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Role of Financial and Management Accounting in the Measurement of Firm's Performance - Essay Example

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The paper "Role of Financial and Management Accounting in the Measurement of Firm's Performance" concludes both are important for the successful development of performance measurement schemes – even if their involvement in such measurement causes delays in the completion of the relevant processes…
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Role of Financial and Management Accounting in the Measurement of Firms Performance
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Extract of sample "Role of Financial and Management Accounting in the Measurement of Firm's Performance"

?There are limitations, but financial and management accounting perform a fundamental role in the measurement of performance within an organization. 1. Introduction One of the key challenges of organizations operating in the global market is the development of strategic decisions that will help these organizations to compete their rivals. The above target cannot be achieved without identifying the organizational strengths and weaknesses – as revealed through the performance of the firm’s daily activities. The use of performance measurement systems has been considered as an effective tool for identifying the potentials of a firm’s departments to follow the rules included in the organizational plans. In this context, the performance measurement has been characterized as an activity of key value for organizations in different industrial sectors. The specific issue is examined in this paper; emphasis is given on the role of the financial and management accounting in performance measurement, as a key part of strategic decision process in modern organizations. It is concluded that both financial and management accounting are quite important for the successful development of performance measurement schemes – even if, in certain cases, the involvement of financial and management accounting in performance measurement causes delays in the completion of the relevant processes – under the terms presented below. Because of the above problem, a series of recommendations has been included in this study aiming to support the improvement of performance measurement systems. 2. Performance measurement in organizations 2.1 Performance measurement – description, role The use of performance measurement in modern organizations has been related to the achievement of specific organizational targets. Most commonly, the performance measurement is used a firm’s managers in order to evaluate whether the organizational activities manage to achieve a particular level of performance – as set by the planners of these activities. In this way, it will be possible to estimate if these activities have paid back the investment made on them or not. In practice, the performance measurement – as one of the firm’s key strategic processes – can be quite complex. This fact is reflected in the theories developed in the particular field – referring to the content, the role and the phases of performance measurement in modern organizations. At a first level, certain differentiations can be identified in the criteria used by theorists when having to define the performance measurement; however, a close examination of their views would lead to the assumption that they all emphasize on the value of performance measurement as a tool for estimating the achievement of organizational goals – including the risks involved. In accordance with Hatry (2006) the performance measurement can be defined as the ‘regular measurement of the results (outcomes) and efficiency of services or programs’ (Hatry 2006, p3). On the other hand, Meyer (2003) notes that the term ‘performance measurement’ can be explained using two different definitions: the dictionary definition, which focuses on the past, i.e. on the performance of the organization up to the time point when its performance is measured and the economic definition, which refers rather to the future, emphasizing on ‘the measurement of the shareholder value into the firm’ (Meyer 2003, p20). It is further explained that in the context of the dictionary definition ‘performance is measured by operational measures or current financial results’ (Meyer 2003, p20); on the other hand, the economic definition is based on the measurement of performance ‘using share prices’ (Meyer 2003, p20). Another definition of performance measurement is mentioned in the study of Harbour (1997); in the above study reference is made to the performance measurement as a method for ‘measuring work accomplishments and output’ (Harbour 1997, p7). At the next level, Epstein et al. (2006) emphasize on the value of performance measurement for modern organizations. In accordance with the above researchers, the ‘implementation of performance measurement systems’ (Epstein et al. 2006, p188) is of key importance for organizations operating in various industries; this view is based on the fact that the specific systems can support a wide range of organizational needs, such as ‘communication, coordination and motivation’ (Epstein et al. 2006, p188); moreover, the use of performance measurement in the operations of modern organizations is characterized as quite valuable leading to the increase of importance of organizational departments which were