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PROJECT TOPIC AND MATERIAL ON ACCRUAL ACCOUNTING AS A DETERMINANT FOR PERFORMANCE EVALUATION: A CASE STUDY OF SOME SELECTED COMPANIES
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- Name: Accrual Accounting As A Determinant For Performance Evaluation: A Case Study Of Some Selected Companies
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- Length:  Pages
1.1 BACKGROUND OF THE STUDY
In the management control literature, accrual accounting has consistently been viewed form a stewardship perspective. Accordingly, “good” accounting rules have the property that the resulting accounting based performance metrics guide manager towards value increasing decisions. This perspective study on divisional performance measurement, the debate about desirable accounting relies has recently been reinvigorated in connection with so-called Economic Profit Plans (EPP) many of which are variants of the familiar residual income concept. The proponents of Economic Profits Plans (EPP) recommend adjustment to GAAP with the stated objective of obtaining accounting metrics that are more useful for internal performance evaluation. Yet, for the most part this debate has been lacking informal criteria for comparing alternative rules and as a consequence, no discernible consensus has emerged regarding the recommended accounting adjustment, Young (1998) and Simons (2000).
The analysis of Rogerson (1997) and Pferiffer (2002) predicated on the notion that managers have superior information about the financial consequence of a proposed transaction while the accounting rules can rely only on general purpose information e.g. on assets useful life for a range of common production, financing and investment decisions. We argue that private information held by management makes intertemporal matching of revenues and expenses essential yet. The specific form of matching needed for goal congruence differs from GAAP in many instances. In connection with long term construction projects for example, Bharket and Bastin (2004) argue that revenue recognition for a project should reflect the underlying intertemporal pattern of relative progress towards project completion. To obtain goal congruence, however, the commonly used percentage of completion method needs to be modified so as to properly reflect the time value of money. Specifically, the estimate of the percentage of completion in a given period should based on the ratio of the period cost to the discounted value (rather than the undiscounted value) of the projects total cost of course, both methods require that the accounting system be in a position to estimate the relative percentages of costs in different construction periods.
1.2 STATEMENT OF RESEARCH PROBLEMS
Over the years, the study of goal congruent performance measures naturally raises the question whether the corresponding accounting rules also emerge as part of second-best contracts in agency models. By construction, the advantage of goal congruence is that managerial incentive are invariants to the choice of compensation parameters and therefore these parameters can be chosen freely to address moral hazard problem. At the same time, though, second-best decision rules generally vary with the underlying agency problem. This would necessitate further adjustment to the performance measure such as changes in the capital charge rate, in order to implement second-best incentive mechanisms. For some transaction in particular those involving sequential information and decision making future agency research will have to verify the “optimality” of congruent performance measures.
Goal congruence does not make it necessary to apportion the present value of a transaction across the useful life of the transaction, for certain transaction such as credit sales, it is plausible that the accounting system has sufficient information to recognize all value creation upfront. Conversely, goal congruence can be obtained by differing the recognition of value creation, the corresponding performance measure would amount to the compounded value of past cashflows. Ehrbar (1998) argue, that such “backloading” will be generally infeasible for a going concern and conflict with the need for performance measures to effectively aggregate the consequences of multiple ongoing projects.
1.2 OBJECTIVE OF THE STUDY
The objective of the research work on “Accrual Accounting as a determinant for performance evaluation in an organization” is to find a meeting point between financial assets and liabilities commonly accrue interest under GAAP on one hand and the goal congruent accounting generally require that the (positive) present value of a transaction is apportioned across time periods in the residual income numbers on the other hand.
Further the work is intended to determine the following:
a. The nature and scope of accrual accounting rules in an organization.
b. How well does each year’s profit reflect the success of that year’s manager?
c. The residual income as the managerial performance measure.
d. The importance of Accrual Accounting rules and performance evaluation not only to an organization but also to the general public.
1.3 SCOPE OF THE STUDY
The project work on “Accrual Accounting rules as a determinant for performance evaluation in an organization” intended to highlight the following areas in the course of the study.
The nature and scope of the accrual accounting rules, the importance of the accrual accounting rules and performance evaluation not only to an organization but also to the general public. Further, the study will focus on residual income as the managerial performance measure. This focus not only reflects that most of the recently proposal and adopted EPPs are variants of the residual income measure, but also the finding of recent theoretical research showing measures residual income has certain uniqueness properties in achieving goal congruence.
1.4 SIGNIFICANCE OF THE STUDY
Accounting and economic observers agree over the years that financial accounting rules which call for the immediate expensing of intangible investments will not lead to goal congruence, Peinreich (1937) argued that certain manifestations of conservations are desirable from a performance measurement perspective. Specifically, Preinreich (1937) find that fair market values will generally exceed book values. This relation emerges because, by the conservation property of residual income, the difference between the fair market value and the book value is just the present of future residual income.
In connection with abandonment options, such as multi-stage investment projects, our analysis advocates full cost rather than successful efforts accounting. Full cost accounting offers the possibility of intertemporal matching.