Comparing Strategic Management Accounting with Traditional Management Accounting

“Strategy is the direction in which the organization plans to move to attain its long-term goal” (Anthony & Govindarajan, 2007). Strategy is concerned with the long-term direction of the business organization, the scope of its operational activities, the matching of operational activities to its resource capabilities and its competitive environment, giving consideration its stakeholders values and expectations (Porter, 1996 ; Anthony & Govindarajan, 2007).

Traditional Management Accounting has tended to concentrate on the tactical and operational decisions in the organization by focussing strictly on financial measures for monitoring and controlling short term activities. It predominately emphasizes on allocating business costs to goods or services and prepare accounting reports using historical and quantitative financial data for internal management business decisions. It is inward-looking with short-term outlook and focussing too much on internal organizational efficiency. In the new competitive environment, for a business to remain healthy there are other aspects that need to be considered such as information on competitors, human resources, customers, suppliers and technologies for developing and monitoring a business strategy.

By focussing only on the cost side of things more heavily than other aspects of the business,traditional management accounting has tended to neglect to provide information to support and attain strategic goals of organizations. Therefore traditional management accounting is considered to be inadequate due to its failure to generate relevant and futuristic non-financial information required to support strategic decision-making (Bromwich, 1990).

Strategic management accounting (SMA) is a newer version of management accounting which adds the strategic perspective to traditional management accounting. SMA is defined as “The provision and analysis of financial information on the firm’s markets ,competitors’ costs, cost structures and the monitoring of the organization's strategies and those of its competitors in these markets over a number of periods” (Bromwich, 1990) . SMA attempts to rectify the weakness of Traditional management Accounting by including (i) Both financial and non-financial indicators and (ii) Both internal and external information.

According to Porter (1996) business strategy, involves (i) Competitive advantage, which focusses on choices and trade-offs between alternatives based on external industry analysis , and (ii) “operational effectiveness,” which focuses on cost minimization based on internal value chain analysis. Thus, SMA can be compared to Traditional Management Accounting from these two perspectives of external competitive environment and internal strategic costing ;

External competitive environment perspective

For an organization to be successful, it is important to gain or sustain its competitive advantage. According to Porter 's (1996) strategy framework, for businesses to generate a sustainable competitive advantage, they have three strategies to choose from. They are the low cost leadership strategy, product or service differentiation strategy, and focussed strategy. A low cost leadership strategy involves seeking to become the lowest cost producer of a product or service in order to earn above-average profits. A differentiation strategy seeks to create a customer perception that a product or service is superior compared to that of the competitor's products or services, based on brand, quality, and performance. A focus strategy involves either a differentiation or cost leadership strategy, but seeks to provide a high perceived value product or service to customers in a niche segment of the market, justifying a price premium. In order to gain competitive advantage, an organization requires constant monitoring of the external competitive environment and must be flexible, adaptable and needs continuous improvement (Porter, 1996).

SMA incorporates strategic thinking into management accounting by including non-financial measures to capture the qualitative attributes and aspects of competitive management. A key component of SMA is analyzing and incorporating external factors such as industry competition to determine the organization's biggest competitors, competitor's positions in the market, threat of new competition in the market, and the cost of entering the market, the threat of substitute products or services which can obsolete the existing product. SMA conveys an externally oriented perspective and helps in the development of long-term plans by collecting and analyzing information on competitors costs, market shares, sales volumes, and resource utilization for comparison against its own internal information. Such competitor data helps business to protect its strategic position or make strategic changes to improve future competitiveness. Thus , SMA looks to the future by measuring trends in the external environment and supports positive longer-term decision makings rather than short-term reactive ones.

Traditional Management Accounting does not offer a full understanding of the external competitive situation. Its focus is on determining costs and financial control, by using methodologies such as budgeting and cost accounting, thus making the organization rigid and not adaptable to the dynamic nature of the external competitive markets. Traditional Management Accounting is inward looking as it focuses largely on accounting functions within internal business units to meet the requirements of the business unit managers. While greater emphasis is given to the internal operations side of the organization, it overlooks potential external competitive threats and external opportunities. Traditional Management Accounting excludes information about competitors, without the information of competition taking advantage of them is impossible. By focussing purely on financial information, Traditional Management Accounting coveys on short-term outlook. Thus, traditional management accounting is considered to be too limited to provide necessary and meaningful information for long-term planning .

Compared to Traditional Management Accounting, Strategic Management Accounting (SMA) is outward looking and helps businesses to evaluate its relative competitive position in industry it operates in. By providing strategic competitive data, SMA helps businesses to analyze the actions of its customers and competitors. In the absence of such information, businesses will be incapacitated in formulation and implementation of business strategies for competitive advantage. Therefore, Strategic Management Accounting (SMA) entails providing management accounting in the context of planning and implementing business strategies.

