Trade-Offs in Using Accounting for Multiple Purposes

A single accounting system can generates accounting numbers for multiple purposes.

But one accounting system is unlikely to be appropriate for all the different purposes of internal and external users of accounting.

For a example, a manager might like to know the cost of developing and maintaining the organization’s website versus hiring an external webmaster, but a creditor would want to know the impact of the method chosen on cash flows available to pay interest.

Since a single accounting system will not provide appropriate information for all decisions, trade-offs must be made among the different roles for accounting.

Under the following headings examples of these trade-offs are discussed.

Trade-Off between Making Planning Decisions and Control

Managers generally have specialized information that is useful for making planning decisions.

To make the best planning decision, the person with the most information about a choice should make the choice.

But there is the problem of motivating the individual to make decisions consistent with the goals of the organization.

For example, an information-systems (IS) analyst may be the best-informed individual on the relative qualities of different systems technologies.

If the analyst is given the responsibility to purchase computer software for the organization, she may choose the most powerful and expensive system available.

Having the most expensive technology may not be in the best interest of the organization, if the organization has a better use for cash elsewhere.

Instead of delegating responsibility to the manager with specialized knowledge, the organization could request the manager to communicate the specialized knowledge to higher-level managers, who would make decisions using the transferred information.

But this information could also be used to evaluate the manager with the specialized knowledge.

Knowledge of this use might motivate the manager to alter it. The information is less useful for making planning decisions. For example, an IS manager might know how to modify the existing computer network to improve its response time.

This information would be useful for upper management in making investment decisions for network upgrades. However, the IS manager is also evaluated based on network response time.

The manager can modify the network to achieve response-time goals, but upper management’s knowledge of this modification would eventually lead to higher expectations about the IS manager’s performance.

The use of information to evaluate and reward the IS manager inhibits the communication of this information for planning decisions.

Trade-Off between Making Planning Decisions and External Reporting

Organizations report financial results to external users.

Current regulations set forth by financial accounting, tax, and securities regulators in many countries specify the use of historical costs to measure the value of most organizational assets.

For example, land purchased 10 years ago for $100,000 may now have a market value of $500,000, but the land is still recorded at $100,000 in the financial reports.

No gain due to the increase in market value is recognized in financial or tax reports until the land is sold.

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An advantage of using historical costs is their objective nature.

Historical costs depend less on the subjective judgment of managers because they reflect actual transactions.

Outside investors, creditors, and tax authorities generally prefer accounting numbers that are not susceptible to manipulation by managers. Nonetheless, historical costs are not necessarily the costs that managers should use for decision making within the organization.

Managers of organizations often make planning decisions, making estimates of future costs if the economic, competitive, and operational environments have remained the same.

For example, the historical cost of a gold watch is not a very good estimate for making another gold watch if the cost of gold or the wages of watchmakers have changed.

Therefore, financially reported (historical cost) numbers should be used with care for planning as they can lead to inappropriate decisions.

Trade-Offs between Control and External Reporting

If a financial report based on historical costs is the only available method of evaluating managers, managers will work to affect the financial report. But maximizing profit based on historical costs may not be consistent with the shareholder goal of maximizing shareholder value.

For example, research and development (R&D) expenditures, which increase the value of the organization, are an immediate expense under International Financial Reporting Standards Opens in new window and local (for example, US, UK, and Canadian) GAAP Opens in new window, and reduce present profit figures.

By cutting R&D, managers increase current profit at the expense of future profits.

If the R&D actively creates value for customers and shareholders in the long run, the focus on short-term financial reports may conflict with long-term strategies.

To achieve the goals of the organization through control, performance measures should be closely associated with those goals.

Financial reports based on historical costs may not be closely linked to the goals of the organization and could lead to dysfunctional behavior by members of the organization.

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Multiple Accounting Systems

Implementing multiple accounting systems could resolve the trade-offs existing among the various uses of an accounting system.

Separate accounting systems could be established for making planning decisions, control, and external reporting.

The problem with the solution is the cost of establishing multiple systems.

Many small organizations have the resources for only a single accounting system. Regulators and banks often require financial reports; therefore, the financial accounting system may be the only accounting system that is available within the organization. Larger organizations, however, might have two or more accounting systems for different purposes.

Multiple accounting systems can sometimes can be confusing, as items may be reported at different costs.

One accounting system might report that a particular division made profits of $6.2 million and the other system reports its profits at $5.8 million. Managers will be forced to spend time reconciling the differences.

Remember the old proverb: “A man with one watch knows what time it is. A man with two watches is never sure.”

An accounting system with only monetary measure is not the only source of information to assist in making planning decisions and control. Planning decisions are likely to be based, at least partially, on non-monetary factors.

For example, planning decisions to achieve goals such as employee satisfaction would use employee surveys as an information source.

Control could also be implemented using non-monetary performance measures. For example, a manufacturing manager could be evaluated based on the percentage of defective units produced.

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