EFFECTS OF MANAGEMENT ACCOUNTING PRACTICES ON FINANCIAL PERFORMANCE OF MANUFACTURING COMPANIES IN KENYA
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ABSTRACT
Management accounting offers a good best opportunity for firms to compete in the market in order to offer best quality products and services at affordable prices to consumers. The general objective of this study was to investigate the effects of management accounting practices on financial performance of manufacturing companies in Kenya. This study adopted a descriptive survey design. The target population for this study was the 455 manufacturing companies in Kenya. Stratified random sampling method was applied to come up with the sample size, since the population in different manufacturing firms was considered heterogeneous, implying that a simple random sample is unrepresentative. The study therefore involved 46 manufacturing companies Nairobi. The study collected primary data from the respondents. The data collected was both quantitative and qualitative. Qualitative data is a categorical measurement expressed not in terms of numbers, but rather by means of a natural language description. Quantitative data is a numerical measurement expressed in terms of numbers. Analysis was done using Statistical Package for Social Sciences (SPSS), allowing the researcher to present the information in form of tables and figures. The study concludes that information for decision making practices is the most highly used management accounting practice amongst the manufacturing companies in Kenya followed by strategic analysis, budgeting, performance evaluation, costing, size and leverage respectively. The study further concludes that the most important elements of management accounting practices amongst the manufacturing companies in Kenya are; the management accounting function identifies key factors that influence performance and risky areas that require improvements and return on equity, ROE (Net income / Average Equity) has increased as a result of application of management accounting practices. This study recommends the creation and enhancement of awareness among firms of the importance of Information for decision making practices as this is the most highly used management accounting practice amongst the manufacturing companies in Kenya.
DECLARATION.. i
ACKNOWLEDGEMENT.. ii
DEDICATION.. iii
ABSTRACT.. iv
LIST OF FIGURES. viii
LIST OF TABLES. ix
ABBREVIATIONS AND ACRONYMS. x
CHAPTER ONE.. 1
INTRODUCTION.. 1
1.1 Background. 1
1.1.1 Management Accounting Practices. 1
1.1.2 Financial Performance. 3
1.1.3 Management Accounting Practices and Financial Performance. 4
1.1.4 Manufacturing Companies in Kenya. 6
1.2 Research Problem.. 9
1.3 Research Objective. 11
1.3.1 Specific objectives. 11
1.4 Value of the Study. 12
CHAPTER TWO.. 13
LITERATURE REVIEW… 13
2.1 Introduction. 13
2.2 Theories of Management Accounting. 13
2.2.1 Contingency Theory of Management Accounting. 13
2.2.2 New Institutional Sociology. 15
2.3 Determinants of financial performance in manufacturing firms. 17
2.4 Empirical Studies. 19
2.5 Summary of literature review.. 28
CHAPTER THREE.. 29
RESEARCH METHODOLOGY.. 29
3.1 Introduction. 29
3.2 Research Design. 29
3.3 Population. 29
3.4 Sample Design. 30
3.5 Data Collection. 31
3.6 Data Analysis. 31
3.6.1 Conceptual Model 31
3.6.2 Empirical model 32
CHAPTER FOUR.. 34
DATA ANALYSIS, RESULTS AND INTERPRETATION.. 34
4.0 Introduction. 34
4.1 General Information. 34
4.1.1 Respondents’ Company Specialization. 34
4.1.2 Current Number of Employees in the Respondents Company. 35
4.2 Management Accounting Practices. 36
4.2.1 Usage of Costing Management Accounting Practices in Respondents Company. 37
4.2.2 Usage of Budgeting Management Accounting Practices in Respondents Company. 38
4.2.3 Usage of Performance Evaluation Management Accounting Practices in Respondents Company 39
4.2.4 Usage of Information for Decision Making Management Accounting Practices in Respondents Company. 40
4.2.5 Usage of Strategic Analysis Management Accounting Practices in Respondents Company 42
4.3 Respondents Opinion on the Importance of Management Accounting Practices. 43
4.4 Inferential Statistics. 46
4.5 Summary and Interpretation of Findings. 49