Internal Strategic Costing perspective

From Porter's (1996) strategy framework, businesses have three strategies at their disposal : product or service differentiation, low-cost leadership and focus strategy . However, to implement any of these strategies , the management must manage costs strictly . Therefore cost management system is a critical source of building a competitive advantage. The 21^st century business environment is characterized by intense competitive rivalry and as a result, businesses have to constantly adapt and change their internal operations in order to maintain or gain a competitive advantage . Successful organizations are those that are able to (i) lower costs and (ii) improve the quality and efficiency of operations. Therefore, an organization's internal cost management system must be aligned to its business strategy

Traditional Management accounting features management control techniques such as budget control and standard costing. Such costing models incorporates arbitrary allocation instead of the cause-and-effect allocations of indirect costs, and they do not provide accurate product cost information in a multi-product organization. Such techniques could lead to accurate product costs in mass-production organizations where direct costs are considerably high and indirect costs are typically low. This was appropriate in mass-production industries which were dominant around 50 years ago, however, the current organizations are characterized with having lower direct costs and higher indirect costs. This makes accurate calculation of product profitability in a modern organization not possible. It is impossible to establish and/or sustain competitiveness without an actual cost calculation mechanism. Also, traditional management accounting has failed to adapt to the modern competitive environment that requires continuous improvement in the entire value chain. The value chain is the set of all the activities involved in the product, from the beginning with the extraction of raw materials to the end with the post-delivery customer support activities (Anthony & Govindarajan, 2007).Traditional Management Accounting does not analyze non-manufacturing costs or the costs of pre-conversion and post-conversion activities. Thus, it fails to evaluate the relative cost positions of competitors as it is concerned more with the internal cost position of the company such as focussing on existing activities and managing the internal resources of the organization. This makes traditionally management accounting backward-looking and reactive to competitive pressure.

For this reason management accounting processes shifted to using costing models under SMA such as activity-based costing methodology. The Activity-Based Costing (ABC) is costing system methodology that reflects the modern complex business environment and facilitates the organization to allocate costs more accurately. ABC assesses and identifies activities in the value chain of the organization and assigns the cost of each activity with resources to all products and services according to the actual consumption by each of them (Anthony and Govindarajan, 2007). Therefore, an organization can accurately estimate the cost elements of the entire range of its product and/or service and to help in management decisions. By identifying and allocating costs to each activity, ABC helps the company to determine whether to lower or raise the activities cost based on the relative cost position. Also, ABC model offers valuable insights toward the strategic planning process (Anthony and Govindarajan, 2007) . ABC focus is not just on the costs of the activities but also value added by these activities from both internal and external positions. SMA views cost drivers by looking at the value they provide to achieve the company's strategic/long-term objectives. In areas where opportunities for lowering costs exists, the long-term impact are addressed, such as the possibility of declining market demand and/or quality. In areas where investment opportunities exists, long-term advantages and/or disadvantages are evaluated, such as whether increasing value-adding activities or eliminating non-value adding activities will raise the profit margin in the future. By integrating costs into strategy, SMA enhances the strategic position of the firm through the exploitation of the linkages in the value chain and optimizing cost drivers. Thus, compared to Traditional Management accounting, SMA uses cost information to formulate strategies and carry out tactics to implement those strategies (Anthony and Govindarajan, 2007).

In conclusion, today's organizations face a lot of competition due to the rapidly changing, complex and uncertain economic environment. For an organization to be successful, it is critical for it to maintain or improve its competitive advantage. By focussing too much on internal organizational efficiency , Traditional Management Accounting does not offer a full understanding of the external competitive situation. It is considered inward-looking aiming to fulfill short-term objectives rather than long-term objectives of the business. Strategic Management Accounting (SMA) looks not only at the internal efficiency of the organization in terms of its resources and operations, but also on the external business environment . SMA aims to provide relevant and both financial and non-financial information on competitors, customers, suppliers, and the external environment to the organization’s management. With such information, organizations can monitor and evaluate the changes in the external environment in which the company operates and enable them to make strategic plans and strategic decisions. SMA also integrates costing into strategy. SMA uses the cost information to improve the strategic cost position of the business and carry out long-term strategic objectives by using cost management as a tool to improve productivity, increase customer satisfactions and increase revenues. Thus, the approach of SMA is in line with the business strategy objectives that produces long-term objectives for the business, taking into consideration competitor's plans and their possible actions, as well as analyzing and improving the value chain to align with the strategic objectives of the organization.