Strategic Management Accounting
Strategic management accounting refers to methods of management accounting that apply significant emphasis on aspects of the Company’s business environment factors from a much wider perspective. In Strategic Management Accounting (SMA) the focus is on generating point-specific information on internal and external factors that are cross-cutting on all issues that are pertinent to the operation of the business (Colier and Gregory, 1995). As such, SMA is a management accounting approach that seeks to utilize all forms of information in the determination of evidence-based decisions in business management that also includes non-financial data. The idea behind the concept of SMA was informed by the need to provide an integrated framework on information for management accounting that is crucial in the development of the Company’s business operation strategy. In this context, the importance of SMA as a management accounting tool for Jessup Ltd is, therefore, to act as an information resource from which the Company can use in designing reliable and effective business operational strategies. Thus, the ability of Jessup Ltd ability to identify and implement range of business strategies decisions that are able to successfully chart the Company to greater heights in the industry is the major deliverable that SMA methodology will achieve. In the following section, we shall discuss in detail what the SMA concept entails and more specifically the advantages of implementing SMA-based management accounting practices in a Company such as Jessup Ltd.
SMA Concept and Deliverables
In a nutshell, SMA is a concept that is defined as “accounting for strategic management” that incorporates all the range of individual elements that are necessary for “planning, implementation and control of business strategy” (Collier and Gregory, 1995). In a very general way, the concept of SMA in businesses operations requires the accounting elements of the Company to be revised and positioned in two different ways. One, accounting approaches should ensure that the business costs are integrated with the strategic elements of the business in order to align these costs along with the best business strategies (Cinquini and Tenucci, 2005). Two, the concept of SMA ensures that accounting approaches are also able to track and monitor the costing systems of other competitors in the industry for purposes of developing business strategies from this context (Cinquini and Tenucci, 2005). The implications of the SMA concept therefore to a Company such as Jessup Ltd means that the Company will have the advantage to base their business costs on reliable and accurate empirical data in addition to being able to anticipate and address their competitors as far as strategic cost systems are concerned.
More specifically the range of benefits that Jessup Ltd is able to gain from the application of the SMA concept in its business operations are numerous and include the following. One, the Company will be able to utilize and apply all the other range of information that impacts in any way on the business including non-financial data in the development of costing systems and business strategies which is an advantage that traditional accounting methods do not offer. Two, SMA concepts consider the impact that the whole range of factors such as competitors, regulations and so on that is found in the business environment has on the specific Company. In fact, this is one of the integral features of the SMA concept which we shall discuss in more detail when we get to analyze the internal and external factors that affect a business in the Michael Porter 5 Forces Model.
Three, SMA concept emphasizes the need for accountant to utilize and go beyond the application of accounting tools that have been traditionally used in management accounting methods. Finally, the SMA concept emphasizes the importance of businesses in factoring costs that arise from post-conversion activities rather than focusing on manufacturing costs aspects alone (Inman, 1999). To fully understand what SMA entails we will have to discuss one of the models that best captures this concept of Strategic Management Accounting which was developed by Michael Porter in 1985 in what has now come to be referred to as Porter’s Five Forces Model.
Porters 5 Forces Model
Michael Porter Five Model Forces is a framework that was developed to serve as a guideline for market analysis and development of strategic business objectives for business organizations (VectorStudy.com, 2008). It is a process of determining the five forces that directly impact a business in terms of financial performance and customer service delivery based on a total of ten economic concepts. Basically, Porter’s 5 forces are made up of two major groups of forces, those that are categorized as horizontal which include threat from substitute product, from established rivals and from new entrants (VectorStudy.com, 2008).
The other group of forces is collectively referred as vertical force and includes customer bargaining power and supplier bargaining power, together these five forces makes up the 5 Porter model as shown below (VectorStudy.com, 2008).
In the context of business environment of Jessup Ltd Company the threat of substitute product area will mean Jessup Ltd is threatened from competitors services that their competitor are developing which the consumers might prefer to use instead of what Jessup is offering. In the second area of threat of entry of new competitors Jessup Ltd is continuously being threatened by the merging of organizations that are in the same industry because mergers enables business to rapidly expand to new markets which means the market share of Jessup Ltd will continue to shrink over the years. Third, the intensity of competitiveness is a real threat that Jessup Ltd must strategize by developing contingencies, this is because ongoing acquisitions and merging of Company’s in the industry have an impact on costing systems because of the advantage of economies of scale that these businesses have but which Jessup does not have.
