Introduction to Strategic Management Accounting PDF

MODULE 1 INTRODUCTION TO STRATEGIC MANAGEMENT ACCOUNTING PREVIEW INTRODUCTION Contemporary organisations face significant internal and external challenges that must be addressed in order to operate and function effectively. It is essential for them to create value for multiple stakeholders, includi...

MODULE 1 INTRODUCTION TO STRATEGIC MANAGEMENT ACCOUNTING PREVIEW INTRODUCTION Contemporary organisations face significant internal and external challenges that must be addressed in order to operate and function effectively. It is essential for them to create value for multiple stakeholders, including customers, employees, management, regulators and their shareholders or owners. This must be achieved in a global environment that is continuously changing and becoming more competitive. This subject focuses on the role strategic management accounting plays in creating, managing and protecting value. For the purposes of this subject, strategic management accounting is defined as follows: Creating sustainable value by: supporting the formation, selection, implementation and evaluation of organisational strategy synthesising information that captures financial and non-financial perspectives for both the internal and external environments, to enable effective resource allocation. Strategic management accounting requires that management accountants embrace new skills that extend beyond their traditional practices. They must collaborate with general management (operational departments), corporate strategists (senior management team) and product development, in creating, managing and protecting value. Fostering organisational capabilities leads to value creation. Value creation is essential in contemporary organisations. One way of thinking about commercial organisations, government bodies and not-for-profit entities is as ‘linked chains’ of resources and activities. These chains produce products and services of value to consumers and end users. The essential requirements for successful performance are: to generate products and services with value that consumers are willing to pay for to constantly develop and improve the resources, activities and processes used to generate that value (Anderson and Narus 1998). This module first considers management accounting and its role in supporting management. It then describes the key changes that have led to the development of strategic management accounting. The module also identifies the challenges that management accountants face and describes the skills required to perform their role, at present and in the future. The ability to support managers at a strategic level has become critically important for organisational survival, and management accountants must broaden their role from traditional scorekeeping tasks to business advisory positions. Advances in technology and information systems now help with capturing and processing the routine events within an organisation. This allows management accountants to spend more time understanding the organisation’s external environment and work on non-routine, complex decisions. This module concludes with an examination of the various analytical techniques available to manage- ment accountants that will assist them to support management in their decisions about strategic direction. OBJECTIVES After completing this module, you should be able to: Explain what is involved in a strategic management process and its various stages. Identify the role of management accounting in strategic management and the mindset and values required to transit from a management accountant to a competent business partner. Assess the key challenges facing management accountants in today’s business environment. Identify various analysis techniques used in strategic management and their functions. SUBJECT MAP Figure 1.1 provides an overview of the important concepts in this subject and how they link together. The highlighted sections show the concepts that are the focus of Module 1. FIGURE 1.1 Subject map highlighting Module 1 rnal environment Exte VISION VALUE INFORMATION STRATEGY STRATEGY MANAGEMENT ACCOUNTANT VALUE INFORMATION OPERATIONS E xte r nal environment Source: CPA Australia 2019. An organisation decides on a strategic direction, where it believes value can be created. This value may be shareholder value, customer value or broader stakeholder value—depending on the type of organisation involved. Creating value for organisations helps sell products and services, increases the share price, and ensures the future availability of capital to fund operations. For value creation to occur there must be a clear strategy, based on a vision and mission that combine resources (including people, technology and time) and their effective use to achieve goals and objectives. The day-to-day activities and projects that are performed must be linked to the organisation’s overall strategy to drive towards its desired outcomes. It is important to perform the work required, but it is also necessary to continuously review, monitor and improve activities and processes. As shown in Figure 1.1, while there must be an information flow from the strategic level to the operational level, there must also be clear feedback and reporting from the operational level. This can be used as a control mechanism to ensure the organisation’s day‐to‐day activities stay in agreement with its vision and mission. The organisation must also be aware of the external environment in which it operates. Competi- tor activity, the broader economic and regulatory environment, technological advancements, alliances, management capabilities, employee and customer relations, and social changes may all affect the organi- sation. So, monitoring these influences and adapting to change are critical activities. 