&counting, Organizations

Printed in Great Britain.

and Society,

Vol. 8, NO. 213, pp. 153-169,

1983.

0361-3682183

$3.00 + .OO

Pergamon Press Ltd.

ACCOUNTING, BUDGETING AND CONTROL SYSTEMS IN THEIR ORGANIZATIONAL CONTEXT: THEORETICAL AND EMPIRICAL PERSPECTIVES*

ERIC G. FLAMHOLTZ Graduate School of Management University of California, Los Angeles

Abstract This paper examines the relationship between accounting, budgeting and control in its actual organizational context from a theoretical as well as an empirical perspective. It argues that the process of exercising control in an organization is significantly more complex than conventional managerial accounting theory suggests. It also argues that budgeting and even an accounting system cannot be viewed as a control system per se; rather, they must be seen as a part of a carefully designed total system of organizational control. If the linkages between budgeting or an accounting measurement system and the other essential prerequisites of a control system are not adequate, then the system may not fulfill its intended functions. The validity and implications of these ideas are examined in the context of the control systems of three organizations. The results suggest the need for a different orientation of the role that accounting and budgeting play in the control process as well as a broader concept of control itself.

During

the past two decades

the idea of behavioral

As Hopwood where tional ships

(1978)

points

out,

even in cases

research in accounting has struck a responsive chord both among behavioral scientists who are aware systems of the significant behavior effects of accounting who on human and accountants

accounting has been studied in its organizacontext, there has been little attempt to of the complex For example, focused upon interrelationand acbetween organizational processes

gain an appreciation counting systems. area studies have

are aware of the interactions between accounting and behavior. Yet the current body of behavioral research in accounting has not fulfilled expectations. One major reason for its disappointing results is that behavioral research in accounting has tended to be focused upon what are admittedly important isolation aspects of the accounting process in of the organizational context in which

in the budgeting static aspects of

the relationship between participation and budgetary behavior, rather than the relationship between budgeting structure. and the overall organizational control

the accounting function operates. Accordingly, a considerable amount of this research is characterized by an almost sterile quality; or at least it certainly fails to capture the richness and complexity of the on going organizational context that provides the raison detre of accounting.

PURPOSE This paper deals with some aspects of the neglected realm of the role of accounting in its organizational ship between context. control, It explores the relationbudgeting and accounting

The author is indebted to Anthony Hopwood for comments on an earlier version of this paper. 153

154

ERIC G. FLAMHOLTZ

systems retical

in their as well

organizational as empirical

context perspectives.

from theoSpecificontrol Then we and

A META-PERSPECTIVE SYSTEMS To system we schematic upon

OF CONTROL

cally, we shall first examine in the context system budgetary from shall examine tion settings. In the paper will be used activities people holtz, attainment will taken of the term a theoretical selected systems

the role of budgeting perspective. facilitate our thinking about as opposed to the techniques a metaperspective representation is shown or of the a control of control A that

of the overall organizational examples

of accounting

need

framework. framework

control

in their actual organizaorganizational sense of any which 1980). control actions lead or that to the (Flam-

shall be employed previous in its full behave

in Fig. 1. It is based & Tsui (1980). of an organization circles. The the core control consisting measure-

work by Flamholtz system

In Fig. 1, the control is represented innermost system. circle

to influence in ways & Berry, organizational

the probability objectives

by a series of concentric comprises (planning, structure operations,

This is a cybernetic

1979; Otley

It is relatively an inevitable The organiza-

of four subsystems

well recognized that control is feature of all human organizations. tional concern incompatibility corresponding ward a specified

ment and evaluation-reward) which are articulated (linked) by feedback and feedforward loops. The middle circle comprises the organizations structure: its set of rules and their interrelationships. The outer circle represents the organizations tions; culture: its value system, beliefs, assumpthe patterned ways of thinking which are of the entity. system These three elements are bounded by the environ-

for control arises because of the of goals among people and the need to channel human goals. of of rules, systems. and proof an if we as or etc., system efforts toset of institutional

To help gain control people, most enterprises mechanisms job budgets, Broadly cesses merely more then Indeed, ought though and comprise view including descriptions, conceived, the control of rules, standard performance these

over the behavior use a combination supervision, operating measurement mechanisms components However, control budgets, such necessity the the control system common. procedures,

characteristic of the control

personal

ment of the organization. The core control system Although the applicability control of cybernetic concepts to organizational has been challenged

tangible system. standards, if we

organizational a collection collection we architecture the not

an organizational treat the systems of with

(Holstede, 1979; Otley & Berry, 1980), the main problem has been the narrow interpretation of mathematical model core cybernetics (Weiner, 1948) and the of the an use of mechanistic of control). control system structure planning, analogies However, presented (i.e. the thermostat the concept here presents

significantly, may of

an ad hoc system, for the

of techniques overlook control

as a control

to be designed. system per se, Thus a

components be confused

integrated processes:

of four basic organizational operations, measurement, and The core model is presented

this error

is sufficiently

evaluation-reward.

budgetary system is not equivalent to a control system, and thus technically we should not use the term budgetary control system.

schematically in Fig. 2.2 Planning, which can itself be defined in many ways, is basically the process of deciding about the

As considered below, a budgetary system may operate with the effect of a control system if the other required elements of the control systems are in place. 2 An alternative model of control based upon the thermostat analogy has been presented by Lawler (1976).