not adequately appreciated in the past – reference is made for example to the Research and Development (R&D) which was characterized, in the past, as of less important compared to key organizational departments, such as the logistics department (Epstein et al. 2006). Therefore, the expansion of performance measurement across modern organizations has led to the increase of equality in their internal environment – at least as of the value of organizational departments as independent organizational units. From another point of view, Andersen et al (2002) highlight the need for increasing the emphasis given on specific aspects of performance measurement: apart from identifying the performance drivers (financial/ accounting drivers) involved in the relevant plan (meaning the performance measurement plan) it would be also necessary to set the time period to which the plan will refer but also the rate of frequency of the relevant initiatives (Andersen et al. 2002). In any case, in order for an effective performance measurement plan to be implemented it is necessary that the ‘performance measurement’ – as a term involved in the above activity – ‘is clearly defined’ (Aristigueta 1999, p5); otherwise, it is possible that the processes or the criteria engaged are inappropriate for achieving the goals set by the specific plan’s developers. 2.2 Performance measurement within an organization – forms and problems The use of performance measurement within an organization needs to be carefully monitored – in all its phases; otherwise, it is quite possible that the results produced through the relevant processes will lack credibility. In any case, managers in modern organizations should understand that performance measurement can support all organizational activities – reference is made to ‘all organizational departments and processes’ (Harbour 1997, p5). Moreover, in organizations with extremely complex and wide processes – referring especially to organizations operating in the global market – the type of performance measurement system used have to be carefully examined – ensuring that the above system will be able to respond to the increased organizational needs; such case is described in the study of Epstein et al. (2006) where reference is made to the ‘global performance measurement systems’ (Epstein 2006, p159) as appropriate strategic solutions for firms operating globally. At the same time, Andersen et al. (2002) note that the performance measurement systems implemented in each organization needs to be appropriately customized – taking into consideration the organizational characteristics and needs – also the resources/ time available for the completion of the specific activity. In this context it is suggested that the performance measurement system adopted by modern organizations would be either of ‘high/ low measurement frequency combined with short/ long measurement period’ (Andersen et al. 2002, p118). On the other hand, the success of performance measure systems cannot be considered as guaranteed – even if they are carefully planned and monitored; this issue is highlighted in the study of Neely (2007); in the above study, emphasis is given on the following problems of performance measurement – as a key strategic tool: a) the drivers used for measuring performance – reference is made especially to the non-financial performance measures – tend to change continuously; the development of credible assumptions on organizational performance by using such performance measures can be a challenging task, b) commonly, it may be difficult ‘to identify measures that both predict the organizational performance and pervade the organization’ (Neely 2007, p116) – again, reference is made especially to the non-financial performance measures, c) in case that a performance-based payment scheme is established in a particular organization, the fairness of this scheme is difficult to be guaranteed – the identification of the actual performance of employees may face difficulties in the context described above; this fact should be taken into consideration by managers when having to decide on the criteria on which employees across the organization will be compensated/ rewarded (Neely 2007). From a similar point of view, Harbour (1997) notes that the pieces of information used in a particular performance measurement process have to be carefully reviewed; it is possible that the information provided for the development of the particular process is not appropriate – maybe information of a different level is required, for instance information referring not to a particular organizational department but to all the departments of the organization (Harbour 1997); the above hierarchy of information used in the performance measurement systems is of key importance for the identification of credible indicators regarding the performance of a particular organization (Harbour 1997). 