CHAPTER FIVE.. 51
SUMMARY, CONCLUSION AND RECOMMENDATIONS. 51
5.1 Summary. 51
5.2 Conclusions of the study. 52
5.3 Recommendations for Policy and Practice. 52
5.4 Limitations of the Study. 53
5.5 Suggestions for Further Research. 54
REFERENCES. 56
APPENDICES. 62
Appendix I: Letter of Introduction. 62
Appendix II: Research Questionnaire. 63
LIST OF FIGURES
Figure 4.1. Respondents Company Specialty. 35
Figure 4.2: Current Number of Employees in the Respondents Company. 36
LIST OF TABLES
Table 4.1: Usage of Costing Management Accounting Practices in Respondents Company. 37
Table 4.2: Usage of Budgeting Management Accounting Practices in Respondents Company. 38
Table 4.3: Usage of Performance Evaluation Management Accounting Practices in Respondents Company 40
Table 4.4: Usage of Information for Decision Making Management Accounting Practices in Respondents Company. 41
Table 4.5: Usage of Strategic Analysis Management Accounting Practices in Respondents Company 43
Table 4.6 Importance of management accounting practices. 44
Table 4.8: Model Summary. 47
Table 4.9: ANOVA.. 47
Table 4.10: Coefficients. 48
ABBREVIATIONS AND ACRONYMS
ABB Activity Based Budgeting
ABC Activity Bases Costing
CVP Cost Volume Profit
IAS International Auditing Standards
IFRS International Financial Reporting Standards
CHAPTER ONE
INTRODUCTION
1.1 Background
Companies use management accounting techniques to assess their operations. These include budgeting, variance analysis and break-even analysis. These methods help organizations to plan, direct and control operating costs and to achieve profitability. It is recognized that management accounting practices are important to the success of the organization (Horngren, et al., 2009). Management accounting is the application of appropriate techniques and concepts in processing the historical and projected economic data of an entity to assist management in establishing a plan for reasonable economic objectives and in the making of rational decisions with a view towards achieving these objectives.
Managerial accounting, or management accounting, is a set of practices and techniques aimed at providing managers with financial information to help them make decisions and maintain effective control over corporate resources. These include the methods and concepts necessary for effective planning, decision making (choosing among alternative business actions and controlling through the evaluation and interpretation of performance.
1.1.1 Management Accounting Practices
Management accounting practice helps an organization to survive in the competitive, ever-changing world, because it provides an important competitive advantage for an organization that guides managerial action, motivates behaviors, supports and creates the cultural values necessary to achieve an organization’s strategic objectives. Management accounting is concerned primarily with the internal needs of management. It is oriented toward evaluation of performance and development of estimates of the future as opposed to traditional financial accounting which emphasizes historical data related to such legal financial matters as ownership, investment, credit granting, taxation, regulation, and the building of foundations for consistent and conservative external reporting, “in accordance with generally accepted accounting principles.” Flexibility is an essential characteristic of management accounting since it presupposes that careful attention has been given to determine the important needs of management, many of which cannot be precisely identified in advance (Parker, 2002). The Institute of Management Accountants (IMA), the professional association of practicing and academic management accountants, defines management accounting as “The process of identification, measurement, accumulation, analysis, preparation, interpretation, and communication of financial information used by management to plan, evaluate, and control within an organization and to assure appropriate use of and accountability for its resources. Management accounting also comprises the preparation of financial reports for non-management groups such as shareholders, creditors, regulatory agencies, and tax authorities” (Smith, 2009).