2 Strategic Management Accounting  The management accountant is at the centre of all these activities. Understanding what creates value helps management accountants focus capital and talent on the most profitable opportunities for survival and growth of an organisation. PART A: VALUE The main theme of this part of the module is value. The analysis and activities, the tools and techniques, the reporting and evaluation—all of these take place in the pursuit of value. Value is a broad concept and has a major influence on an organisation’s behaviour and drive to achieve its vision, mission and goals. It can be described as combining resources in a manner that creates desirable outcomes. Examples of value creation include growing food, generating energy, providing health care and building new machines, software programs and infrastructure. The role of management accountants is to support management in creating, managing and protecting value. Value is usually described as increasing shareholder wealth. However, this is both narrow and simplistic because it ignores other important and interested parties or stakeholders, as shown in Figure 1.2. FIGURE 1.2 A broad range of stakeholders Shareholders Community Lenders groups Stakeholders Regulators Customers Employees Suppliers Source: CPA Australia 2019. Each group has its own interests and desires and therefore its own definition of the ‘value’ it wishes to receive from an organisation. Failure to consider stakeholder needs and desires will make it difficult to maintain and increase shareholder wealth. Value creation is just as relevant in the not-for-profit and public sectors. For example, national infrastructure, education, health and social welfare need to be managed just as effectively as privately run organisations. In the not-for-profit and public sectors, value is created for the members, citizens or residents (or taxpayers) of the nation, instead of wealth being increased for shareholders. Value creation in contemporary organisations is based on creativity and innovation. This includes the innovative ways that management adapt to take advantage of new materials, technologies and processes, as compared to value creation in the past, which was based on economies of scale and mass production. SHAREHOLDER VALUE The ultimate outcome for many organisations is to generate wealth for the owners. The owners have either started or invested in the organisation to obtain appropriate returns for the risk involved. As such, many measures of value focus on shareholder value. However, pursuit of shareholder value while ignoring other areas of value creation is not sustainable. To ensure that an organisation is able to create shareholder value MODULE 1 Introduction to Strategic Management Accounting 3 over a prolonged period, its actions and use of resources need to be sustainable. For example, if the impact on the natural environment is not acknowledged or minimised, long-term sustainable shareholder value is unlikely to be achieved. CUSTOMER VALUE The primary task for an organisation is to create an output that has customer value. A key requirement is to produce this output at a cost that is lower than the price the customer is willing to pay, which leads to profitability and creates shareholder value. Figure 1.3 shows a simple version of the organisational value chain. This provides an overview of how the organisation performs a sequence of activities to provide outputs or outcomes to create customer value. FIGURE 1.3 Organisational value chain Business cycle Operations (obtaining/producing goods or services) Sales Distribution After-sales service These activities are supported by a variety of business functions. Support activities Research and development, accounting, human resources, information technology and infrastructure Source: CPA Australia 2019. For a further explanation of and practice in the concept of value chains, please access the ‘Value chain’ learning task on My Online Learning. STAKEHOLDER VALUE Shareholder wealth is a by-product of generating value in other areas. To create products or services, an organisation will require community permission to operate, infrastructure, customers and employees— who will only supply their effort if the wages and conditions are adequate. So, consideration of stakeholders is critical to organisational success. WHICH VIEWPOINT SHOULD BE TAKEN WHEN DETERMINING ‘VALUE’? A significant philosophical issue that must be considered with regard to value is: ‘From which perspective should value be determined’? The most obvious perspective is from the organisation itself. Value is linked to the concept of ‘anything that is good for the business or organisation’. However, other perspectives also exist, including that of society. Some actions may bring value to the organisation as well as to other groups at the same time—for example, more efficient farming practices may lead to higher yields, lower prices and more nutritional food. However, other actions may benefit the organisation while causing significant harm to others, as shown by the examples in Figure 1.4. The development of corporate social responsibility (CSR) indicates that people are interested in more than just the pure economic value that organisations create. They are also interested in ‘how’ that economic value is created, and they assess the impact of those actions (or inactions). CSR reporting has increased to help people understand the sustainable value or effect of an organisation’s activities from a social and environmental perspective. Such reporting aims to increase the level of ethics and accountability demonstrated by organisations when making value-based decisions. Value is either created or destroyed by management through the business model they use. The business model is highly dependent on a broad range of relationships and activities that take place in the market, in a societal and environmental context within which the organisation operates. Therefore, to be truly valuable, something must offer economic value to the organisation and provide sustainable value to other stakeholders within society. 