3. The influence of financial and management accounting on the measurement of performance within an organization – presentation and analysis In accordance with the issues discussed above, the performance measurement within modern organizations is likely to be based on various financial or accounting drivers; these drivers are used as criteria for measuring organizational performance and have been tested for quite a long time – as of their effectiveness. However, they are related to the following risk: the interpretation of the results produced after using these drivers can be different – in accordance with the personal perceptions of the persons (accountants, managers) involved. The following example is mentioned in the study of Neely (2007): the traditional accounting methods and the ABC costing technique can lead to different estimation of costs related to various organizational activities (Neely 2007). Of course, the level at which the findings of the financial accounting and the management accounting schemes are contradictory is depended on the level at which the managers involved in the interpretation of these findings are based on objective criteria – rather on their personal perceptions – for evaluating the results of the relevant processes. At the next level, financial statements are developed using ‘different measurement bases – such as historical cost and present value’ (Schroeder et al 2010, p102). In the above context, the risk involved in the information available through the financial statements of a specific organization can have two different forms: a) it is possible that certain figures are not appropriate – are false, either by accident or in purpose, b) it is also possible that the firm’s manager does not take into consideration these figures even if they are available in the financial statement – mostly because the manager is not aware of the value of these figures for developing key strategic decisions. In case that one of the above conditions exist, then the value of financial accounting as a tool of support of performance measurement within a particular organization is limited. In accordance with the above, the performance measurement of modern organizations is not standardized; rather, it can be based on different techniques each of which can lead to different assumptions in accordance with the drivers on which the relevant processes have been based – as described above. Similar views have been used in the literature in order to justify the relationship between the financial/ management accounting and the performance measurement. In the study of Needles et al. (2007) the relationship between the financial accounting and the performance measurement is explained by referring to the role of financial accounting in modern organizations: it is noted that the key mission of financial accounting is ‘the provision to external decision makers of the necessary information in order to evaluate the level at which a specific firm has achieved its goals’ (Needles 2007, p7); at this point, the key difference between financial accounting and management accounting is made clear: the former addresses the external decision makers – as described above – where the latter addresses the internal decision makers. In both the above organizational activities, the use of data and information related to the firm’s daily performance is necessary. It is on these facts, that the relationship between financial/ management accounting and the performance measurement can be based. From a similar point of view, Schroeder et al. (2010) note that financial accounting is of key importance for performance measurement and this view is based on the following fact: the main role of a firm’s financial statements is ‘to provide information about a firm’s financial position and performance’ (Schroeder et al. 2010, p.100-101); in other words, financial statements – one of the most important parts of financial accounting – have been initially established for supporting the measurement of organizational performance; this fact is another sign of the strong dependency of performance measurement on financial accounting. In accordance with Meyer (2003) the close relationship between the performance measurement of organization and the accounting techniques – referring both to financial and management accounting – has been made clear in the case of Enron; in the above firm, the use of accounting practices which were opposite to relevant laws led to false findings of the specific firm’s performance, a fact that had severe effects not only on the local but also on the international market. However, it cannot be doubted that financial measures are generally ‘easy to be understood being governed by accounting conventions’ (Meyer 2003, p164) – a fact that has supported the expansion of these measures/ drivers in performance measurement. In this way, performance measurement, as a technique for estimating organizational performance, has become clearer for managers worldwide. Regarding this issue, Coombs et al. (2005) note that managers at lower levels of the organizational hierarchy are more likely to develop effective performance measurement schemes; the above fact is explained as follows: managers at lower level tend to check carefully the financial drivers used in the performance measurement systems – in this way, their findings on the firm’s performance are usually more credible (Coombs et al 2005). The above view highlights the following problem: financial drivers are of key importance for the development of effective performance measurement schemes but they are likely to have no particular value if they are not checked carefully – if mistakes are made, either accidentally or in purpose, related to the financial data used in performance measurement systems, then the relevant findings will not reflect the actual organizational performance – a fact that can lead to severe organizational failures, either in the short or the long term. However, not all forms