ACCOUNTING, BUDGETING

AND CONTROL SYSTEMS IN THEIR ORGANIZATIONAL

CONTEXT

155

Reward system Performance i 4-2 Reward Evaluat Ive 1 system V

*
Operations

(I-I)
cl-2 Standards)

t
Corrective

feedback Ls_ Measuremeti system 3-l Accounting system 3-2 hfso;emmatlon

_ Performance measurement

Fig. 2. Schematic model of the cone control system.

156

ERIC G. FLAMHOLTZ

goals ational the

of an organization goals, according ends system allocated. refers

(and/or

its members)

as

well as the means to attain desired or states

those goals.3 of affairs this paper,

Organizfor the whose and term about

the phenomena caused by the act or process of measurement per se. The very fact that something is the subject the behavior 1976; stimulus. Prakash of measurement and Rappaport, tends 1977; to influence (Cammann, Flamholtz, is itself a of function of people in organizations of measurement the process

to Hall (1975, p. 12) are are committed

achievement resources goals things financial goal. may assets ard of

policies In

1980). Thus the medium This is termed system measurement. The accounting measurement The budgeting the planning system. budgetary controI ponents. pieces system system system

to relatively

broad statements products,

an organization results, etc.).

wishes

to achieve in a given personnel, the for a given upon might net be represent

performance

area (markets, sought

is a component control

of the system. is part of

Standards

of an overall

level of aspiration For example, be to earn employed

to be attained return while year

in organizations the accounting they lack and

the financial a satisfactory

goal for Pepsico its stand-

as well as the measurement nor the comthe to the whole of a critical system

However, system system, missing

neither because are

in the business, for a given

are equivalent

performance

18% pre tax ROI. Operations, tions required or the operational system for day to subsystem, day refers to the on going for performing the func-

In the case of the accounting planning

evaluation-

organizational

reward, while in the case of budgeting the element lacking is the evaluation-reward system. The evaluation-reward system refers to the mechanisms for performance assessment and the administration of behavior of rewards. which Rewards are outcomes Alor intrinsic, system are are desirable to a person.

activities. These are the responsibilities and activities specified in organizational roles. In an organizational context, measurement is the process of assigning numbers to represent aspects of organizational behavior and performance. The overall measurement system includes the accounting system with its measures of financial and managerial performance. It also includes nonfinancial including capacity ratios) measures production utilization measures of organizational indices such and product as well performance, as scrap rates, (rejection

though rewards can either be extrinsic those used in the evaluation-reward extrinsic. Different elements Although control the four basic elements configurations

of core control systems of the core to

quality

as (at least

potentially) as part

systems

must be present

for the system

social accountability measurements. Measurement performs a dual function

of a control system (Flamholtz, 1980). One function is that the numbers generated may be used to monitor have the extent been to which goals and standards so that organizational achieved,

function fully, it is possible to find in actual organizational settings different configurations of one or more of the systems elements.4 For example, it is possible to observe a control system that consists merely of a planning system with little else. In such situations measurements may be available only at year end and thus are not available for periodic assessment of performance on a real time basis. In contrast, performance measurement systems may be found in situations without any formal system for planning and goalas a proprietorship, dominant coalition,

members may be provided corrective and/or evaluative feedback. This is termed the output function of measurement. The second function of measurement relates not to the numbers produced by measurement operations, but rather to

The problem of reification need not hinder us if we view the organization or institution comprised of individuals and groups.

4 The author is indebted to Denise Niterhouse for raising a question on the paper by Flamhoitz and Tsui (1980) during its presentation at the Harvard Business School Seminar on Planning, Accounting, and Accountability, January, 1981, that stimulated the development of this line of thought.

ACCOUNTING, BUDGETING

AND CONTROL SYSTEMS IN THEIR ORGANIZATIONAL

CONTEXT

157

setting.

Control levels

Illustrative conf iquratlons of control system elements

I
I st Degree: Operations

/
Results

2nd

Degree:

2-1

Planning

Operations

2-2

,~A+-jG~

3rd

Degree.

4th

Degree

Fig. 3. Levels of control achieved by different configurations of system elements.

The amount of control produced by the given control system may be expected to increase with the addition of each element of a control system. For example, the degree of control can be expected to be greater if a control system includes planning and measurement components than if it includes either planning or measurement. Accordingly, it is useful to conceive of control as a variable, where the amount of control is a function

are present we shall define this condition as first degree control. In this condition, there are merely operations (decisions and actions) which produce results. This type of condition is not uncommon and is characteristic of entrepreneurships and relatively small businesses. Second degree control consists of operations plus (any) one additional element: planning, measurement, or evaluationreward. For example, an organization may have

158

ERIC G. FLAMHOLTZ system without formal planning or markets, technology and the environment (Child,

a measurement even without ment control in Fig. ations example, different

any system

for performance of rewards. and may control exist configurations

assessSimilarly, of

and the administration combinations system 3. Third plus any elements degree two system