Management accounting provides information from its environment to management to facilitate decision-making. Good management accounting information has three attributes: Technical-it enhances the understanding of the phenomena measured and provides relevant information for strategic decisions, Behavioral-it encourages actions that are consistent with an organization’s strategic objectives, and Cultural-it supports and/or creates a set of shared cultural values, beliefs, and mindsets in an organization and society (Ashton et al., 1991). The development of management accounting is responsive to the demands of management and the environment. Management accounting adapts to organizational change and three major forces cause organizations to evolve: technological change, globalization, and customer needs (McWatters, 2001). In order to remain competitive in today’s global market, business must continually improve. Good management accounting practices help the organization to improve continually. Due to these all over the world there are so many management accounting tools & techniques developed and practiced.
1.1.2 Financial Performance
Financial performance can be defined as a subjective measure of how well a firm can use assets from its primary mode of business and generate revenues (Mills, 2008). This term is also used as a general measure of a firm’s overall financial health over a given period of time, and can be used to compare similar firms across the same industry or to compare industries or sectors in aggregation. The performance measurement concept indicates that employees can increase the value of the firm by; increasing the size of a firm’s future cash flows, by accelerating the receipt of those cash flows, or by making them more certain or less risky (Cadbury, 1992).
There are many different ways to measure financial, but all measures should be taken in aggregation. Some of the indicators of financial performance are return on equity, liquidity ratios, asset management ratios, profitability ratios, leverage ratios and market value ratios.
Carreta and Farina (2010), argue that use of financial performance could still be justified on the grounds that it reflects what managers actually consider to be financial performance and, even if this is a mixture of various indicators like accounting profits, productivity, and cash flow. Financial performance is determined by the following indicators; profit or value added; sales, fees, budget; costs or expenditure and stock market indicators (e.g. share price) and autonomy. Proxies for the financial performance also include the accounting measure of performance; return on equity (ROE) and return on asset (ROA).
1.1.3 Management Accounting Practices and Financial Performance
Ittner and Larcker (2002) defined management accounting practices as a variety of methods specially considered for manufacturing businesses so as to support the organization’s infrastructure and management accounting processes. Management accounting practices can include budgeting, performance evaluation, information for decision-making and strategic analyses, among many others.
Ittner and Larcker (2001) argued that due to the development of these new methods, the basic principles of management accounting has changed to a more superior one that adds value to various practices. The literature has also indicated that some practices such as absorption costing and marginal costing have not been highly favoured by most businesses. For example, Dugdale and Jones (2002) stressed that there is a limitation within these costing systems, since they do not provide an accurate method of recording costs to be exact in order to make sound management decisions.
Management accounting practices enable management to obtain relevant information for meaningful decision making (Alleyne and Weekes-Marshall, 2011). Uyar (2010) noted that the perceived importance of cost accounting is driven by decreasing profitability, increasing costs and competition, and economic crises. The author also noted that while companies still perceive traditional management accounting tools as still important, new management accounting practices such as strategic planning, and transfer pricing are perceived less important than traditional ones. The study also found that the most important three management accounting practices are budgeting, planning and control, and cost-volume-profit analysis.
A number of factors influence the changes in management accounting practices within some organisations. Otley and Berry (1980) made reference to some systems as open, that is, there is a continuous cycle of resources that are inputs which moves from the external environment. It is a common belief that such changes will have an influence on the selection of the appropriate management accounting practices within any organization. Some researchers have commented that such changes may originate due to different settings of both economic and cultural environments. Most of the research focused on changes in management accounting practices, primarily in countries such as South Africa and Canada (for example Luther and Longden, 2001). However, some researchers noted what is often taught in schools is far different in the world of work and therefore creates a breach in knowledge between the practice and the theory. Johnson and Kaplan (1987) argued that management accounting has not changed over the past years. However, Libby and Waterhouse (1996) were convinced that there were changes. Burns et al. (1999) further argued that there is evidence that management accounting practices have changed over the last decade in a developed country such as the UK.