4 Strategic Management Accounting  FIGURE 1.4 Organisational value and potential impact Organisational viewpoint Society’s viewpoint Unemployment, Cost cutting—reducing financial pressure on the number of staff communities and additional by 10% to increase stress for employees who profitability remain employed Switching production Local unemployment, to cheaper offshore environmental degradation, locations with lower and an increase in injuries standards of employee and incidents among employees and environmental who receive little protection protections Massive price A small price reduction discounting of key items for individual consumers by supermarkets to gain but at the expense of market share, forcing producers who are suppliers to reduce prices unable to remain viable Selling addictive Social issues in products or services communities and an including gambling, increase in health- alcohol and cigarettes related costs Source: CPA Australia 2019. Strategic management and strategic management accounting While some areas of accounting, such as financial reporting and auditing, may have a regulatory compliance focus to inform and protect external stakeholders, strategic management accounting is aimed specifically at improving organisational outcomes. Strategic management describes the process by which an organisation decides: the direction it will take the industry it will operate within the types of products or services it will provide its structure, systems and processes its goals and objectives. It also includes the development of specific approaches or strategies as well as implementation plans and performance measurement that support this process. Strategic management accounting aims to provide forward-looking information to assist management in decision-making. Unlike typical cost or/and management accounting, which focuses on internal accounting information, strategic management accounting evaluates external information—for example, trends in costs, prices, market share, competitors, suppliers and technologies—and their impacts on resources. Strategic management accounting uses a wide range of tools and techniques that support each stage of the strategic management process. So, strategic management accounting becomes an enabler, or a catalyst, that helps initiate and drive strategic management activity. Strategic management accounting helps organisations in their desire to create long-term, sustainable value that is of benefit to all stakeholders. MODULE 1 Introduction to Strategic Management Accounting 5 PART B: THE STRATEGIC MANAGEMENT PROCESS The main theme of this part of the module is to explain the strategic management process—the role of strategic management accounting in supporting managers. The strategic management accounting process involves defining the organisation’s strategy and the process by which managers make a choice of a set of strategies for the organisation that will assist managers in value creation. Throughout Part B, the strategic management process is presented as a continuous process that evaluates the business and the environment within which the organisation operates, evaluates/re‐evaluates its competitors, and defines its objectives and strategy. Strategic management accounting—supporting managers Management activities can be classified into the broad categories of: strategic management, which focuses on determining the direction and structure of the organisation and developing plans and objectives for achieving this operational management, which can be considered as the implementation phase of strategic management—turning the strategy into reality. Strategic management accounting provides a supporting role to managers in both categories. This section examines the activities that managers are involved in and the types of support management accountants can provide to help managers perform these activities better. Strategic management The strategic management process involves: addressing key issues, including determining the vision, mission and purpose of an organisation setting specific objectives creating and implementing the strategies to achieve these objectives. Important phases in the strategic management process are shown in Figure 1.5. FIGURE 1.5 The strategic management process Strategic analysis— both internal and external Strategy evaluation— performance Strategy planning measurement, and choice feedback and review Strategy implementation Source: CPA Australia 2019. This strategic management process shown in Figure 1.5 is continuous, and the phases are closely interwoven rather than being clearly separate events. The stages are critically useful in evaluating an organisation’s planning systems and processes and for indicating ways of improving their effectiveness. Significant amounts of information are required to successfully complete each of the stages. The stages in the process are briefly discussed below. Strategic analysis The strategic management process begins with strategic analysis, which is undertaken through scanning the internal and external organisational environment. It is important for the organisation to know itself and its competitors. 