1979; Chandler, 1962; Lawrence & Lorsch, 1969). Specifically, the choice of an organizational structure represents a managerial strategy on how to adapt the organizational entity to the requirements of its environment. For example, in its competition with Ford Motor Company for leadership Alfred the two specific their (1965, of the U.S. auto Motors (1965) market under perceived during the the early of that 1920s, General P. Sloan firms products organizations p. xxiv) stated:
takes various

as illustrated of operFor may elements. of

consists

additional consisting

as illustrated

in Fig. 3, organizations

have a control operations and control consists

planning,

leadership accurately

Fourth degree of all of the four basic elements of system: planning, evaluation-reward. operations, This conas well

measurement.

were in competition but with were structured.

not only with As Sloan

the core control measurement and ceptualization

the very issue of how

may be used both

in understanding

the effects and defects of control systems as a guide to their evaluation and design. Organizational structure as a component control The system, tional state: second shown structure. Indeed, component previously in Fig. of

It should be recognized that competition

forms: General Motors, for example, has competed with other enterprises as a type of organization (decentralized) and in its long-range way of doing business (up-grading the product), as well as usual day-to-day business activ-

of the overall

control

1, is organiza-

ities. The elder Henry Ford, on the other hand, believed more in centralized organization and in a static car model.

As Otley & Berry (1980, p.232) organization can itself be viewed

as a control process, occurring when groups of people feel the need to co-operate in order to achieve purposes which require their joint actions. structed theorists developed (Blau Thompson, Several process ization tion, and the Similarly, are organizations Etzioni (1966) states social units deliberately goals. structure of control 1977; to the that conis

Organizational culture as a component of control The term culture is subject to many different definitions and denotations. Kluckhohm (195 1, p. 6) stated that:

to seek specific as a response 1962; 1967). structural

Other organization

Culture consists in patterned ways of thinking, feeling and reacting, groups, essential acquired and transmitted mainly by symembodiments consists of in artifacts; traditional the (i.e. bols, constituting the distinctive achievement of human including their core of culture

have argued that organization to the problem Hall, 1972; & Scott,

Perrow,

dimensions including

contribute

historically derived and selected) ideas and especially their attached values.

of control degree span

the degree functional

of centralspecializaintegration of

or decentralization, of vertical of control.

or horizontal Some

dimensions

In the organizational context, Ouchi (1979) refers to culture as the broader values and normative patterns which guide worker behavior, practices and policies. In this paper, we shall refer to organization culture as the set of values, beliefs and social norms which tend to be shared by its members and, in turn, tend to influence their thoughts and actions. Although culture is shown as the third circle in Fig. 1, it is, in fact, the starting point for the design of an organizational control system, because it determines (or at least ought to determine) the

organizational structure ation or rules) facilitate

(i.e. functional specializcontrol by reducing the

variability of behavior and, in turn, increasing its predictability. Other dimensions (i.e. centralization) facilitate control by direct influence over the decision making process for non-programmable events. In contrast with the core control system, organization structure is relatively static. It represents a strategic response to the requirements of

ACCOUNTING,

BUDGETING

AND CONTROL SYSTEMS IN THEIR ORGANIZATIONAL

CONTEXT

159

nature an quired and

of the other

components. organization

For example, the culture

in re-

In brief, and beliefs These behavior desired elements (structure the tional

culture shared

is a pattern of culture

of values, help influence the control system) culture

norms the

entrepreneurial flexibility,

by an organizations of an organization. defined,

members. Once the remaining system help transthroughout and opera-

may be based upon the values of individual lack of bureaucratic of action. by Given structure roles than there the ought this rather rather ought control culture, to be than than

dimensions of members culture of the

initiative,

independence

has been

the required characterized centralization; tight ard rules obvious culture entitys patible structure. ought The have operating and

organizational loosely procedures

organizational the entitys to govern

decentralization defined and minimal rather If not, between system the overall

and the core control

mit and reinforce organization decisions

role definitions procedures. incongruity and core both control with

rules and standextensive will be an

strategic

and actions. implications of organizational several preliminary below. If we accept of control, system budgets, system the notion the conlimited to control impli-

organizations Similarly, the the to be comand system

Some preliminary presented cations.

its control

structure.

The meta-perspective above suggests

culture

These are presented and control. part system

The nature dimensions

of the firms planning with its culture. of culture for the and structure firms

to be congruent implications system.

Budgeting also system of the three ventional accounting

then

concept

of a control

measurement

Thus, the accounting

in decentralized organization will simultaneously provide information to permit day-today decisions to be exercised by divisional managers while also permitting overall coordination and control. In spite of the fact that it changes slowly and typically with great difficulty, culture is a variable. It is subject can be the product example, U.S. that based in early RCA of management Corporation organizational to design, and decision. For of with

the accounting-measurement Statements such as Through different parts

is spurious. activities of

of an organization

can be coordi-

nated and controlled (Bruns & Waterhouse, 1975, p. 180) are technically incorrect or at least incomplete. It is possible that a budgetary may operate as though it were a complete system system control and

if

there are certain implied or perceived between budgetary

measures

connections

1981 the Board of Directors decided Edgar H. Griffiths, According Week (February

to replace

organizational rewards. This means that the budgetary system is a part of a control system configuration control. figuration that achieves without the fourth the degree of connot However, complete may simply

companys

president,

Thornton presented

F. Bradshaw. in Business

to an analysis 9, 1981: to change the value stresses

the budgetary

system

p. 72), Bradshaw was chosen explicitly RCAs culture. His task is to change system in the company from one

fulfill the assertion by Bruns & Waterhouse (among others) that through budgets an organization can be controlled. a study context of the In a subsequent of budgeting in which budgeting section, exists comwe shall present organizational independently in an actual

that

short-term projects and planning to long range goals. Business Week quoted an unidentified source Griffiths: we going close to the Board, Long-term to do after as stating meant, In that under What are addition, planning lunch?

