Summary by James R. Martin, Ph.D., CMA
Professor Emeritus, University of South Florida
The purpose of this paper is to explore the historical conditions that motivated organizations to develop management accounting. Johnson points out that management accounting systems did not develop as an extension of the market oriented double-entry booking keeping process, but instead management accounting systems emerged from efforts to overcome various market imperfections in order to serve organizations' internally1.
Origin of the Western Market Economy
The market economy originated around 1000 A.D. and involved exchanges between institutions and individuals. This created the need for double-entry bookkeeping to keep "track of what was owing and owed" (p.140). The information (or control concept) that supported economic activity was the market pricing mechanism. Later firms, or economic organizations, developed and began to perform economic activities within the firm, rather than in the market. Johnson indicates that this development probably started with the increased demand for textiles in Western Europe. Textiles had been provided by self-employed artisans. A market imperfection of this "putting out" system (p. 140) was simply too little output. Increasing the price seemed to encourage the artisans to produce less rather than more. (An interesting example of the backward-bending labor supply curve). To overcome this market imperfection the merchants became employers. Their purpose was to gain control over labor productivity by hiring workers to perform the activities internally for wages.
Early Cost Accounts in the Factory
A new problem emerged. The wage contract did not provide the information needed to evaluate the labor conversion costs, or labor productivity. Cost accounting was developed to provide this information. Cost accounting helped motivate the merchant factory organizers to seek ways to reduce the slack in the production process. Members of the scientific management movement emphasized standard costing to monitor production efficiency.
Management Accounting in the Vertically Integrated Firm
The vertically integrated firm emerged as a new form of non-market organization emphasizing marketing, purchasing and transportation as well as production. The industries involved were steel, petroleum refining, farm implements and food processing. Gains were captured by moving the purchasing and distribution activities from the market into the firm. This integration helped drive the slack out of the system. Budgeting systems and the return on investment (ROI) measurement were subsequently developed by DuPont (1903-1912) to further serve the information needs of these integrated firms.
Management Accounting in the Multidivisional Firm
The multidivisional firm was created by organizations in the 1920s to use capital more effectively. According to Johnson there strategy was "to control a group of vertically-integrated enterprises through a non-market, internal structure" (p. 144). This structure allowed capital rationing among divisions based the ROI measurements, and the removal of managers that did not produce expected results. General Motors management accounting system (based on the measurements developed at DuPont), provides the earliest and best-known system that linked all phases of the company's internal activities to ROI goals. According to Johnson, empirical evidence supports the view that GM and other multidivisional (i.e., internally-controlled, vertically-integrated) firms produced higher returns than autonomous firms with similar capital2.
In this section Johnson makes a few comments about future forces on the development of management accounting specifically related to the influence from social and political pressures. Future management accountants will perhaps measure the "social efficiency" of activities, i.e., the cost and benefits of economic activities within non-market organizations from a social perspective3.
2 Ouchi describes three types of control mechanisms: 1) the market pricing mechanism, 2) bureaucratic control and 3) the clan. Johnson's description above shows how the bureaucratic control mechanism evolved and provides an explanation for the first stage in the Evolution of Management Accounting. (See the Ouchi summaries 1 and 2 for more information). For a great deal more depth on how American business developed see Chandler, A. D. 1980. The Visible Hand: The Managerial Revolution in American Business. Belknap Press.
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