of performance measurement are related to financial accounting and management accounting; this is a view highlighted in the study of Sharma (2009) where reference is made to the following fact: the performance measurement schemes which are based on non-financial drivers are not related to management accounting; it is assumed that if the above schemes fail – because of the lack of credibility of their findings, as explained above – then the above failure should not justified using the relationship between the performance measurement and management accounting (Sharma 2009). Using the specific argument, the potential negatively influence of management accounting on performance measurement is decreased – almost eliminated. From another point of view, Hatry (2006) notes that performance measurement is a process which can be used for estimating the performance of all organizational activities and services, including the accounting – meaning the accounting both as a service provided to the public but also as an activity on which the financial reporting of a firm is based. Through the above view, the relationship between the performance measurement and accounting – both financial and management accounting – can have two directions, leading to the mutual dependency of these sectors. Additionally, this view is in accordance with that of Sharma (2009) who emphasized on the rapid development of management accounting – incorporating a wide range of performance measurement techniques, including the ‘activity based management, the value based management and the quality management approaches’ (Sharma 2009, p9). In other words, the relationship between the performance measurement and the management accounting has become closer because of the development of the latter, in terms of its potential forms and thus of its role for managing and evaluating various organizational activities. 4. Conclusion and recommendations The use of performance measurement systems for the development of effective management decisions is quite necessary; however, the role of these systems in the strategic planning process should not be overestimated. In fact, performance measurement should be used for the design of key strategic decisions up to a level; in other words, it should not have a decisive role in the form and the content of organizational plans (Hatry 2006). The above view is justified by the fact that performance measurement has been often found to lead to inconsistent and contradictory results – as highlighted in the study of Neely (2007) – mostly because it is based on drivers that are not likely to be, at least not all of them, standardized. Moreover, the interpretation of the findings of performance measurement can be differentiated among managers with different perceptions on organizational performance (Epstein et al. 2006); additionally, the research on the practical aspects of performance measurement – as the relevant issues are developed in section 2.2 above – has revealed that the use of performance measurement within modern organizations is related to a series of problems – which are difficult to be eliminated, or even controlled. For the above reasons, the credibility of performance measurement as a tool for establishing effective strategic decisions can be often doubted. The measures required for facing the above problem would be indicatively the following: a) effort to avoid the extensive use of non-financial drivers when measuring organizational performance – as revealed through the research on the specific issue, by relying solely on non-financial measures for measuring performance, managers could be led to false assumptions regarding the actual organizational weaknesses and needs, b) the findings of performance measurement systems used in organizations of different industrial sectors should be cross-checked using data and information retrieved through different techniques/ sources – for instance, material retrieved through the meetings of the firm’s managers or through the survey conducted among the employees (the employee engagement survey and so on) – in organizations where such plans are used and c) the persons involved in the relevant processes – referring to the various phases of a performance measurement project – should be appropriately skilled, being able to interpret effectively the relevant findings and suggest the measures required for the improvement of the performance of the measurement systems involved. References [with links, Bibliography added] Andersen, B., Fagerhaug, T. (2002) Performance measurement explained: designing and implementing your state-of-the-art system, Milwaukee, ASQ Quality Press (p.118) http://books.google.com/books?id=TeVQJmnq8lEC&pg=PA117&dq=Performance+measurement+and+definition&hl=el&ei=goteTcIFj5uFB4nh6LEN&sa=X&oi=book_result&ct=result&resnum=6&ved=0CEIQ6AEwBTgK#v=onepage&q=Performance%20measurement%20and%20definition&f=false Aristigueta, M. (1999) Managing for results in state government, Westport, Greenwood Publishing Group (p.5) http://books.google.com/books?id=URNLGA-29PEC&pg=PA5&dq=Performance+measurement+and+definition&hl=el&ei=goteTcIFj5uFB4nh6LEN&sa=X&oi=book_result&ct=result&resnum=2&ved=0CCsQ6AEwATgK#v=onepage&q=Performance%20measurement%20and%20definition&f=false Coombs, H., Hobbs, D., Jenkins, E. (2005) Management accounting: principles and applications, London, SAGE (p.298, From section, People