6 Strategic Management Accounting  Organisations must continuously analyse the external environment to understand trends and changes that affect the industry and the economy. For instance, Apple redefined the smartphone technology, and its decision to create the iPhone shows its ability to analyse the traditional industry and create a product that distinguished Apple in the mobile phone industry. Organisations must also analyse their own resources and capabilities to understand how they might react to changes in the environment. For instance, changes in the global economic environment have influenced the development of business models where intellectual property (IP) has become an important resource for many contemporary organisations, such as Google, Apple, Louis Vuitton and Mercedes-Benz, for establishing value and potential growth. Organisations use various management tools and techniques to scan the organisational environment. A well-established tool that captures the idea of scanning the environment both external and internal to the organisation is strengths, weaknesses, opportunities and threats (SWOT) analysis (discussed later in this module) (Saylor 2012). Strategy planning and choice Strategy formulation is the next step in the strategic management process. This includes developing specific strategies, actions and measures. For instance, part of Apple’s success is due to the unique features of products it offers, and how these features and products complement each other—for example, an iPod that plays music from iTunes, which can be stored on Apple’s Mac computer. Strategy implementation The next step of the strategic management process is strategy implementation, which entails crafting an effective organisational structure, organisational processes and culture. For example, the rate of Amazon’s innovations in supply chain management (SCM) has been significant, with investment in supply chain automation lessening the overall product delivery time, and increasing the number of warehouses. Its unique supply chain strategies and continuous technological innovations have changed the way SCM works. This helped Amazon to successfully implement its Amazon Prime service in 2005 providing guaranteed two-day shipping of products. Strategy evaluation The final stage of the process is strategy evaluation. This involves measuring performance, providing feedback and undertaking continuous review for improvement. The focus of every organisation is to lead strategically in order to attain long-term goals. Consequently, how managers understand and interpret the performance of their organisations is critical to evaluating strategy. Operational management The relationship between senior strategic managers and operational managers is usually drawn as a pyramid. The senior management team is at the top and focuses on strategic tasks. Underneath this are the operational managers who focus on the medium- to short-term tasks of running an organisation. There should be a strong link between these levels via the strategic implementation phase. However, strategy often fails at the implementation phase due to poor integration of the strategic and operational levels. Formal strategies are often ignored or postponed as day-to-day issues receive all the attention. Managers need to produce short-term operational objectives and implementation plans to achieve long- term strategies. Strategic management accounting supports operational planning with tools including budgeting, costing systems and variance analysis. Constant feedback is required for an organisation to achieve short-term plans. If there is a deviation from the plan, the objective may need to be adjusted or controls put in place to correct the situation. Management accountants provide support for this controlling function by giving feedback with financial and non-financial information. There is a direct and impactful relationship between strategic and operations management. The success of an organisation depends on both the strategic and operational elements. As described earlier, strategic management is the process of understanding the business environment and developing and implementing strategies, while operational management involves executing those strategies on a day-to-day basis to achieve the outcomes in the long run. Table 1.1 summarises the broad difference between strategic management and operational management. MODULE 1 Introduction to Strategic Management Accounting 7  TABLE 1.1 Broad differences between strategic and operational management Strategic management Operational management Directly linked to survival of an organisation Not directly related, but indirectly influences organisational survival Organisation-wide phenomenon Relates to specific operations of the organisation Long-term process Focused on short and medium terms Involves non-routine activities Involves routine day-to-day activities Sometimes very ambiguous Does not involve any ambiguity Requires high-level strategic management orientation Requires tactical management orientation and focus on doing, implementing and achieving operational excellence Manages critical success factors (CSFs) Performs activities on a day-to-day basis of the organisation Source: CPA Australia 2019. QUESTION 1.1 Will the role of strategic management accounting change if the roles and