evaluation-reward

ponent of control and examine the consequences for effective organizational control. Zntegration of control system elements. Given concept of a tri-part control system, it is

Bradshaw . . . must redirect the culture of the company from one based on intense politicking to one that rewards performance.

the

This notion of budgeting as a control system pervades accounting and thus is not a criticism of Bnms & Waterhouse (1975) per se.

160 implied system, that all of the three and culture) elements ought

ERIC G. FLAMHOLTZ

(the culture

core de-

the tional

operation context.

of such In this

systems section,

in their three

organizastudies of organ-

structure

to be de-

signed in concert.

The organizations ought required

accounting izational

and budgetary environment

systems

in their

termines what its structure turn, the nature of the system. control resistance purposes system.

to be and, in core-control

are presented

and analyzed

The failure to design a structure or core system which are consistent with the value the system is likely and/or this organization to create the in control in a suband produce of We shall a motivation to defeat core phenomenon

from the perspective of the meta-framework. The first deals with a traditional system for budgetary control residential politan study system tional small study deals control distributor deals with budgeting in a very together, some that area had been real estate of with the the applied company United ability at a medium in a major States. of The sized metrosecond

organizations

structure examine

an accounting of a relatively The final a zeroCheek,

to function system

as part of the overall organizain the control of industrial an attempt system large U.S. abrasives. to introduce (Phyrr, financial 1973;

the context of an actual sequent section. Institutionalization of designing tion. finesse process a core

of core control system as control system can itself

base 1977) Taken the

vehicle of organizational change. The very process be used as a vehicle in an invisible of cultural change in an otganizaengaged may wish to and use the system as a

institution. of

they will provide of the preliminary presented insights budgetary milieu. about

an opportunity implications the operation in their above as well as systems

to assess control to develop

In an organization

with two cultures conflict control

framework additional

war, top management a core

the issue of cultural of designing

of accounting and actual organizational

de facto mechanism

to change

the organizations Conventional budgeting and control systems In this section we examine a study of budgeting system of a mediumsized U.S. the real

value system. For example, in an entrepreneurial culture the very idea of control being exercised on a top-down basis may be anathema to divisional managers who accept the culture of autonomy and the personal freedom it implies.

estate company located in a large metropolitan area. The primary purpose is to use this field study of a budgetary system in its actual organizational setting as a test of the question of whether: (1) budgeting is a control system (the traditional view) or at least operates with the effect of a control system; or (2) budgeting is a component of an overall control system and therefore does not actually other influence behavior unless it is linked system. to critical components of a control

Dominance

of cultural traditions versus formal

control systems. The traditions which characterize an organizations culture may be an equally or even more than with and important core control factor control in predicting mechanisms. it is not behavior Faced traditions clear the formal a conflict a new

between

organizational mechanism,

which element of control will ultimately affect actual behavior. We shall examine an actual instance of this conflict in the organization context of a natural experiment in a subsequent section. ACCOUNTING, BUDGETING AND CONTROL SYSTEMS IN THEIR ORGANIZATIONAL CONTEXT The systems framework for organizational control presented above can be useful in analyzing

This issue is not merely a question of semantics. There is a fundamental difference in the two views of budgeting as a control mechanism or as a component of a control system. The issue is significant because if budgeting is not equivalent to a control system, then efforts to design effective systems of channeling human efforts toward organizational objectives will fail if they follow conventional orthodoxy and merely presume an identity between budgeting and control. study involved an

Nature

of study. This field

ACCOUNTING, BUDGETING

AND CONTROL SYSTEMS IN THEIR ORGANIZATIONAL

CONTEXT

161

attempt of the

to examine companys

a firms system presidents

of motivating because that in assisting

Firmss to study. ships initially founded business. residential management other firms of the a

culture, Residential

structure They tend

and budgeting

prior

and controlling these processes

its managers

performance perceptions

real estate or a few

firms in the U.S. people who were

are sales oriented. begun

to be entrepreneur-

were not fully effective

by one

the firm in achieving its goals. In the course of this study, we examined the nature and operation of the firms budgeting system, using the model presented in Figs. 1 and 2 as a reference point for evaluation. Nature of the research site. The organization

successful sales-persons themselves and their own companies because of available Neither training the owners firms or managers experience in in real estate typically have formal in such culture.

or managerial

industries. Thus the culture found may be characterized as a sales the explicit emphasizes and implicit sales: listing firm

serving as a research site is a residential real estate firm. The firm provides a full set of services (brokerage, to buyers relatively city. in Fig. 4. property of residential management, real estate leasing, throughout is shown etc.) U.S.

