Management Accounting Research: Trends, Perspectives, and Future

Management Accounting Research: Trends, Perspectives, and Future University Hohenheim 1

Management accounting Disclose inventories and cost of goods sold Unit manufacturing costs Planning and control functions Management Accounting Assessing the efficiency and effectiveness of operations Evaluate and reward employee performance Manage activities that Consume resources 2

Conditions for effective management accounting systems The existence of an objective or standard that is desired. (otherwise control has no meaning) The measurement of process outputs along the dimension specified by the objective. (the output of the process must be measurable) The ability to predict the effect of potential control actions. (a predictive model of the system is required) The ability to act in a way that will reduce deviations from the objective. (a selected action requires to be implemented) Formal control mechanisms Risk sharing. Goal convergence Informal control mechanisms Employee motivation 3

Objective: From improving value drivers to maximizing shareholder value Value of the firm Periodic performance measures Value drivers Firm value: Present value of cash flows Firm value invested Capital = NPV Actual return vs. benchmark Residual income/value added (e.g. EVA, CVA..) Cash flow Production (scrap, capacity utilization,...) Procurement (price, process cost,...) Other efficiency indicators 5

DCF-Valuation for an equity financed firm (APV) detailed planning (e.g. 5 years) perpetuity CF 1 CF 2 CF 3 CF 4 CF 5 V U 1 ( + r ) 1 1 U 1 ( + r ) 2 1 U 1 ( + r ) 3 1 U 1 ( + r ) 4 1 U 1 ( + r ) 5 1 U CF ( + g ) 1 1 5 = U ( 1 ) r g + r U 5 r U g CF V U = cost of equity of an unleveraged firm = annual growth rate of CF for perpetuity = Cash Flow assuming 100% equity financing = Value of the company for equity financing 6

Value based management Cash Flow Value of the firm Cost of capital Value analysis to identify relevant key indicators Benchmarking using relevant references from the industry to determine the economic situation of the firm Dependent on: Risk Capital structure 7

Value based management: Value driver analysis 8

Methods for firm valuation Problematic methods for value based management : Multiples e.g.: - Earnings-Multiple: P/E-ratio - Enterprise Value: Enterprise Value / EBIT Substance value Risk neutral valuation Useful methods for value based management: Discounted Cash Flow (DCF) methods: Adjusted Present Value (APV) WACC-approach Flow-to-Equity 9

Measurement: Overview on return and performance measures Return /performance measures IRR Accounting measures Residual income RI Profit margin Return measures Cash Flow Return on Investment CFROI Profit margin before taxes PM b.t. Profit margin after taxes PM a.t. Return on Assets ROA Return on Invested Capital ROIC Return on Equity ROE b.t. a.t. b.t. a.t. b.t. a.t. 11

ROIC-tree PM b.t. : Sales - Personnel cost - Material cost - Depreciation - Other expenses ROIC b.t. * Sales Sales Capital turnover : Invested capital (IC) Fixed Assets + Intangible Assets + Current Assets - Accounts payable - Accruals for pensions 12

Performance evaluation Performance evaluation solely based on accounting return is not sufficient: Value based orientation is missing: - Incomplete adjustment for opportunity costs (no cost of equity) - Incomplete adjustment for risk besides the accounting based inclusion of risks - Not cash flow based Performance could be manipulated utilizing window-dressing techniques. Performance measurement in the interest of the owners: Periodic signal that indicates a change in the value of the company without using the concept of the IRR as independent as possible of the unknown results of future periods considering the risk of the project/firm considering the financing of the project/firm utilizing the data used for traditional performance measurement (Income statement, Balance sheet, etc.) Solution: Residual income (RI), which has a clear relation to the NPV of the project/firm value (V) in t 0. 13

Necessary transformations for value based management Financial risk Economic profit = Value generated Operational risk Revenues Expenses Accounting profit Profit Economic loss = Value destroyed PV Free Cash Flow Risk adequate Cost of capital Accounting loss t 1 t 1 t n 14

Necessary transformations for value based management Cost accounting: Total cost of period Labor cost Material cost Machine related etc. Variable cost Fix cost Allocation of cost to cost-centers: Costcenter A Costcenter B... Costcenter M Costcenter N Costcenter A Costcenter X... Main costcenter A Main costcenter B Cost product 1 Cost product 2 Cost product 3 Cost product... c 1 c 2 c 3 Total cost of period 15

Disaggregation of the performance measure and sensitivity analysis Identification and linking of value drivers Identification of critical value drivers using sensitivity analysis Operating result Revenues Production RI Effect of a x% improvement on RI Expenses R&D A&S RI Etc. Etc. A&S R&D Production r Simulation analyses Capital charge Crystal Ball Academic Edition Forecast: CF 96 Not for Commercial Use 20.000 Trials Frequency Chart 20.000 Displayed,032 645,024 483,7 IC,016,008 322,5 161,2,000 0-170,6-35,7 99,1 233,9 368,8 Certainty is 75,33% from 0,0 to +Infinity 17

Value driver analysis: R&D Percentage Process Savings potential Responsible cost driver R&D costs Personal cost Overhead Depreciation Material cost Purchases services Overhead allocation headquarters Infrastructure (e.g. IT, rent) 17% 4% 1% 37% 33% 5% 3% Product A development Product B development Asset management Product C development Choice of suppliers Product D development Management infrastructure Short-term Intermediateterm Area rep. Product manager Project team 18