Management accounting as a research paradigm has not been fully explored in Kenya. A few studies exist on the same mainly as theses and dissertations in various universities in Kenya (for instance Arithi, 2001; Waweru, 1999; and Mapetla, 1982) and around the world (for example Ndwiga, 2011), a few in local journals in the country (for example Waweru, Kamasara and Anyangu, 2003) and very few, if any, in international journals (for instance Abdel-Kader and Wadongo, 2011; and Mathenge, 2012). Therefore, it can be concluded that the effects of management accounting practices on financial performance in Kenya is not well documented just as much as in other developing countries as had noted Li and Yu (2002).
1.1.4 Manufacturing Companies in Kenya
The manufacturing industry in Kenya is dominated by subsidiaries of multinationals. The players fall in the following categories as represented in the Kenya association of manufacture’s listings; food and beverages processing, Paper and paper board, Wood products Pharmaceutical and medical equipment, Leather products, Chemical and allied, Textiles, Tobacco, Plastics and rubber (Association of Manufacturers, 2013). Manufacturing is a significant contributor to the economy as it contributes 10% of GDP, 12.5% of Exports and 13% of formal employment (CBK, 2013). Kenya is a favourite destination for investors willing to put their money in manufacturing. While the country is not endowed with the mineral wealth most of its neighbours flaunt, it more than makes up for it, thanks to the following: one of the best workforces in Africa, a productive agricultural sector and hence a dependable source of raw materials for agro-based manufacturing, a fairly versatile financial services sector, bankable telecommunications and proximity to port facilities. A wide range of opportunities for direct and joint venture investments exist in the manufacturing sector including processing, manufacture of garments, assembly of automotive components, electronics, plastics, chemicals, pharmaceuticals, metal engineering products for both domestic and export markets (Republic of Kenya 2003).
The manufacturing sector was initially developed under the import substitution policy. There has been a shift, however to export oriented manufacturing as the thrust of Kenya’s industrial policy. The sector plays an important role in adding value to agricultural output and providing forward and backward linkages, hence accelerating overall growth. By the year 2003 the manufacturing sector comprised more than 700 established enterprises and directly employed over 218,000 persons as at the year 2000 (Kenya Association of Manufacturers, 2010).
Kenya also has locational advantages as the gateway and a natural launch pad to the markets of the mostly Landlocked East and Central African countries like Uganda, Southern Sudan, Rwanda, Burundi, parts of northern Tanzania and Eastern Democratic Republic of the Congo (DRC). According to the Economic Recovery Strategy for Employment and Wealth Creation Report, the manufacturing sector in Kenya is a major source of growth, still with high potential for growth and investment. The role of the manufacturing sector in Vision 2030 is to create employment and wealth.
A set of key target areas have been identified and specific goals set to steer industrial growth. These include the development of Special Economic Zones (SEZs), Industrial Parks, Industrial Clusters, promotion of small and medium scale manufacturing firms, development of niche products, commercialization of research and development results, attraction of strategic investors in strategic sectors, i.e. iron and steel industries, manufacture of fertilizer, agro -processing, machine tools and machinery, motor vehicle assembly and manufacture of spare parts. According to the Major et al., (2005), the productivity growth in the Kenyan manufacturing sector had been zero or negative since the early 1990s. Productivity declined by 0.5% per year between 1991 and 1998. Regression analysis of companies’ data suggests that between 1999/2000 and 2002/03; almost no productivity improvement was visible in the average firms. There had been virtually no change in labour productivity. Capital increase was not statistically distinguishable from zero. Total factor productivity appeared to have increased by 7% between 1999 and 2002, but again this estimate was not statistically different from Zero.
To promote development in the target areas, projects are designed and implemented through a Public, Private, Partnership (PPP) framework. Some key Kenyan manufacturing subsectors that have increased demand in the recent past include galvanized iron sheets, cement, cigarettes, beer and Wheat flour. All of these have increased production between 2003 and 2005, particularly cement which is a good indicator of economic activity. On the consumer goods side, goods manufactured locally include stationery and grooming products. Based on the Kenya Association of Manufacturers (2010), majority of the Kenyan manufacturing firms are slowly adopting modern models of overhead allocation techniques as they have previously been using traditional allocation Methods. The majority are adopting the Activity based costing which they consider superior to other overhead allocation techniques. However, they lack expertise in implementing the modern overhead allocation techniques.