Accordingly,

value system of properThe culture game. If you etc. you will to be

ties to be sold and sales of properties.6 also states get listings Branch that sales is a numbers calls, house tend showings, almost make so many

large metropolitan organizational

area in a major structure

The firms

and sales and, in turn, earn income. managers exclusively

I I

I I
Mortgage department

I
Property management and IeasIng department

I
Administratlon department

Sales department

Fig. 4. Organizational structure of metropolitan residential real estate firm.

At the time of the study, branches located throughout

the firm had 12 sales the metropolitan

former recently Since there

salespersons promoted the firms

who have been promoted., training programs managers. are They are expected

Few for to

real estate

firms have formal

area. Each branch was headed by a branch manager who was supposed to be responsible for branch branch typically revenue had and costs. a between Thus technically center. sales each constituted profit lo-25 Branches associates

learn on the job. entrepreneurial in style, for branch are not typically job descriptions

managers,

or if role descriptions

exist, they tend to

(sales personnel) and l-2 clerical personnel. The annual volume of residential real estate sold was approximately $300 millions.

be vague. Accordingly, the branch manager tends to define his/her own job and, not surprisingly, the notion of the jobs often emphasize the sales

A listing is a contract between the principal (property rights to sell the property.

owner) and agent (broker) for the latter to have exclusive

162

ERIC

G. FLAMHOLTZ

component

or things

which

support matters

sales, rather as budgeting,

as consultants ledge

on

complex

transactions. controls

Knowskills

than such administrative planning, cost control, etc.

of accounting

and budgetary

Branch managers receive a base compensation of X thousand dollars per month. In addition, they receive (Gross an override Commissions of 1% of Company Income share). The basic firm ignored problem is that the with branch income ignored received Dollars, by the firm

are not explicitly viewed as part of the role and, if present, are not highly valued. The core control system and budgetary control. The firms core control system was not explicitly designed as such. There is a plan (budget), a measurement system (the accounting system), feedback (budget reports and income statements) and an evaluation-reward system (performance However, not been profit in an appraisal and compensation systems). these components or subsystems have designed on profits budgets either: (1) explicitly and attention to variances

less the salespersons

The control problem. respect managers statement. variances, looked to budgeting paid little They Stated

in this virtually

or no attention branch Many,

to the budget

or variances.

simply,

managers statement.

to lead to emphasis from with one another

large or small.

if not all, hardly

at the budget

or income

or (2) to articulate

The theoretical as well as practical managerial question underlying this behavior may be stated quite simply: Why did the branch statement managers ignore the to the firms income and budget variances?

integrated fashion. The former problem concerns the purposes of the system while the latter concerns the systems In the language managers do not architecture perceive or structure. the branch of the ownership of the firms culture,

To answer this question we shall draw upon control framework that has been outlined examine structure an analysis behavior statements the elements of culture, system. explains and core control of these of branch

organizational Taken together, the rational income

budget. It is not their budget, but top managements budget. There is also a problem with the accounting formation contract closure sales culture for system such as it relates to providing and control. inIn a a for real time decisions of sale is the major point a salesperson

elements managers

in ignoring

as this, the art of completing of psychological manager. and a branch

and budgets.

Culture and budget control. The firms culture unintentionally mitigated against branch managers paying attention to budgets, income statements and even profits; the culture emphasized SALES. The explicit value system as well as the informal socialization system all held the successful salesperson in high regard. This carried over to successful branch could attract, people. managers; they were successful if they motivate and retain top sales

From both a legal and accounting point of view, however, the transaction is not totally completed (final) until the deal closes (that is, all the conditions of the transactions have been satisfied and deeds to property are exchanged). may occur 30-60-90 days or more after the deal has been reached, and by this time salespersons and branch managers are absorbed by other potential transactions. To deal with the uncertainty in realization of income, the firms accounting system either operates on an accrual basis with an allowance for cancellations which is similar but not identical to an allowance for uncollectables. Thus there is a conflict between the psychological mind set of branch managers with respect to income earned and the accounting definition
which income is realized and commissions paid when

money and A closing

Organizational structure and budgetary control. The role of sales manager emphasized selling rather than administration. In addition to the ability to recruit and manage personnel, the sales managers must be knowledgeable about real estate transactions both to train sales associates and to serve
7 Some residential real estate

firms use a cash basis under

escrow

closes.

ACCOUNTING,

BUDGETING

AND CONTROL

SYSTEMS

IN THEIR ORGANIZATIONAL

CONTEXT

163

of income of such managers accounting accept their

earned income. to reject systems

as well as the financial This and while difference ridicule still has being

reporting led forced the and to

an accounting that accounting The ability able extent the managerial

system function

is insufficient of control. system

to guarantee

information of an accounting system

will be used to fulfill to function to a considerculture. below in the The as actual

accountants

dictates.

