Being productive means many things: fruitful, fertile, rich, fecund, plentiful, abundant, prolific, dynamic – as well as imaginative, creative, inventive, resourceful, profitable, rewarding, generative, ingenious. The term productive is an adjective. Productivityis a noun. The underlying process is one of efficiency in industrial production, or in the service industry.
Greater productivity obtained through an interactive, accurate, and timely account- ing and statistical system, is a payoff that can cover all IFRS-related expenses and leave a profit to the company. A strategy targeting managerial production is akin to that followed by well-managed firms in the mid- to late 1990s in connection to the Year 2000 (Y2K) problem, when they used the solution they had to implement as an opportunity to renew their information technology.
Therefore, greater individual productivity by exploiting the opportunities offered by IFRS should be at the top of the task force’s list of objectives. Here is a practical example. In 1990 Banker’s Trust studied the way its managers and professionals spent their time, and what it found out was:
● That 33% of their time was truly productive
● While 67% went on trivia and administrative activities.
After that, the executive committee decided that new information technology investments would be tied to inverting these percentages: making 67% of
managers’ and professionals’ time productive and leaving only 33% wasted on trivia and administration – available technology did not allow any further shrinkage of that share. A similar goal should prevail among task force aims, with regard to managerial and professional productivity in two domains:
● Management accounting, and
● Financial accounting.
The primary objective of financial accountingis that of providing financial infor- mation to people and entities outside the business: shareholders, bondholders, bankers, regulators, and other parties. To a considerable extent the techniques, rules, and conventions according to which financial accounting figures are col- lected and reported reflect the requirements of these outsiders and, as its title implies, IFRS is primarily oriented to their information needs.
By contrast, management accountingis concerned with accounting information that is useful to the firm’s own management. This is the theme of Chapter 8. The problems we shall discuss are those of the use of accounting figures in the recog- nition, or solution, of management problems. On the other hand, managementis also responsible for the content of financial accounting reports.
Professional productivity is important in connection to both management accounting and financial accounting. Not many companies appreciate the impor- tance of productivity on their bottomline, yet its impact can be major. Two ques- tions come to mind when industrial engineering studies document wide differences in productivity of competing companies:
● Is company management too lenient, and the professionals themselves untrained on how to improve their performance?
● Or do the differences lie in the quality of capital equipment, in the devel- opment and installation of new technology, and in obsolete methods?
According to certain studies, differences in management practices account for much of the gap in total office productivity – a finding not too different from that concerning factory productivity. Moreover, higher management quality scores correlate with higher returns on capital employed, as they do with sales per employee, sales growth per employee, and other measures of personal output.
The European Central Bank made a study of productivity in Euroland’s banking industry and its conclusion has been that there are indications that the slower pace of productivity growth observed since the mid-1990s reflects an insufficient
use of new methods and tools, particularly of productivity-enhancing technolo- gies. The way ECB sees it:
● Productivity has increased in sectors that produce information and com- munication technologies.
● But it has declined in many other areas of the economy, pointing to struc- tural rigidities that prevent or hinder change.5
This should be an alarm signal for the task force. IFRS conversion is a major investment, and there should be a return attached to it. Such a return is in direct proportion to effective dissemination of new technology and improved production processes across the firm. Against this background, reforms that stimulate innova- tion, investment, and productivity, and promote the use of new productivity- enhancing technologies, are of critical importance.
In an organizational sense, one of the reforms that must enter into an overall plan for greater efficiency is the flattening of the company structure, by eliminating intermediate management layers through expert systems and on-line datamin- ing. It is not the job of the IFRS task force to do so. What it should do is to pro- vide the incentives and infrastructural support that would make it possible.
Notice, however, that reorganization can also have a downside, particularly so if it is only done for reorganization’s sake. This does not happen only today. ‘We tend to meet any new situation in life by reorganizing,’ Petronius Arbiter, a 1st century Roman satirist had remarked, ‘And what a wonderful method it can be for creating the illusion of progress while producing confusion, inefficiency and demoralization.’ The Romans, too, had efficiency problems to cope with!
An example of what the task force can contribute is the commissioningof a new and effective management accounting system, which will significantly contribute towards results along the Bankers Trust frame of reference (see Chapter 8). This is one of the basic reasons why in section 2 I insisted that the members of the task force should be innovative and creative thinkers who:
● Are open to new ideas
● Are willing to take risks and able to communicate with all levels of man- agement, and
● Have corporate-wide knowledge, perspective, and respect.
To achieve this aim of contributing towards greater productivity, the chairperson and members of the task force must have sufficient clout, and use their work
stature to make some tough decisions. Beyond this, for reasons already explained, good understanding of business and technology trends, as well as a willingness to learn quickly, are most welcome traits.
Another interesting example of the productive use of IFRS accounting is the abil- ity to provide a timely and accurate customer mirrorwith every counterparty the bank has. Box 7.1 shows the component parts of a customer mirror I designed some years ago for the retail and small business trade of a commercial bank.
Wholesale trade requires a more sophisticated approach which:
● Capitalizes on the fair value component of IFRS, and
● Provides account managers in the institution with a clear picture of risk and return assumed with every client relationship. (See also the virtual balance sheet in Chapter 15.)
Along with the stimulus it should provide regarding productivity of people, the task force should also be looking after the productivity of money. Its job is not to make investments, but to provide the infrastructure necessary that those who do make investments can:
● Deliver a better job for the same time they are spending
● Or, produce the same results for less time and lower cost.