functions of management identified so far in part B of this module change in any way? Example 1.1 highlights how strategic management accounting information can support operational management. EXAMPLE 1.1 Supporting operational management with management accounting information Planning Alpha Pty Ltd (Alpha) sells educational toys for children aged one to four years. One of its products is an electronic reading support toy that is expected to have good sales before the start of the school year at the end of January. The budget for the next quarter (January–March) is set in mid December—it includes a sales revenue target of $165 000 for January. A bonus will be paid to sales staff in mid April if both revenue and profit targets are achieved for this product. Plan Sales target The planning phase is supported by the use of previous sales figures, consumer confidence in the economy and required profit targets to achieve a minimum return above the cost of capital. The plan and expected levels of performance are then communicated to staff. Evaluating On 5 February, the results for January are reported, and actual sales for the toy are $130 000. Not only are January’s figures short of the target, but there is also doubt about achieving the sales target for the whole quarter. The cost of producing each unit has risen because of raw material price increases caused by unfavourable foreign exchange fluctuations. It appears that there will be no bonuses for the sales staff for quite some time. Evaluation occurs continuously, and in this situation, it was supported by the use of actual versus budgeted figures to identify current performance and establish whether bonus criteria were being achieved. 8 Strategic Management Accounting  Actual result Sales target Analysing An analysis of the sales revenue variance uncovers two major issues: 1. An external issue was caused by Alpha’s main competitor, Zeta Pty Ltd (Zeta). During the Christmas period, Zeta heavily discounted a similar toy to successfully attract market share away from Alpha. This had a flow-on effect on January’s sales. 2. An internal problem was caused by a delay in the product being delivered to several large retailers who had sold out. Several days’ worth of sales was lost as a result. Analysis of the causes of the variance indicates that coordination within the organisation needs to be examined and decisions must be made about how to take control of the situation. Control Alpha decides to reduce the selling price by 15 per cent and increase advertising to generate additional sales. Sales estimates for February and March are also slightly reduced. A series of meetings are arranged between sales, purchasing and logistics personnel to ensure that the company has enough stock and that it is being distributed to retailers on time. 1 January 31 January 31 March Sales target decreased Planned result Variance to be controlled Actual result The company is off target. Several approaches to control the situation are made: changing the target—reduced sales target changing the course to the target—reduced sales price and increased target sales volumes attempting to improve coordination within the company. In Example 1.1, the decisions made at each stage needed to be based on rigorous financial and qualitative analysis. This required an understanding of different cost concepts, as well as various tools and techniques to support the analysis. For example, the original variances would have been identified by variance analysis, and the decision to reduce the price by 15 per cent and increase advertising to increase market share could have been modelled using cost-volume-profit (CVP) analysis. A range of operational support techniques are regarded as assumed knowledge for this subject, including: cost classifications CVP analysis product costing marginal costing working capital management. If you are unsure about your knowledge in these areas, you can find resources through our Guided Learning offer on My Online Learning. Strategic management accounting and line managers Organisations have become leaner with fewer employees and have had their hierarchies flattened with reduced levels of management. As a result, greater levels of authority and decision-making power have been delegated to lower-level employees. This has been essential to improve flexibility and responsiveness within organisations. Management accountants were once the providers of all management accounting information, but the tasks of collecting and communicating key performance information are now often delegated to line managers and employees. MODULE 1 Introduction to Strategic Management Accounting 9  Instead of merely recording and providing the information, management accountants are required to provide support and training to assist line managers and employees to undertake these tasks. An advantage of this approach is that it transfers routine tasks to other employees to allow time to be devoted to more complex, non-routine and strategic-level tasks. Strategic management accounting and service industries Many management accounting examples involve the manufacture of products. These products are tangible, easy to visualise, and often produced systematically, so costs can be easily identified and allocated to each element of the product. However, service industries also require the support of management accounting tools and techniques. The detailed Case study at the end of this subject demonstrates this by considering the Australian domestic airline industry. The same approaches and tools are used to analyse services, but the main characteristics