Consequently,

the numbers

as part of a control upon validity context of this notion

depends

generated by the accounting system as reported in Company income statements are viewed as irrelevant to managers for action tuking purposes. The numbers compensation In addition, affect the timing of the managers but are not seen as useful. the most relevant numbers concern

an organizations

shall be illustrated of industrial

we examine

the role of accounting

of a U.S. distributor

abrasives.

sales revenues not net profit, because the compensation system provides for an override (bonus) based upon sales not branch profits. This is conof the firm. has referred hoping gruent with the sales-oriented culture It is an instance of what Kerr (1975) to as the for B. folly of rewarding

Nature of the research site. The organization serving as a research site serves as a distributor of a full set of industrial bonded, coated, abrasive products and precision) (loose, for in-

dustrial firms which use the products in their own manufacturing processes. Loose abrasives include such things as sand or grain; bonded abrasives refer to materials which have been bonded include precision diamond into grinding wheels; products such as abrasives vitrified bonded refer coated abrasives sand papers; and to such things corporate city as

A, while

Implications. trol system at dramatic

The operation this real system. the little estate

of budgetary company that of

conis a set of firms branch

illustration

of the fallacy nature attention

budgeting the

abrasives. the firms major as its distribution

per se is a control reasons, including culture, managers structure paid very

For a complex system,

At the time headquarters facility

of the study as well

and accounting

was located

in a major

metropolitan

to budgets; profit targets income statewords, the

were not concerned when budgeted were missed and tended to disregard ments budget system. for their branches. In other

in the U.S. The firm also had one satellite branch office in another major city. The firms sales volume exceeded $12 million annually and the firm employed approximately 75 persons.

was not integrated with the overall control These observed behaviors are contrary to accounting findings theory but are rational context. view of a in

managerial These

Firms culture and firm had been founded prior and to this personnel. study, remained relatively

structure. Although the more than twenty years of its history it had had of sales volume the firm attribuits full to meet

view of the firms actual organizational support the broader

for most

small in terms

control system presented in this paper as well as the notion that the design of an effective control system must explicitly consider the relationship between system. Accounting and control systems culture, structure and the core control

Beginning

in 1976,

experienced rapid growth in sales volume table to favorable economic conditions, range of products, sales force and ability

customer service requirements. During the period 1976-1978 the firm increased in size from $3% millions to more than $12 millions. The firm was owned by a single family and three family members (father and two sons) ran the firm along with other family members. As typical in firms of this size, responsibilities were not formally defined and tended to be overlapping. The firm had been successful, at least in part, because of competitively priced products and skill

In discussions of the nature and purpose of accounting, scholars and text-book writers typically state that the functions of accounting include the ability to control operations, or, at the least, accounting can play a significant role in organizational Reece, control (see, for example, Anthony & of 1979, pp. 4-S). Yet the mere existence

164

ERIC G. FLAMHOLTZ

at selling by family members and the sales staff. None of the members of the family as well as virtually trained all other in managers The had been formally firm did have a management.

In brief, control not perform

there

was

not

a formal functions

system system

or did

in this firm and the accounting any of the control

ordinari-

Controller, The

who was a CPA. system and organization system

ly associated with it. Indeed, the firms financial statements were virtually ignored except to determine whether or not a profit had been made. If this illustration cated ance. many rapid their atypical, successful industries. Impact of culture upon utilization of accounting and control. formal What explains control the firms lack of system as well as its organizational organizations of an isolated firm were merely an firm that lacked sophisti-

accounting

control. The firm did not have any formal of management control As an organizational exercised members rather ment, of by the than

as has been defined above. function, control was involvement activities planning, and reward its type system and of family of the firm, measuresystems.

management, it would be of little significHowever, this firm is, I believe, typical of entrepreneurships growth changed it but is the firms of have which not have yet Rather of in size a experienced responded a great to many of than being variety

personal

in the day-to-day through formal appraisal with

circumstances. prototype its

performance organizations firms income

In this respect, most The annual indicate modified These end income wise illustrative rapid growth

the firm was probably as an entrepreneurship. accounting statement statement used;

quite typical of history: produced sheet. an An

balance

income the format

is shown the numbers were both were

in Fig. 5 to have been at the yearly

but are illustrative financial statements position

of the key variables. prepared the firms

failure to use accounting information to facilitate organizational control? The key is in the organizations culture. The firm is an entrepreneurship. ful because very well: service business family firm formal it could do certain buy product, sell Personal open-ended and many it, It was success. operational deliver things it and the by the

of each year to determine and financial but they

for ownership not used other-

and tax purposes; in day-to-day

management

of the business. statement format

As seen in Fig. 5, the income

customers. and an members

attention to commitment employees made

is very simple. Expenses are listed alphabetically rather than by functional categories (selling, administrative, warehouse, etc.). Although the firm has four different product lines, there is no attempt at product line profitability analysis and this did not occur in any other way in the firm. In neither this income statement nor any supplementary analysis was there any attempt to classify costs as fixed or variable, controllable or uncontrollable. As noted above, the income statement was prepared annually and therefore was not available for periodic monitoring during the year. In addition there was no budget or profit plan. Thus, there was neither an attempt to set profit profit goals nor to assess in relation to goals. the variance of actual

prosper

and grow.

However,

the firm lacked It did no

a professional planning

management and there

orientation.

was not even informal

long range planning; rather, the firm reacted tc changing events and circumstances. Organizational roles were not defined explicitly. People did whal work had to be done. There was no budget but the controller paid attention to cash flow. Because thr firm was growing sales revenues were sufficient tc cover expenses and the firm had a line of credil sufficient to cover short term cash requirements The firm was sales and product+riented. It: owners were skilled in personal selling and because of good interpersonal skills they were also able tc maintain relations with suppliers. If expenses hat

a Indeed, management did not know what the relative product line profitability was except in terms of gros margin: selling price less direct materials costs.