CalPers, California’s state employees fund, presents a good example. It grew from
$28.6 billion in fiscal year 1984–5 to $161.4 billion as of fiscal year 2004–5 – an
Box 7.1 Component parts of a customer mirror 1. All transactions done with the customer, by channel 2. Cost of each of these transactions to the bank
3. Risk assumed by type of instrument and by transaction
4. Monetization of risk the bank has taken with these transactions 5. Customer collateral, and unsecured loans
6. Fees the bank charged for the transactions
7. Other fees pro rata, like portfolio management and safekeeping 8. Volume of and income from cross-sales in relationship banking 9. Strengths and weaknesses in historical customer relationship 10. P&L with this customer, seen as a profit centre
increase of 564% in managed money. In those two decades, the average return was 11%, which is well above the average of most privately run funds.
● In the past decade, 76.2% of CalPers’ growth has been made from invest- ments.
● An additional 12.7% came from employee contributions.
● Employers, that is California’s state agencies, provided only 11.1%.6 But at the same time CalPers is highly cost-conscious. Its administrative cost is 18 cents per $100 invested, while in the typical pension fund costs are higher by nearly an order of magnitude, and the brokerage and securities firms charge $2 per $100 invested.
A prerequisite to providing the right infrastructure for productivity of people and money, as well as for cost control, is understanding of a broad range of mar- ket requirements, application complexities, and advanced technologies and techniques. Moreover, cost reduction that facilitates competitive pricing throughout the lifespan of a financial product is crucial to success. (More on cost control in Chapter 8.)
Notes
1 BIS 75th Annual Report, Basel, 2005.
2 D.N. Chorafas, Economic Capital Allocation with Basel II: Cost and Benefit Analysis, Butterworth-Heinemann, Oxford and Boston, 2004.
3 D.N. Chorafas, Systems and Simulation, Academic Press, New York, 1965.
4 D.N. Chorafas, Rocket Scientists in Banking.Lafferty Publications, London and Dublin, 1995.
5 ECB, Monthly Bulletin, March 2005.
6 EIR, 18 March, 2005.
Part 3
Management Accounting and the Budget
8
Management Accounting and Corporate Governance
1. Introduction
President Lyndon B. Johnson is famous for his penetrating remarks. A story mak- ing the rounds in Washington is that an assistant tried to impress upon the US President the need to attend a lecture by a well-known economist, who was pre- senting his latest theory on federal budgets, employment, and growth. Johnson refused. ‘He is also a Democratic Party fund raiser,’ insisted the assistant. ‘Yes,’
said Johnson, ‘but the theories of economists are like somebody who is pissing in his pants. To him, but only to him, it’s hot stuff.’
And there is another Washington story about economics and economists. This concerns another US president: Harry Truman. President Truman had his way of reacting to the rather ambiguous advice he got from economists. ‘I am looking for a one-armed economist,’ he is rumoured to have said in a cabinet meeting at the White House. When asked why, he answered: ‘So that when he gives me an opin- ion, he does not immediately add “… on the other hand …”.’ Between them, these two presidential stories do indeed provide a take on what management accounting seeks to achieve:
● To provide shareablehot stuff on the facts and figures for decision-makers, rather than individually assembled incompatible numbers, and
● To assure that data are complemented through qualitative information, detailing an array of options, as well as their likelihood, so that alternatives are available for decisions to be taken in an informed manner.
Traditionally, the accountant has been thought of as a person engaged in report- ing the financial facts of an enterprise, from a dispassionate and fully objective viewpoint. This view defines the accountant as a recorder of facts so that the finances of business may be written down in a reliable, systematic way. This sim- plistic view of accounting, and of accountants, forgets that there are many prob- lems which have to be met and solved in carrying on such duties. Examples are:
● Interpretation of transactions in terms of their materiality
● Recognition of contingencies regarding revenue credits
● Probable useful life of depreciable assets, and
● Management implications embedded in financial reports.
From this viewpoint, the results of the accounting process are statements which set out income, profits, losses, assets, liabilities of the enterprise for a given period, as well as its financial position at given dates. This necessarily involves subjective
judgment. Moreover, what the above bullet point stated is more or less the tradi- tional conception of accounting; modern accounting must go much further.
Parts 1 and 2 of this book have explained why the International Financial Reporting Standard (IFRS) is a good basis for modern accounting. Since it has become the accounting standard in the 25 countries of the European Union, IFRS can serve regulatory general accounting, financial accounting, and management accounting(see section 2 for a definition).
This plurality of services is important inasmuch as accounting operations are not separate and apart from other activities in the business, for instance those relat- ing to management decisions. Quite to the contrary, they are highly intercon- nected with them. Chapter 7 brought to the reader’s attention the difference between management accounting and financial accounting. Here is a comparison between management accounting and general accounting.
● General accounting reflects this interconnection in a precise, detailed manner looking after compliance to rules and regulations, and seeing to it that what is written in the books squares out.
● By contrast, management accountingmust be accuraterather than precise, reflecting internal company rules, showing trends, informing management, and serving internal control procedures.
Financial accounting essentially sits at the junction between these two bullet points. On the one hand, the making of financial statements is part and parcel of business operations; on the other, formatted in an order of magnitude way, these records are action-oriented senior executives’ tools. Management cannot depend upon mere memory or hunch in making decisions. Financial records are, indeed, an integral part of business activity.
● The recording process should not be maintained only for general account- ing purposes.
● It must also be designed for, and used by, senior management to help in business operations day-to-day and in the longer term.
Management accounting’s rationale lies in the fact that both tactical and strategic decisions must be made when they are of consequence. To a significant extent they must be formulated with reference to future activities, because what has been done cannot be undone though its recurrence may be avoided. Moreover, managerial decisions must be made promptly when they are called for, even if the information available for such decisions is incomplete or inconclusive.