that all important factors should be considered in the investment decision including quantitative financial, quantitative non-financial and also qualitative factors. Companies that only consider quantitative financial data are simply misusing the technique. In addition, advocates of the portfolio idea seem to ignore the fact that investment analysis is not costless. Taken to the extreme, an investment proposal would have to be considered in terms of the interdependencies between all current, all past, and all future investments. There is clearly a practical limit to the number of investment projects that can be evaluated simultaneously. The portfolio approach is perhaps sound in theory, but not feasible in practice.

10. Whether cultural and economic differences between the U.S. and Japan will prevent U.S. firms from successfully implementing Japanese and Deming management methods.

Issue number 10, which deals with the ability of American companies to compete with the Japanese, is fairly comprehensive and extremely thought provoking. This issue obviously extends well beyond the field of accounting, but relates to how the economic system affects accounting and vice versa. Researching this question reveals the source of most of the other controversial questions. Nearly every new controversy in management accounting has been created by the fact that American and Japanese management and accounting practices are based on two entirely different economic models.

Critics of the American system contend that successfully competing in today's global economy requires a whole new set of attitudes and assumptions about how to optimize the benefits obtained from economic activity. Becoming or remaining globally competitive requires adopting the lean production paradigm including the concepts of JIT and continuous improvement. However, the foundation for these concepts is cooperation across the company's value chain, and a long run emphasis on investing in human resources and technology. These ideas are inconsistent with the assumptions underlying the American system which emphasize competition as the way to optimize economic performance. As a result, Americans are too individualistic, too self centered, too competitive, too heavily oriented towards short term profit and consumption, and too anti-government to successfully implement these team oriented concepts. On the other hand, Japan's culture and economic system fit the requirements perfectly. The Japanese people identify with work groups and teams which emphasize collective performance rather than individual performance. Cooperation between individuals, employees and management, departments, companies, industries, and government and business are key ingredients in the Japanese system. (See Martin, Schelb, Snyder & Sparling 92).

Defenders admit that Americans are individualistic and competitive, but point out that teamwork is certainly not a foreign concept. Americans do work together in a crisis and tend to be more creative than their Japanese counterparts. Although there have been some failed attempts to implement JIT and related ideas, there are a growing number of success stories and some notable green field factories based on these concepts (e.g., Saturn). Changing from an individualistic system to a networked or team oriented system must be accomplished in stages, but there are no insoluble problems to prevent American companies from adapting to the new competitive model. A system defines the behavior of the individuals working within the system and the theory of management needed for systemic change is readily available in the works of Deming and others. Initiating the change merely requires a commitment from the top of an organization. "When the student is ready, the teacher will come." (See Deming 93).


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