ACCOUNTING, BUDGETING

AND CONTROL SYSTEMS IN THEIR ORGANIZATIONAL

CONTEXT

165

to be increased, and implicitly,

the

culture

responded,

explicitly

More

appropriately,

the

accounting

literature

by saying

So well have to go out

and get some more business.g

ought to indicate that accounting systems are potentially useful as tools of control in an approYears ending September 30,

Sales Cost of Goods Sold GROSS PROFIT OPERATING ON SALES

EXPENSES

Advertlslng Bad debt provision Car expense Commlsslons Cantrlbutlons Data processing service Depreclatian Entertainment Freight out Insurance - officers life Insurance - general Insurance - group Interest MedIcal and dental Offlce expense Postage ProfessIona I fees ProfIt sharing Rent Repalrs and malnterlance Salarles - officers, manager SalarIes - office Salaries - sales SalarIes - warehouse Shtppmg suppl les Taxes - payroll Taxes and licenses yr;v;;one Utilities TOTAL INCOME Other income INCOME OPERATING EXPENSES

FROM OPERATIONS (Expense) BEFORE INCOME TAXES

Fig. 5. Industrial abrasives, Inc. Income statement before income taxes.

hplications. terizes above, the the notion

In the kind of culture industrial abrasives firm of using accounting

that characdescribed as a control

priate organizational culture. This suggests that accounting must be viewed more as a component of a socio-technical system rather than merely as a technological control mechanism that operates in isolation of an organizations particular values, beliefs and norms. An accounting system can exist in an organization and not function as a control mechanism. In a culture characterized as

mechanism is something alien. This observation of the actual low degree of use of accounting in its organizational setting is in sharp contrast to the statements ture that sometimes found accounting systems in accounting literaare tools of control.

Indeed, in late 1980 when a profit budget had been prepared for the first time and the President was advised of a

projected loss the possibility of personnel layoffs was proposed. The president responded: Why dont we just go out and get some more business. Although this response was quite typical, it was not appropriate to the current economic environment.

166

ERIC G. FLAMHOLTZ

entrepreneurial which tionships and freedom accountability that tional ence that accounting control of the may

emphasizes informal relafrom restraints, the idea of Similarly, the idea to tool of organizaas not relevant the does mere exist-

be generalized

to organizations

irrespective

of size.

be alien.

Nature of zero-base budgeting. The term zerobase tional budgeting Cheek budgeting refers (1977) process to proposals by Pyhrr (1973); budgeting tures. cess, et al. to modify in organizations the tradiin which proprotheir expendi-

can be a useful may be perceived managers. Thus, systems

entrepreneurial

accounting

not insure

is to a great extent the traditional are not

an incremental or conventional to justify

it will be used

in control. to change

As a prerequisite, the organizations

cess in relation Under managers

to the prior years actual required

it may be necessary

culture so that the idea of accountability is incorporated as a positive value. Once this cultural change readiness mechanism. as a control system, or cultural has occurred, to utilize In this mechanism system there sense, may be an increased as a control the use of accounting change interacts in the social with the accounting

total budget; rather, they are merely justify the incremental portion that actual each though from expenditures manager ground or budget his/her from budget In contrast, the proposed to justify zero.

required to exceed the prior years. requires request zero-based as

ZBB process functions the term

is part of a socio-technical which

becuase

it involves

the organizational Hence

were starting

accounting technology. This, in turn, also supports the broader concept of control argued for in this paper. Organizational culture and zero based budgeting we have examined and control organizaof a quasithe notion of of

budgeting. The process goals of an organizational ing the functions

requires clarifying the unit as well as identifyit proposes to peractivities Ranking

and projects

form in order to achieve its goals. These are then ranked in order of importance.

as a control mechanism In the two previous sections some tions. aspects This of accounting, section designed budgeting control presents in the context experiment zero-based organizational Our purpose question control of system

of activities (functions and projects) priority is intended to be a representation of the organizational units managements judgement of their relative importance. management desire request, projects perceived they with Then if higher levels of to reduce the total budget able to choose relative degree the of

budgeting a study

of small and medium-sized to implement in the

(ZBB) as a mechanism context another

are rationally the greatest

of a very test per of the se is a a com-

value to the firm.

large U.S. corporation. is to provide

(1)

whether:

budgeting system unless

The research study. The study was intended as an action research project to test the applicability There of ZBB on a pilot basis in one department. were several related objectives: (1) to dedepartment information

or (2) budgeting

is merely

ponent of an overall control does not influence behavior other critical system

and therefore it is linked to A related pur-

components.

velop a budget for the personnel from the ZBB process; (2) to obtain

pose is to study the effects that cultural traditions play in relation to more formal mechanisms of control such as the budget in influencing the behavior of people in an actual organizational setting. In addition, the size of the particular firm used here as a research site provides an interesting complement to the prior two studies. For it will permit us to assess, at least to some extent, whether the phenomena described previously operate only in firms of relatively small size, or whether they can

on the benefits and problems of applying ZBB and (3) to make recommendations as to future uses of ZBB in the firm. In the course of this study, an opportunity emerged for a quasi-experiment. Specifically, deteriorating economic conditions caused the firm to initiate a request to all departments including the personnel department) to recommend reductions in their proposed 1980 budget. This request occurred just after the ZBB pilot study had been completed. Thus, a natural

ACCOUNTING,

BUDGETING

AND CONTROL

SYSTEMS

IN THEIR ORGANIZATIONAL

CONTEXT

167

experimental possible budgetary included to

condition compare reductions

existed the with actual the

in which proposals list

it was for the

Results of the natural experiment. As part of pilot test of ZBB, each division head in the department which total listed and cost was required rankings. Total to prepare activities, cost of the and other For each form division was to a all of the divisions

of priorities

personnel budget their

in the ZBB pilot study.

