&counting, Organizations and Society, Vol. 8, NO. 213, pp. 153-169, 1983. 0361-3682183 $3.00 + .

OO
Printed in Great Britain. 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 organiza-
tional 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 ac-
counting 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 (1978) points out, even in cases
research in accounting has struck a responsive where accounting has been studied in its organiza-
chord both among behavioral scientists who are tional context, there has been little attempt to
aware of the significant effects of accounting gain an appreciation of the complex interrelation-
systems on human behavior and accountants who ships between organizational processes and ac-
are aware of the interactions between accounting counting systems. For example, in the budgeting
and behavior. Yet the current body of behavioral area studies have focused upon static aspects of
research in accounting has not fulfilled expecta- the relationship between participation and budget-
tions. One major reason for its disappointing re- ary behavior, rather than the relationship between
sults is that behavioral research in accounting has budgeting and the overall organizational control
tended to be focused upon what are admittedly structure.
important aspects of the accounting process in
isolation of the organizational context in which
the accounting function operates. Accordingly, a PURPOSE
considerable amount of this research is character-
ized by an almost sterile quality; or at least it This paper deals with some aspects of the
certainly fails to capture the richness and com- neglected realm of the role of accounting in its
plexity of the on going organizational context that organizational context. It explores the relation-
provides the raison d’etre of accounting. ship between control, budgeting and accounting

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

153
 154 ERIC G. FLAMHOLTZ

systems in their organizational context from theo- A META-PERSPECTIVE OF CONTROL

retical as well as empirical perspectives. Specifi- SYSTEMS
cally, we shall first examine the role of budgeting
in the context of the overall organizational control To facilitate our thinking about a control
system from a theoretical perspective. Then we system as opposed to the techniques of control
shall examine selected examples of accounting and we need a metaperspective or framework. A
budgetary control systems in their actual organiza- schematic representation of the framework that
tion settings. shall be employed is shown in Fig. 1. It is based
In the paper the term “organizational control” upon previous work by Flamholtz & Tsui (1980).
will be used in its full sense of any actions or In Fig. 1, the control system of an organization
activities taken to influence the probability that is represented by a series of concentric circles. The
people will behave in ways which lead to the innermost circle comprises the “core control
attainment of organizational objectives (Flam- system”. This is a cybernetic structure consisting
holtz, 1979; Otley & Berry, 1980). It is relatively of four subsystems (planning, operations, measure-
well recognized that control is an inevitable ment and evaluation-reward) which are articu-
feature of all human organizations. The organiza- lated (linked) by feedback and feedforward loops.
tional concern for control arises because of the The middle circle comprises the organization’s
incompatibility of goals among people and the structure: its set of rules and their interrelation-
corresponding need to channel human efforts to- ships. The outer circle represents the organiza-
ward a specified set of institutional goals. tion’s culture: its value system, beliefs, assump-
To help gain control over the behavior of tions; the patterned ways of thinking which are
people, most enterprises use a combination of characteristic of the entity. These three elements
mechanisms including personal supervision, rules, of the control system are bounded by the environ-
job descriptions, standard operating procedures, ment of the organization.
budgets, and performance measurement systems.
Broadly conceived, these mechanisms and pro- The core control system
cesses comprise the tangible components of an Although the applicability of cybernetic con-
organizational control system. However, if we cepts to organizational control has been challenged
merely view an organizational control system as (Holstede, 1979; Otley & Berry, 1980), the main
a collection of rules, standards, budgets, etc., or problem has been the narrow interpretation of
more significantly, if we treat such an ad hoc mathematical cybernetics (Weiner, 1948) and the
collection of techniques as a “control system”, use of mechanistic analogies (i.e. the thermostat
then we may overlook the necessity for the model of control). However, the concept of the
architecture of control systems to be designed. core control system presented here presents an
Indeed, the components of the control system integrated structure of four basic organizational
ought not be confused with the system per se, processes: planning, operations, measurement, and
though this error is sufficiently common. Thus a evaluation-reward. The core model is presented
budgetary system is not equivalent to a control schematically in Fig. 2.2
system, and thus technically we should not use the Planning, which can itself be defined in many
term “budgetary control system”.’ 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 V
system ’
(I-I) * Operations
cl-2 Standards)

t
Corrective
feedback

Ls_
Measuremeti
system
3-l Accounting _
system Performance
3-2 hfso;emmatlon measurement