Quantitative risk management Identification and linking of value drivers Simulation of RI using the value driver analysis data integrating assumed distributions: RI Operating result Revenues Expenses Production R&D A&S Etc. 0 500 1000 1500 2000 0,00% 0 500 1000 1500 2000 0,02% 0,00% 0,02% 0,04% 0,04% 0,06% 0,06% 0,08% 0,08% 0,10% 0,12% 0,10% 0,14% 0,16% 0,12% 0,18% 0,14% 0,16% 0,18% r Simulation analysis: Evaluation of the Value at Risk p 0,18% 0,16% Capital charge IC VaR RI RI 19

Unbiased Accounting considering Profitability University Hohenheim with Martin Staehle

Introduction Unbiased Accounting: Theoretically: Which accounting regime results in correct accounting data? Practically: Implied biases when implementing accepted accounting standards. Objective: Improving the understanding of various accounting regimes. Improving the understanding of the economics implied by accounting data and ratios (ROCE, ROE, P/E, M/B) considering leverage and taxes. Improving accounting standards and the measurement of biases resulting from these accepted accounting standards. Evaluation of regulatory implications and regulatory efficiency. Agency theoretical implications of accounting regimes, i.e. under-/over-investment incentives. 22

Model Steady state-model: Company undertaking overlapping joint capacity investments in a representative project. Growth: Changes in the invested capital each period. Profitability: - IRR exceeding the cost of capital - NPV-criterion Accruals: Depreciation of the representative project. Criterion of Unconditional Conservatism (and liberalism) measured using book values. Market Values: Multi-phase valuation concept (Residual income, certainty equivalent, APV-approach, WACC-approach, FTE-approach). Constant growth residual income valuation model (Gordon-growth-model). Accruals are value-neutral in steady state via Conservation Property of residual income. 23

Steady state-model Individual project: t 0 t 1 t 2 t 3 t 4 I 0 CF 1 CF 2 CF 3 CF 4 Steady state model with varying growth rates: g 1 g 2 g 3 g 4 g 5 g 6 g 7 g 8 g 9 g 10 g 11 g 12 g 13 g 14 I 1 I 2 I 3 I 4 I 5 I 6 I 7 I 8 I 9 I 10 I 11 I 12 I 13 I 14 t Ramp-up phase Steady-State phase Ramp-down phase Perpetuity phase 24

Economic benchmark for the measurement of biases Neutral Accounting: RoI t = IRR Gordon, L. A., & Stark, A. W. (1989). Accounting and economic rates of return: A note on depreciation and other accruals. Journal of Business Finance & Accounting, 16(3), 425-432 Rajan, M. V., Reichelstein, S., & Soliman, M. T. (2007). Conservatism, growth, and return on investment. Review of Accounting Studies, 12, 325-370 Unbiased Cost Accounting: AHC t = mc t Rogerson, W. P. (2008). Intertemporal cost allocation and investment decisions. Journal of Political Economy, 116(5), 931-950 Rajan, M. V., & Reichelstein, S. (2009). Depreciation rules and the relation between marginal and historical cost. Journal of Accounting Research, 47(3), 823-865 Value Accounting: BV t = MV t Hotelling, H. (1925). A general mathematical theory of depreciation. Journal of the American Statistical Association, 340-353 Feltham, G. A., & Ohlson, J. A. (1995). Valuation and clean surplus accounting for operating and financial activities. Contemporary Accounting Research, 11(2), 689-731 25

Model and various results Economic accounting process: Allocations of NPV to single periods as the only accrual: ( 1 ) ( 1 ) IC = IC + r CF BV = BV + r + npv CF t t 1 t t t 1 t t Allocation is determined via sequence of weights: NPV allocation-weights: T T i i γ t t 1 i i = 0 i = 0 = = = NPV npv npv w NPV w Traditional-accruals follow implicitly: [ ] w NPV = CF BV BV r BV BV BV = d IC t t t 1 t t 1 t 1 t t 0 i γ 26

Neutral accounting: Sequence of weights: Economic profit: Constant RoI T. IRR-accruals: Upfront knowledge of IRR necessary. Unbiased accounting BV w = RoI = IRR ; RoI = Inc N t 1 T t T T T i BV BV T 1 i 1 γ i = 1 Unbiased Cost-Accounting: Sequence of weights: Economic Cost : Constant AHC T. RBD-rule, RRC-rule, RPC-rule, etc. Value Accounting: Sequence of weights: Economic Depreciation / Fair Value. Knowledge of market values is required. CF H wt = AHC T = mc ; AHC T T = i K CF γ C t T i = 1 i 1, for 0 V t = wt = BVT = MVT ; MBT = 1 0, for t > 0 T 27

Synthesis and results Conservatism Ranking: t w V i t N i t C i 0 i w i i 0 i w = = i = 0 i γ γ γ Value Accounting is less conservative than Neutral Accounting which is less conservative than Unbiased Cost Accounting Remarks: Profitability results in strict inequalities. Conditions under which this result is derived are linear or geometric decay of cash flows. Deviating from linear or geometric cash sequences requires huge kinks in the cash flow sequence to destroy the conservatism ranking. 28

Results Steady state Quadrant Results 1) Residual Income T Return on Investment T Market-to-Book T growth T 1) Example is derived for constant project cash flows growth T growth T 29

Synthesis and conclusion Results: For Single Projects: Conservatism Ranking (most likely) In Steady State: Quadrant Results (most likely) Defining any of the accounting regimes to be the proper one implies that the other regimes generate systematically biased accounting data Why is that interesting? Standard Setting: What information should be delivered by accounting data? Regulation: How do we measure (excess) profitability? Financial Analysis: How do we infer economic performance from accounting data? 30

Thank you for your attention. 31