of services can make this analysis more difficult. Services differ from products in the following ways: A service is intangible, so it can be more difficult to define or measure systematically. Once a service is provided, it cannot be consumed or used again in the same way as a product. This means there is no ability to store a service as inventory, which makes it more difficult to manage supply and demand levels. A service is more of a unique offering than a product. So providing it in a systematic and identical way is much more difficult. Unused capacity is lost forever. It cannot be used to create something that is stored for later—that is, inventory cannot be created. An important issue in a service environment is the proper management of excess capacity. For example, an airline provides a service by flying passengers from one city to another. But, if half of the seats on the flight are empty, that ‘excess capacity’ can never be recovered once the service is provided. Similarly, managing customer call centres is an area in which employees must be available to answer queries even if there are no customers using the service at a particular time. In these situations, the idle resources can cause significant costs. Other important issues include measuring and maintaining quality, which can be difficult because providing a service can be more individual or unique than producing identical products. Therefore, accurately costing the provision of services to different customers is challenging. Strategic management accounting and the public sector The main difference between the public and private sectors is that many (but not all) public sector organisations do not use profit as their primary measure. An example of this different focus is shown in Question 1.2, in which important themes for local government are well planned urban growth and fostering liveability—an enjoyable place to live. From a strategic management accounting viewpoint, there is still the need to support both the strategic and operational processes. The key questions to consider are: what decisions do public sector managers need to make and how does strategic management accounting support these choices? For instance, in performance assessment, strategic management accounting can help establish metrics for measuring: economy—the extent to which resources of a given quality were acquired at the lowest cost efficiency—the maximisation of outputs for a given set of inputs effectiveness—the extent to which an organisation achieved its objectives. QUESTION 1.2 Read this extract from a local government planning document. STRATEGIC OBJECTIVES STRONG LEADERSHIP Council will lead our changing city using strategic foresight, innovation, transparent decision making and well-planned, effective collaboration HEALTHY AND INCLUSIVE COMMUNITIES Council will provide and advocate for services and facilities that support people’s wellbeing, healthy and safe living, connection to community, cultural engagement and whole of life learning 10 Strategic Management Accounting  QUALITY PLACES AND SPACES Council will lead the development of integrated built and natural environments that are well main- tained, accessible and respectful of the community and neighbourhoods GROWTH AND PROSPERITY Council will support diverse, well-planned neighbourhoods and a strong local economy MOBILE AND CONNECTED CITY Council will plan and advocate for a safe, sustainable and effective transport network and a smart and innovative city CLEAN AND GREEN Council will strive for a clean, healthy city for people to access open spaces, cleaner air and water and respond to climate change challenges Source: Maribyrnong City Council 2018, Council Plan 2017–21, Maribyrnong, Victoria, Australia, p. 1, accessed June 2018, https://www.maribyrnong.vic.gov.au/About-us/Our-plans-and-performance/Council-plan. What strategic management accounting information may be used to support these objectives? Goal Strategic management accounting information Strong leadership Healthy and inclusive communities Quality places and spaces Growth and prosperity Mobile and connected city Clean and green PART C: THE ROLE OF MANAGEMENT ACCOUNTANTS IN STRATEGIC MANAGEMENT The objective of this part of the module is to highlight the role of management accountants in the strategic management process. Management accountants are seen as information providers for business processes, organisational planning and control, resource management and utilisation, and creation of value through effective use of financial and non-financial resources. As a trusted business partner, new challenges facing management accountants mean they must constantly advance their knowledge in diverse areas, and improve their soft skills to effectively communicate with internal and external stakeholders. THE ROLE OF MANAGEMENT ACCOUNTANTS The accounting profession has witnessed significant changes due to globalisation, digital transformation, regulations and competition. Accountants have to adapt to changing circumstances. The role of man- agement accounting has expanded to include a focus on helping managers solve problems and improve their competitive position. For example, management accountants now conduct product life cycle costing and customer profitability analysis, and prepare balanced scorecards (BSCs); with these contemporary management accounting tools, dissemination of information has become easier and hence led to faster customer response times. This is coupled with technological advances that enable electronic data capture, MODULE 1 Introduction to Strategic Management Accounting 11