Nature of the research site. The organization serving as a research site was a large U.S. bank. At the time $18 largest The personnel thought tions of the study ranking was the firms the firm assets exceeded of the ten the banks was funcbillion, study as one within

activity included compensation expense operating expense, classified separately. activity, prepared. a budget These allocation forms request the required

U.S. banks. conducted This department. to be well suited (employment, department

specify: (1) the activitys goals, (failure of non-performance activity), activity, current (3) method each alternatives for (4) the recommended

(2) consequences to perform the performing alternative, each (5) the of

to be a site for pilot testetc.) and pro-

ing ZBB, because jects (management Thus this firm entrepreneurships professionally of banking quite ment, formal services

it had a mix of ongoing compensation,

and (6) the costs and benefits division was required

each alternative. Although priorities divisions reduce the stated to list its when the request to process, were not in preparing the budget, were faced with an actual the budget priorities in the profit in the ZBB budget

development, research, etc.). is quite different from the described above. from members management, It is a large, a variety simple have to had and managevery of firm. Most senior It provides

managed

planning

ranging

sophisticated. especially training.

The firm is used to budgeting

adhered to in making the required budget reductions. As stated in the final report to the comThis means that the priorpanys management: ities developed in the ZBB pilot study were merely nominal and not real priorities. This may be because the banks history prior to the ZBB study has not tended to result in actual budgetary cuts. The division heads may not seriously have been concerned with establishing real priorities and viewed it (ZBB) as an exercise. It appears that managers at the bank are not used to thinking in terms of real budgetary cuts based on their priorities.

has a regular annual profit planning cycle. As part of its budgeting process the Controllers department provides managements assumptions and a set of guidelines for justifiable increases in compensation and other operating expenses. The firms culture and budgeting. In spite of these differences, the firms culture plays a crucial role in budgeting in this type of organization norm just is as it did in the real estate and industrial companies. Specifically, one unwritten that Thy budget request shall not exceed lines without punishment. so-called guidelines for other sanctioned budget within operating limits proposals. guidelines, expense for abrasives guide-

Implications. zero-based variety, effective When

The

aim of budgeting, or the more

whether

This means that the compensation and are quasi-officially increases in

budgeting

conventional

is typically to provide planning and control asked to do an in depth

a mechanism for in organizations. analysis of their

incremental

So long as a budget request stays it is likely to be approved. How-

operations, to state their goals, and then to prepare a budget in relation to those goals, the managers in a large, professionally sophisticated firm executed the process. managed, Yet when

ever, if a request exceeds guidelines, the managers must pay a serious price by undergoing a rigorous budget scrutiny and request for justifications. A corollary to this norm is a tradition that budget proposals within guidelines Thus the firms conventional clearly not a zero-based tend to be approved. budgeting system was

asked to make real budget cuts, this analysis was virtually ignored. Clearly, this suggests a great deal about the nature of the firms culture. It may, for example, indicate that the division heads thought the ZBB budget ought to be prepared in a way

approach.

168

ERIC G. GLAMHOLTZ

that they

perceived

would

be acceptable

to senior

essential

prerequisites

of a control system may

system not

are not fulfil its role but of

management. It strongly suggests that we are naive to presume that the mere act of preparing a zerobased the control budget information over costs. will provide it needs top to management exercise with effective

adequate, then the intended functions. In addition, not only

we have observed core culture

the crucial system as a mechanism its core

of the formal If a firms

control and

also of an organizations control. system CONCLUSIONS even aspects budgeting context of the and from a actually are not a well influence appreciation control This paper

culture core of the

control will ways. of

synchronized, behavior

it is not likely that control complex still to develop system process a different and budgetof empirical control few. in Alare in in its intended

integrated

This control

paper

has examined between

some

Our fancy.

relationship

accounting, organizational

organizational orientation concept studies action though

is probably

in its in-

in its actual

has tried

theoretical as well as an empirical perspective. We have seen that the process of exercising control in an organization is significantly more complex theory than conventional managerial would have us believe. We have also seen that accounting system control. accounting a carefully system designed
per se ; rather

to the role that accounting process of control itself. The number budgeting presented and

ing plays in the control of accounting, in an studies

as well as a broader

accounting

organization of the type

is relatively

budgeting

and even an as a control

here are not

can not be viewed total system between system

they must be seen as a part of of organizational budgeting and the or an other

without difficulties I believe that such studies an essential prerequisite to fu&re progress understanding organizational the role of control settings.

in complex

If the linkages measurement

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