The following article is from guest blogger, Gary Cokins.
I will substantially oversimplify the history of accounting for the purpose to provide perspective for a new era that is now emerging. It is an era of progressive managerial accounting methods enabled by computer software. Here is all you need to know about accounting’s history:
1494 – The Italian Franciscan friar, Luca Pacioli, documents double-entry bookkeeping to track sailing ship cargo and for merchants in his book Summa de arithmetica, geometria. Proportioni et proportionalita.
1890s – Alexander Hamilton Church designs managerial cost accounting practices to mirror the industrial scientific revolution techniques of the famed industrial engineer Frederick Winslow Taylor used in manufacturing such as for Henry Ford’s early Ford Motor Company mass production operations.
1910 to 1985 – Accounting’s Dark Ages. Regulatory laws enacted in the USA (e.g., The U.S. Securities and Exchange Commission) following the Great Depression vaults financial accounting performed by chartered accountants to protect investors to dominate managerial accounting developed by engineers to support analysis and decisions.
1985 – Professors Robert S. Kaplan and Robin Cooper publish research about activity-based costing (ABC). Kaplan co-authors the book, Relevance Lost soon followed by Relevance Regained.
2002 – the Enron Corporation scandal. New regulatory laws are enacted, most notably Sarbanes-Oxley Act of 2002 (SOX) .
2003 to 2010 – Accounting’s Dark Ages resume. I have suggested to Professor Kaplan, who trained me on ABC when I was with KPMG consulting, that he should write a third book in his series, “Relevance Re-lost” because of the distraction from managerial accounting needed for regulatory compliance reporting.
A Need for Leadership Accounting
So what is now the current situation regarding the health of accounting? Sadly, financial accounting (i.e., external compliance reporting; for valuation) remains dominant over managerial accounting (i.e., internal reporting; for creating value). I am observing a reversal shift in importance and emphasis of these two branches of accounting and possibly a punctuated leap. In this shift organizations will place more emphasis on managerial accounting and advance to managerial economics, including driver-based budgeting and rolling financial forecasts. This advance will better support analysis and decision making powered by business analytics such as correlation and regression analysis.
What is now needed is “leadership accounting”. It is a term coined by Doug Hicks, founder of a cost accounting consulting firm, DT Hicks & Company in Farmington Hills, Michigan. Hicks observes that the demands of external reporting, regulatory compliance, and financial administration have prevented accountants from performing their role in driving economic value for their organization.
Hicks views “leadership accounting” as a way to increase an organization’s economic value (i.e., generating increasing income). It involves strategy management (i.e., actions with key performance indicators, KPIs, and their target levels) and applying principles-based managerial accounting (e.g., reflecting cause-and-effect relationships) to support analysis and decisions. It acknowledges that GAAP-based financial and performance measurements obstruct accountants from contributing to economic value.
Hicks describes a “decision maker” as one who has the ultimate responsibility for a decision. This contrasts with a “decision leader” as someone who ensures the quality and capability of decision making for all managers and employee teams. The darkest time is before the dawn.
Hicks observes that management accountants are well-positioned for a “decision leader” role because they already have much governance and oversight responsibilities. Further, they are the closest role of an economist for most organizations.
Expanding on this “decision leader” concept, Hicks notes one of its roles is to prevent or eliminate biases in thinking. Two examples are:
– Interpreting information (or selectively searching for specific evidence) in a self-serving way solely to confirm, and not to refute, one’s preconceptions.
– Favoring alternatives that perpetuate the status quo rather than being transformational.
Another “decision leader” role is to prevent dysfunctional managerial methods and incentives. This includes assuming that financial accounting conventions result in economic data appropriate for decision making. The conventions do not. Applying traditional standard costing for GAAP may be acceptable for external financial accounting, but managerial accounting should be used for internal analysis and decisions.
Examples of dysfunctional methods and practices are treating depreciation expense as a period expense (and not ignoring it as a sunk cost during analysis) and excluding the cost of capital from cost calculations.
From Single-Point Decisions to a Process
The message here is that decisions are often viewed as an event – a discrete choice occurring at a single point in time. Decisions should be viewed as an ongoing and repeating process. The annual budget should be driver-based and expand to frequent interval rolling financial forecasts extending beyond the fiscal year end.
I hope that I am correct when I predict that the profession of managerial accounting and FP&A will lift from the stagnation since the early 1900s. The shift from financial accounting to managerial economics (e.g., incremental / marginal cost analysis in the “relevant” range) is now enabled with commercial software to financially model physical operations with increasingly more accurate forecasts and valid assumptions.
Just as the Dark Ages evolved into the Renaissance era, the shift to place much greater value on managerial accounting is sure to come.
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ABOUT THE AUTHOR
Gary Cokins, CPIM
Gary Cokins (Cornell University BS IE/OR, 1971; Northwestern University Kellogg MBA 1974) is an internationally recognized expert, speaker, and author in enterprise and corporate performance management (EPM/CPM) systems. He is the founder of Analytics-Based Performance Management LLC www.garycokins.com . He began his career in industry with a Fortune 100 company in CFO and operations roles. Then 15 years in consulting with Deloitte, KPMG, and EDS. From 1997 until 2013 Gary was a Principal Consultant with SAS, a business analytics software vendor. His most recent books are Performance Management: Integrating Strategy Execution, Methodologies, Risk, and Analytics and Predictive Business Analytics.