The multiple role of accounting systems

The multiple role of accounting systems

Taxing Authorities


Regulation Board of Directors

Senior Management Compensation Plans

Regulatory Authorities


IRS & Foreign Tax Authorities

External Reports

Accounting System

Internal Reports

Decision Making

Control of Organizational


Debt Covenants Bondholders

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6 Chapter 1

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important source. These internal reports are also used to evaluate and motivate (control) the behavior of managers in the firm. The internal accounting system reports on manag- ers’ performance and therefore provides incentives for them. Any changes to the internal accounting system can affect all the various uses of the resulting accounting numbers.

The internal and external reports are closely linked. The internal accounting system affords a more disaggregated view of the company. These internal reports are generated more frequently, usually monthly or even weekly or daily, whereas the external reports are provided quarterly for publicly traded U.S. companies. The internal reports offer costs and profits by specific products, customers, lines of business, and divisions of the com- pany. For example, the internal accounting system computes the unit cost of individual products as they are produced. These unit costs are then used to value the work-in-process and finished goods inventory, and to compute cost of goods sold. Chapter 9 describes the details of product costing.

Because internal accounting systems serve multiple users and have several purposes, the firm employs either multiple systems (one for each function) or one basic system that serves all three functions (decision making, performance evaluation, and external report- ing). Firms can either maintain a single set of books and use the same accounting methods for both internal and external reports, or they can keep multiple sets of books. The decision depends on the costs of writing and maintaining contracts based on accounting numbers, the costs from the dysfunctional internal decisions made using a single system, the addi- tional bookkeeping costs arising from the extra system, and the confusion of having to reconcile the different numbers arising from multiple accounting systems.

Inexpensive accounting software packages and falling costs of information technol- ogy have reduced some of the costs of maintaining multiple accounting systems. However, confusion arises when the systems report different numbers for the same concept. For example, when one system reports the manufacturing cost of a product as $12.56 and another system reports it at $17.19, managers wonder which system is producing the “right” number. Some managers may be using the $12.56 figure while others are using $17.19, causing inconsistency and uncertainty. Whenever two numbers for the same con- cept are produced, the natural tendency is to explain (i.e., reconcile) the differences. Managers involved in this reconciliation could have used this time in more productive ways. Also, using the same accounting system for multiple purposes increases the credibility of the financial reports for each purpose.4 With only one accounting system, the  external auditor monitors the internal reporting system at little or no additional cost.

4A. Christie, “An Analysis of the Properties of Fair (Market) Value Accounting,” in Modernizing U.S. Securities Regulation: Economic and Legal Perspectives, K. Lehn and R. Kamphuis, eds. (Pittsburgh, PA: University of Pittsburgh, Joseph M. Katz Graduate School of Business, 1992).

Multiple accounting systems are confusing and can lead to errors. An extreme example of this occurred in 1999 when NASA lost its $125 million Mars spacecraft. Engineers at Lockheed Martin built the spacecraft and specified the spacecraft’s thrust in English pounds. But NASA scientists, navigating the craft, assumed the information was in metric newtons. As a result, the spacecraft was off course by 60 miles as it approached Mars and crashed. When two systems are being used to measure the same underlying event, people can forget which system is being used. SOURCE: A. Pollack, “Two Teams, Two Measures Equaled One Lost Spacecraft,” The New York Times. October 1, 1999, p. 1.

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