There are still many obstacles to the development of strong management accounting in China but some companies have led by example. By Stathis Gould, head of technical issues, CIMA.
One of the main ways of entering the Chinese market for a foreign firm is through a joint venture with a local company. It is in these companies that western management accounting techniques are developing quickest.
However, these techniques are by no means limited to joint ventures with foreign capital and influence. More advanced management accounting approaches have been selectively implemented in Chinese companies and we are starting to hear success stories.
Field study research, such as that undertaken by Lin and Yu in the Han Dan Iron and Steel Company, and recently published in CIMA's "Management accounting research" journal, shows local companies reaching international standards of competitiveness. The impact of management accounting change in such companies should help influence wider state policy on education and training of accountants in business.
More importantly, it shows practitioners and academics how business performance is accelerating in some Chinese companies and provides lessons on how business management can be changed in emerging economies.
Although there is limited information on accounting development in China apart from the anecdotal, there are some indicators of the nature of change. Xu-Dong Li in his book "Development of accounting and auditing systems in China", provides a survey of management accounting Chinese companies.
According to the book, accountants play a less important role in management decision making than those in more developed countries. Planning departments, rather than accounting departments, take responsibility for investment decisions while the accounting function provides cost, profit and fund data to internal departments and government authorities. Because the nature of the Chinese culture is to exaggerate achievements and play down weaknesses, management may ignore accounting figures and may even force accountants to manipulate information. In 2001, the Chinese finance ministry released a report showing that 276 state-owned firms had fabricated their performance results.
Xu-Dong Li's other key findings were that:
As more Chinese companies evolve into shareholder corporations and become responsible for their own investment, this picture of management accounting is likely to change.
Three key factors enabled the successful implementation of a responsibility control system in the Han Dan Iron and Steel Company. First, there was the tough economic and business environment including increased market competition and falling prices. Previously, with no exposure to external market pressures, directors of internal production units were concerned only with fulfilling production quotas. Hence cost information was only concerned with the execution of production plans or spending quota imposed by government authorities.
Second, there was the Han Dan management's enthusiasm and ability for the design, implementation, control and monitoring of the responsibility cost control system. There were several innovations in business operations that helped the process along.
The failure in many state-owned enterprises to engage in better management accounting relates, at least in part, to the lack of training and skills of Chinese managers directly appointed by government authorities. The listing on the Shanghai Stock Exchange of a subsidiary of the Han Dan Iron and Steel Stock Limited Company in 1997 also added a new market oriented dimension to the company.
Third, and not be underestimated, was the integration of the cost management and performance evaluation and reward scheme. Individual workers failing to meet cost targets specified in responsibility contracts forfeited bonuses (even where other responsibility targets were met). The forfeit can amount to 40-50 per cent of total income. Managers at various levels of the responsibility chain, including along the value chain to include suppliers, are assigned cost/profit targets through a top-down approach.
The Han Dan story shows how it is possible to overcome some of the cultural issues met when operating in what was a planned economy and that are inherent in Chinese management thinking. It shows it is possible to implement advanced control frameworks with related accountabilities.
There was initial scepticism about the applicability of responsibility accounting and techniques such as target and standard costing, flexible budgeting, internal transfer pricing, variance analysis and performance evaluation. This was overcome by the insistence of the director of finance and accounting from the outset that the responsibility and accounting and standard costing system used in western management accounting could be a solution to the deficiencies of the old costing system. A sustained push by senior management was crucial in overcoming resistance to an unfamiliar concept.
Change was all encompassing. More than 60 internal units or subsidiaries were regrouped according to their functions that related to the company's operational goals. A new design of multi-tier responsibility centres helped to clarify operating responsibilities among different levels of producing units and helped the implementation of cost targets within the entire company.
Control of responsibility cost, the most important measurement in the cost control system, required that managers at all levels were assigned cost/profit targets. Cost targets were set separately for each of the main products sold to external markets. Target costs or profits were set for the 13 primary production factories along the product line or manufacturing processes. Internal transfer prices were used to facilitate the performance evaluation of each production factory as an independent profit centre. Responsibility standards were then translated to producing departments, processing sections and individual workers. Performance evaluation also involved responsibility contracts between factory managers and supervisors at lower levels.
Based on the experience of this successful implementation over a 10-year period, the researchers of the study have recommended refinement of the responsibility cost control system. They suggest considering the incorporation of techniques such as activity-based costing and just-in-time.
There is also scope for refining the performance evaluation system to deal with non-controllable factors in performance that could have behavioural impacts on individual responsibility centres or workers. Some managers feel that they might have been penalised by factors outside their control and this may be leading to demotivation in parts of the workforce.
Reform of China's state-owned enterprises is important to its sustained economic growth. However, the relative success shown at Han Dan in implementing better management accounting cannot hide the fact that many enterprises are still losing money (particularly steel producers). Their moves toward becoming more market oriented are hindered by national and local political decisions that affect major capital investment.
Western management accounting techniques cannot work effectively without market oriented corporate governance. Enterprises that cannot make decisions independently of direct political influence will probably never survive competition in liberalised markets. Those that do progress to be internationally competitive will tend to have one thing in common - the infusion of knowledge and capital from a foreign partner.
Further reading
"Responsibility cost control system in China: a case of management accounting application" by Jun Lin and Zengbiao Yu.