This is because mergers increase competition in terms of price within the industry because of the ability of large corporations to significantly lower costs in order to attract customers. The bargaining power of customers has relevance in that clients that source and purchase services from Jessup are naturally very sensitive to price changes like all other customers. The implication is that Jessup prices are dictated by two major factors; market price in the industry and customer bargaining power ((VectorStudy.com, 2008). Finally, the bargaining power of suppliers is a key determinant that determines Jessup’s financial performance and operations in general. It is perhaps the major force of threat that faces any type of business in any sector where the cost of production is ultimately a function of various factors such as politics, government policy, currency change and civil wars are always influencing the price in one way or another.
Thus, the roles of a strategic management accountant working at Jessup Ltd must have job responsibilities that are aligned with these deliverables that are central to the concept of SMA. Ultimately the idea of applying the SMA concept in a business Company such as Jessup is to ensure that the cost systems of the Company are integrated with the business strategic objectives. Because business strategic management is a core feature of the SMA model let us briefly discuss what the SMA-driven business strategic management involves and the role of strategic management accountant who functions as a driver of the same.
SMA Driven Business Strategic Management
The importance of strategic management in a business is one of great importance that organizational management cannot afford to overlook. It refers to plans, decisions and actions that an organization must implement in the course of business operations in order to chart the organization towards the most desirable level that the management desires as envisioned in the mission statement (Pearce and Robinson, 2008). The single most important aspect of strategic management in the running of an organization is its ability to provide the management with contingencies at every level of difficulty that a business will encounter during its operation (Pearce and Robinson, 2008). More importantly it enables the direction of the business to be informed by use of best practices that utilize range of information sources as opposed to decisions that are not based on any strategic management models as was traditionally the case.
Strategic management in business operations involves various activities that are roughly nine in number that is seen to occur at three levels within an organization namely: functional level, business level and corporate level (Pearce and Robinson, 2008). At each of these levels of business operations, the concept of strategic management requires it to be incorporated in a way that contributes to the overall strategic plans of the organization. This is necessary because each of these levels provides different insight regarding the business operations at that level which is necessary since it informs executive level management on the best decisions to undertake (Pearce and Robinson, 2008). In this context, the emphasis of the SMA concept is on the second level of business operations where the elements of costing among others are found. But because SMA also gets to utilize non-financial data, functional and corporate level business strategies are also regarded as key to this process since it makes it possible to pull together various resources in arriving at the best business operational options for the Company.
Another importance of strategic management in a business is its ability to provide a business with the tools and capability to effectively respond to the range of challenges that might hamper or run down a business, in what is usually referred to as internal and external threats (Pearce and Robinson, 2008). The external threats or environments refers to factors that adversely affect a business that are beyond it scope of control, such as government compliance requirements that increases the cost of doing business or marketing competition that requires a company to spend more in order to keep up. The internal environment incorporates all issues that limit the performance of the organization from within and which can effectively be addressed through proper management skills such as employee motivation.
Utilization of all these ranges of information sources and their implications to the business establishment is the responsibility of a strategic management accountant as far as the SMA concept is concerned. This is in addition to routine accounting roles that accountants have traditionally undertaken in a business operation. In accounting there are four types of documents that are referred to as financial statements which are usually prepared by an accountant; they include a balance sheet, income statement, statement of cash flow and statement of retained earnings (Stitle, 2004). According to IFRS, financial statements should specifically include statements of financial position, statements of income, statements of changes in equity (SOCE), cash flow statements and a summary of accounting policies that the organization must adhere to (Stitle, 2004).
All these financial statements are crucial in the strategic management of the business and also rely on some form of non-financial information data in their preparation. For instance, IFRS requires Companies to prepare a summary of financial policies that it relies on upon in its preparation of these financial statements as well as in its daily transactional activities (Stitle, 2004). In preparation of all these financial statements, IFRS emphasizes five core values to be considered by accountants that mirror the integrity of accounting standards that are contained in IFRS series; they include; reliability, relevance, comparability, understandability and fair representation all of which have nothing to do with financial data (IFRS.org, 2010).