1.2 Research Problem
As today’s business environment becomes increasingly competitive, business organizations are becoming more aggressive and dynamic in identifying strategies that will ensure profitable existence. Competition may be attributed to business innovations, advancement in technology and the changing demand of customers. Competition amongst business organizations may compel the management to develop business techniques and strategies that would guide an organization towards the maximization of profits. This may be achieved through increased sales and reduced cost of production. The optimization of profits and minimization of costs may enable an organization to create a competitive advantage in its industry. Certain management accounting practices provide strategies that can influence a large number of customers to have a lasting preference for a company’s products. Thompson, Strickland and Gamble (2009) are of the view that the adoption of management accounting techniques may provide an organization with a sustainable competitive advantage over its rivals.
Management accounting practices have moved from reporting historical information, especially on variance analysis, to taking part in the strategic planning process of an organization (Kiesler and Sproull, 1982). These authors contend that management accounting skills are actively applied in the business environment where both market intelligence is sought and evaluated, and strategic decisions are made and competitive strategies put in place. These are factors which Ittner and Larcker (1997) argue that they enable an organization to gain an advantage in the ever demanding competitive business environment where innovative management accounting practices need to be employed. The management accountants, especially those in the manufacturing sector, should therefore be at the forefront in the search and development of innovative competitive strategies that may enable an organization to remain profitable and competitive. These measures are particularly important in the manufacturing sector where efficiency and cost effectiveness may be used as a competitive tool for growth and profitability. Studies in other countries have shown that despite the developments in management accounting theory, the practice has not changed as companies still prefer the use of traditional management accounting tools (Uyar, 2010).
The accounting profession in Kenya has grown tremendously with the adoption of IFRS and IAS as accounting and auditing standards. Over the years, the challenge to keep costs down in order to keep better performance has been predominant in most companies and especially those listed on the NSE given the pressure from the shareholders for firms to post better performance. With the overall economic situation in Kenya, investors are looking for companies that can create wealth for them hence companies which perform poorly do not attract investors. Management accounting offers the best opportunity for firms to compete in the market in order to offer best quality products and services at affordable prices to consumers. Most of the existing research literature on accounting in Kenya manufacturing companies tends to be more biased toward the arm of financial accounting, information technology adoption as well as research in credit accessibility for manufacturing companies, more so only remote exists in regard to effects of management accounting practices on financial performance of manufacturing companies in Kenya (Wairegi, 2011),(Makau, Wawire, & Ofafa, 2013), (Waweru, 2012), (Mugambi, 2010), despite this previous research studies being vital, lack of management accounting practices for decision making and lack of technical skills are as much obstacles to developing manufacturing companies as is the inability to access credit (Mbogo, 2011). This study thus sought to establish the effects of management accounting practices on financial performance of manufacturing companies in Kenya
1.3 Research Objective
The general objective of this study was to investigate the effects of management accounting practices on financial performance of manufacturing companies in Kenya.
1.3.1 Specific objectives
- To establish the management accounting practices undertaken by the manufacturing companies in Kenya.
- To establish the effects of management accounting practices on financial performance.
Value of the Study
This study adds onto the theory of management accounting in developing countries by focusing on the practice of manufacturing companies in Kenya. The study will show whether the manufacturing companies still prefer the traditional tools or if there has been developments in practice as has the theory. The study will also benefit various other companies in Kenya as they will understand the methods and tools available for them as far as controlling costs are concerned. The recommendations provided will help the firms improve their practice. The study will also benefit scholars and academicians interested in pursuing a study in accounting and especially management accounting as it will form a foundation for other studies.
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