Aspects) http://books.google.com/books?id=MgvzofjWlLMC&pg=PA295&dq=management+accounting+and+measurement+of+performance&hl=el&ei=ZZxeTdL0GYW6hAfP66jCDQ&sa=X&oi=book_result&ct=result&resnum=9&ved=0CFQQ6AEwCDgK#v=onepage&q=management%20accounting%20and%20measurement%20of%20performance&f=false Epstein, M., Manzoni, J. (2006) Performance measurement and management control: improving organizations and society, Oxford, Emerald Group Publishing (p.159, 188) http://books.google.com/books?id=UEGinVfIYOEC&pg=PA188&dq=Performance+measurement+and+definition&hl=el&ei=goteTcIFj5uFB4nh6LEN&sa=X&oi=book_result&ct=result&resnum=8&ved=0CE0Q6AEwBzgK#v=onepage&q=Performance%20measurement%20and%20definition&f=false Furstenau, D. (2008) Process Performance Measurement: Integration of Process Information in the Performance Measurement System, Norderstedt, GRIN Verlag (p.19) – as Bibliography http://books.google.com/books?id=-yO1tnAZkuUC&pg=PA19&dq=financial+accounting+and+measurement+of+performance&hl=el&ei=go5eTZPmM5OAhAfDpPTQDQ&sa=X&oi=book_result&ct=result&resnum=8&ved=0CE4Q6AEwBw#v=onepage&q=financial%20accounting%20and%20measurement%20of%20performance&f=false Hatry, H. (2006) Performance measurement: getting results, Washington, The Urban Insitute (p.3) http://books.google.com/books?id=PQNUNlwdbDQC&pg=PT17&dq=Performance+measurement+within+an+organization&hl=el&ei=-IxeTazIPI2JhQfc9aW4DQ&sa=X&oi=book_result&ct=result&resnum=2&ved=0CCsQ6AEwATgK#v=onepage&q=Performance%20measurement%20within%20an%20organization&f=false Harbour, J. (1997) The basics of performance measurement, New York, Productivity Press (p.5, 7) http://books.google.com/books?id=884j82FFMKUC&printsec=frontcover&dq=Performance+measurement+within+an+organization&hl=el&ei=ioxeTYWQMcyxhAfC9rD1DQ&sa=X&oi=book_result&ct=result&resnum=2&ved=0CCwQ6AEwAQ#v=onepage&q=Performance%20measurement%20within%20an%20organization&f=false Meyer, M. (2003) Rethinking performance measurement: beyond the balanced scorecard, Cambridge, Cambridge University Press (p.20, 164) http://books.google.com/books?id=n1UQcn6L4f4C&pg=PA20&dq=Performance+measurement+and+definition&hl=el&ei=mopeTa60OsmYhQfC8fWwDQ&sa=X&oi=book_result&ct=result&resnum=2&ved=0CCwQ6AEwAQ#v=onepage&q=Performance%20measurement%20and%20definition&f=false Needles, B., Powers, M. (2007) Financial Accounting, Boston, Cengage Learning (p.7) http://books.google.com/books?id=mlNaxcLjLmwC&pg=PA158&dq=financial+accounting+and+measurement+of+performance&hl=el&ei=go5eTZPmM5OAhAfDpPTQDQ&sa=X&oi=book_result&ct=result&resnum=9&ved=0CFMQ6AEwCA#v=onepage&q=financial%20accounting%20and%20measurement%20of%20performance&f=false Neely, A. (2007) Business performance measurement: unifying theories and integrating practice, Cambridge, Cambridge University Press (p.116) http://books.google.com/books?id=EnFsx6svfL8C&pg=PA201&dq=Performance+measurement+and+definition&hl=el&ei=mopeTa60OsmYhQfC8fWwDQ&sa=X&oi=book_result&ct=result&resnum=5&ved=0CDsQ6AEwBA#v=onepage&q=Performance%20measurement%20and%20definition&f=false Schroeder, R., Clark, M., Cathey, J. (2010) Financial Accounting Theory and Analysis: Text and Cases, Hoboken, John Wiley and Sons (p.100-101, 102) http://books.google.com/books?id=HTXzc5VjT4QC&pg=PA102&dq=financial+accounting+and+measurement+of+performance&hl=el&ei=zZVeTbiPKMuZhQexzYT0DQ&sa=X&oi=book_result&ct=result&resnum=6&ved=0CEAQ6AEwBTgK#v=onepage&q=financial%20accounting%20and%20measurement%20of%20performance&f=false Sharma, B. (2009) Accounting Management: Information for Decisions, New Delhi, Global India Publications (p.9) http://books.google.com/books?id=rey1YxP9fNgC&pg=PA44&dq=management+accounting+and+measurement+of+performance&hl=el&ei=Ip1eTcjNPMSZhQfsrZDiDQ&sa=X&oi=book_result&ct=result&resnum=2&ved=0CDEQ6AEwATge#v=onepage&q=management%20accounting%20and%20measurement%20of%20performance&f=false More sources – as Bibliography Stickney, C., Weil, R., Schipper, K. (2009) Financial Accounting: An Introduction to Concepts, Methods and Uses, Boston, Cengage Learning http://books.google.com/books?id=M72b6tXgT1MC&pg=PA26&dq=financial+accounting+and+measurement+of+performance&hl=el&ei=go5eTZPmM5OAhAfDpPTQDQ&sa=X&oi=book_result&ct=result&resnum=5&ved=0CDwQ6AEwBA#v=onepage&q=financial%20accounting%20and%20measurement%20of%20performance&f=false Jankowski, T. (2009) Investment Performance Measurement: Evaluating and Presenting Results, Hoboken, John Wiley and Sons http://books.google.com/books?id=jrjtdt157TQC&pg=PA839&dq=financial+accounting+and+measurement+of+performance&hl=el&ei=go5eTZPmM5OAhAfDpPTQDQ&sa=X&oi=book_result&ct=result&resnum=6&ved=0CEMQ6AEwBQ#v=onepage&q=financial%20accounting%20and%20measurement%20of%20performance&f=false Hopwood, A., Chapman, C. (2008) Handbook of Management Accounting Research. Oxford, Elsevier http://books.google.com/books?id=dIbYmN57sMwC&pg=PA1390&dq=management+accounting+and+measurement+of+performance&hl=el&ei=V5deTZPlJ4ebhQfMyLScDQ&sa=X&oi=book_result&ct=result&resnum=6&ved=0CEYQ6AEwBQ#v=onepage&q=management%20accounting%20and%20measurement%20of%20performance&f=false Taticchi, P. (2010) Business Performance Measurement and Management: New Contexts, Themes and Challenges, London, Springer http://books.google.com/books?id=ipsunutmPC0C&pg=PA243&dq=Performance+measurement+within+an+organization&hl=el&ei=-IxeTazIPI2JhQfc9aW4DQ&sa=X&oi=book_result&ct=result&resnum=4&ved=0CDUQ6AEwAzgK#v=onepage&q=Performance%20measurement%20within%20an%20organization&f=false Read More
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