Finally, in order to determine the progress of a business, strategic management is used as a benchmark in which to assess the performance of the business against its objectives and goal as described in the mission statement of the organization (Pearce and Robinson, 2008). Perhaps one of the most desirable advantages of the application of the strategic management concept in business operations is the way that it allows management to determine both the short-term and long-term plans for the business at the same time. This has the advantage of providing the business with the best plans of action at any given time that best favors its success. Thus, strategic management enables businesses to use the same concept to monitor as well as evaluate the performance of the business in consideration with its competitors at any point and take corrective measures (Pearce and Robinson, 2008).
SMA Relevant and Irrelevant costs and revenues
There are two types of relevant costs from an SMA perspective; opportunity costs and what is referred to as “future differential cash outflows and inflows (Gulati, 2006). Irrelevant costs on the other hand are divided into three major categories; sunk costs, future, non-differential cash flows and finally allocated indirect costs (Gulati, 2006). Differential costs refer to costs that tend to change with the kind of business decision that is arrived at while incremental costs/revenues are based on the degree of change that affects such costs. As such what is notable about these costs from an SMA perspective is that the relevance or irrelevance of a cost is something that is relative rather than fixed; this is because a cost that could currently be described as irrelevant could very well be relevant in a different scenario. A perfect example of a differential type of cost for instance is a vehicle insurance premium that changes based on the type of business that the motor vehicle is involved in at the time. If it is a commercial truck for instance the insurance premium that is charged is ideally higher than would be the case if it is a personal truck.
An incremental cost on the other hand could be the amount of money that one would hope to spend on gasoline if one was to transport goods to a client. The further the distance in terms of miles the costs associated with gasoline that the vehicle needs to use is directly proportional to this distance.
In SMA, data is considered to be relevant only under those circumstances that it is seen to have a direct impact on future costs or revenues; otherwise, it must be considered to be irrelevant (Gulati, 2006). In decision making under the framework of the SMA model one of the first steps that one needs to undertake is to separate the cost and revenues into either relevant or irrelevant categories. For instance, any costs must be considered to be sunk costs where future anticipated costs have been determined to have no bearing on previous posts that have already been incurred.
For this reason sunk costs are considered to be irrelevant because they have already been incurred in the past and are not a factor to present circumstances (Gulati, 2006). An example of sunk cost is where a person gets to buy an airbus for example only to have it realize that its cost of gasoline exceeds the profit margin. The decision of selling this airbus or having its engine size and sitting capacity changed to reduce jet fuel expenses after realizing that for instance should have nothing to do with how much the airbus might have cost in the first place.
Benefits and Challenges of Activity-based Costing (ABC) in an Organization
ABC is a financial costing approach that seeks to match all cost activities of a business to a specific group of services or products, either as indirect costs or direct costs based on their exact consumption for each one of them (Brimson, 2010). The rule of the thumb in cost allocation demands that each department that benefits from another department should be allocated a portion of the cost that is emanating from that department which is determined by two factors: ideal allocation criteria and allocation method (Pearce and Robinson, 2008). The importance of ABC in strategic business management is an integral feature that is important in facilitating the enactment of evidence-based decisions because it provides uncommon insight into all the range of cost activities that directly affect business profitability. For this reason ABC concept is important for business that seeks to determine desirable price levels of their products and services, cost implications of outsourcing and determination of financial benefits of any form of business improvement initiative.
In addition, ABC will enable a business establishment such as Jessup Ltd to allocate costs which is vital in ensuring cost control for budgeting purposes; this is to ensure that each department does not exceed the required limits. This measure is important for various reasons but generally, it ensures that department operates within their fiscal limits and therefore do not comprise other equally important projects due to over expenditure (Ma and Tayles, 2009). The objective, therefore, is both for strategic reasons and essentially to increase profits. These are among the most important benefits that the ABC concept will be able to provide to Jessup Limited. On the other hand the challenges that are associated with use of ABC method emanates from the difficulties of the approach that one should adopt to ensure that cost allocation is accurately undertaken.
Some of the approaches that Jessup limited might use in their ABC methods are the double allocation method which is most appropriate for businesses that have services as their end products; unfortunately, this approach is complicated by the need to set up cost centers where costs are grouped first before they can be dispersed (Ma and Tayles, 2009).
A more reliable form of cost allocation that can be used in this case is the multiple distribution methods since it provides one with the advantage of factoring for multiple sources of resources and enables intermediary costs to be structured. Both of these double allocation methods allow cost elements for a particular department to be funded by more than two sources of revenues which is important for a more balanced cost-revenue distribution (Ma and Tayles, 2009). The downside for these methods is that they are complex and difficult to implement besides requiring a lot of time to undertake.
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