Thursday, February 17, 2011

Contingency Theory in Management Accounting

Contingency theory in management accounting describes the situational factors and portrays that management accounting system is contingent upon such factors in reality. Situational factors or contingent factors vary organization to organization and it is impossible to describe and spell out the character of management accounting in the prevalence of each such factor. The circumstances in which the organizations move are distinctive in nature and largely effect the adoption, mechanism, and sophistication of management accounting system. These idiosyncratic circumstances or contingent factors are major contributors towards non-formation of universally acceptable effective management accounting system.  As situational factors are unique in nature and are unfeasible in reckoning and elucidation in isolation hence they can broadly be categorized in six foremost areas according to the dominant characteristics of such circumstances.

  • The external environment
  • Strategies and mission
  • Technology
  • Firm Interdependence
  • Business unit, firm and industry variables
  • Knowledge and observable factors

External environment

The differing traits of external environment surrounded by an organization effect management accounting systems to a greater extent and mold it towards prerequisite of exterior conditions. External environment can be uncertain or certain, static or dynamic, simple or complex, and turbulent or calm. Empirical studies suggest that organization with a stable and certain environment rely on financial performance measures particularly budgetary conformance and other type of monetary variables. The management accounting system does not require greater sophistication in such organizations and it works on presupposed targets expected to remain valid for ensuing performance appraisals. Pragmatic studies further reveal that greater decentralization, larger erudition, and availability of broad scope management accounting system attributes to the conditions of environmental uncertainty, complexity, and turbulence.

Strategies and mission

The adoption of varying corporate strategies and firms’ strategic mission also determine the level of management accounting system to be in place. The strategies may be low cost or differentiation, defending or prospecting, and harvesting or divesting. It is observed that with low cost and defending strategies the firms main focus remains towards standardized or limited product lines, lower costs, economies of scale, and ensuring operating efficiency through cost, quality, and service leadership. This focus, through undemanding management accounting information system, necessitates SOPs for employees designed to maximize efficiency and emphasizes on cost reduction and budget achievement to motivate them. On the other hand prospective and visionary firms with differentiation strategies and competing mission tend towards more participative decision-making process and reward employees and managers based on number of appraisal parameters including financial variables such as budgetary achievements and non financial variables such as product innovation, market development, and growth. The management accounting information systems in such organizations are relatively more advanced and sophisticated with greater devolution and employees’ participation.


The simplicity and complexity of management accounting information system heavily depend upon the classification of technology either for small batches, large batches, process production, or mass production. A relatively sophisticated management accounting information or control system requires high tech mechanism to perform complex tasks and for information flow in process production and mass production environments. The level of technology an organization is willing to set up demonstrates an outlook towards call for a sound management accounting information and control system.

Firm interdependence

The interdependencies within an organization are categorized as pooled, sequential, and reciprocal interdependencies. Pooled interdependencies prevail when different responsibility centers use common resources and share them collectively. The management accounting information system addresses towards protecting the unrelated managers from responsibilities of inefficiency costs associated with sharing the common pool of resources of which they can not be held accountable. It requires a complex management accounting control system to differentiate among related and unrelated responsibility centers. Contrarily where pooled interdependencies are low and role of responsibility centers is quite clear an unsophisticated management accounting system has been found through empirical studies.

Sequential interdependencies exist when output of one responsibility centre is the input of another. Whereas reciprocal interdependencies subsist when two or more responsibility centers depend upon inputs and outputs of each one and vice versa. Such interdependencies necessitate a multifarious management accounting system to assimilate the costs associated with each responsibility centre and transfer pricing mechanism among them.

Business unit, firm, and industry variables

The size and structure of the firm and the type of industry in which it operates has an obvious effect on the unfussiness and intricacy of the management accounting information and control system. Researches divulge that bigger organization have been found with more complex management accounting systems perhaps because such organization are capable of arranging and organizing required resources to develop a relatively compound and innovative kind of management accounting system.  Control systems have also been watched different in manufacturing organizations which operate largely on standard costs procedures and depend heavily on variance analysis and other advanced costing and controlling variables. However studies revealed majority in service sector with attributes of discretionary cost and responsibility centers and relatively unsophisticated management accounting and control systems.

Knowledge and observables factors

The areas falling under this category require a detailed description and deliberation on each one however in-depth analysis of these areas is out of the scope of this article. Nevertheless, as the four broad areas of study under the knowledge and observable factors are quite related to the contingency theory, therefore, it is appropriate to spell out them briefly here. The first relates to the types of control that are suitable in relation to the manufacturing or transformation process and ability to measure output. It explains the fitting of control type such as behavioral, output, or clan in a matrix form keeping in view the intensity of the ability to measure output and knowledge of transformation process. Similarly second area of study examines the appropriate type of performance assessment in relation to the extent to which cause and effect and uncertainty to the goals are well understood. Cause and effect usually referred to as task instrumentality means the ability to understand transformation process and measurement of output. Third area relates to programmability of the decisions which means the extent to which a decision is sufficiently well understood with respect to the outcome. It elucidates that how programmability of the decision affects the type of control to be used. The fourth and last area under knowledge and observable factors examine the relationship between management accounting information system and uncertainty about objectives and process.    

1 comment:

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