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

 156 ERIC G. FLAMHOLTZ

goals of an organization (and/or its members) as the phenomena caused by the act or process of
well as the means to attain those goals.3 “Organiz- measurement per se. The very fact that something
ational goals”, according to Hall (1975, p. 12) “are is the subject of measurement tends to influence
the desired ends or states of affairs for whose the behavior of people in organizations (Cammann,
achievement system policies are committed and 1976; Prakash and Rappaport, 1977; Flamholtz,
resources allocated.” In this paper, the term 1980). Thus the medium of measurement is itself a
“goals” refers to relatively broad statements about stimulus. This is termed the “process function” of
things an organization wishes to achieve in a given measurement.
“performance area” (markets, products, personnel, The accounting system is a component of the
financial results, etc.). “Standards” represent the measurement system of an overall control system.
level of aspiration sought to be attained for a given The budgeting system in organizations is part of
goal. For example, the financial goal for Pepsico the planning system as well as the measurement
may be “to earn a satisfactory return upon net system. However, neither the accounting nor the
assets employed in the business,” while its stand- budgetary system are equivalent to the whole of a
ard of performance for a given year might be controI system, because they lack critical com-
“18% pre tax ROI”. ponents. In the case of the accounting system the
Operations, or the operational subsystem, refers pieces missing are planning and evaluation-
to the on going system for performing the func- reward, while in the case of budgeting the element
tions required for day to day organizational lacking is the evaluation-reward system.
activities. These are the responsibilities and activ- The evaluation-reward system refers to the
ities specified in organizational roles. mechanisms for performance assessment and the
In an organizational context, measurement is administration of rewards. Rewards are outcomes
the process of assigning numbers to represent of behavior which are desirable to a person. Al-
aspects of organizational behavior and perform- though rewards can either be extrinsic or intrinsic,
ance. The overall measurement system includes the those used in the evaluation-reward system are
accounting system with its measures of financial extrinsic.
and managerial performance. It also includes non-
financial measures of organizational performance, Different configurations of core control systems
including production indices such as scrap rates, elements
capacity utilization and product quality (rejection Although the four basic elements of the core
ratios) measures as well as (at least potentially) control systems must be present for the system to
social accountability measurements. function fully, it is possible to find in actual
Measurement performs a dual function as part organizational settings different configurations of
of a control system (Flamholtz, 1980). One func- one or more of the system’s elements.4 For
tion is that the numbers generated may be used to example, it is possible to observe a “control
monitor the extent to which goals and standards system” that consists merely of a planning system
have been achieved, so that organizational with little else. In such situations measurements
members may be provided corrective and/or may be available only at year end and thus are not
evaluative feedback. This is termed the “output available for periodic assessment of performance
function” of measurement. The second function on a real time basis. In contrast, performance
of measurement relates not to the numbers pro- measurement systems may be found in situations
duced by measurement operations, but rather to without any formal system for planning and goal-

’ The problem of reification need not hinder us if we view the “organization” as a proprietorship, dominant coalition,
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.

Illustrative
Control conf iquratlons of
levels 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 are present we shall define this condition as first
control system may be expected to increase with degree control. In this condition, there are merely
the addition of each element of a control system. operations (decisions and actions) which produce
For example, the degree of control can be expect- results. This type of condition is not uncommon
ed to be greater if a control system includes plan- and is characteristic of entrepreneurships and
ning and measurement components than if it in- relatively small businesses. Second degree control
cludes either planning or measurement. Accord- consists of operations plus (any) one additional
ingly, it is useful to conceive of “control” as a element: planning, measurement, or evaluation-
variable, where the amount of control is a function reward. For example, an organization may have
 158 ERIC G. FLAMHOLTZ

a measurement system without formal planning or markets, technology and the environment (Child,
even without any system for performance assess- 1979; Chandler, 1962; Lawrence & Lorsch, 1969).
ment and the administration of rewards. Similarly, Specifically, the choice of an organizational
different combinations and configurations of structure represents a managerial strategy on how
control system elements may exist as illustrated to adapt the organizational entity to the require-
in Fig. 3. Third degree control consists of oper- ments of its environment. For example, in its
ations plus any two additional elements. For competition with Ford Motor Company for leader-
example, as illustrated in Fig. 3, organizations may ship of the U.S. auto market during the early
have a control system consisting of planning, 1920’s, General Motors under the leadership of
operations and measurement. Fourth degree Alfred P. Sloan (1965) perceived accurately that
control consists of all of the four basic elements of the two firms were in competition not only with
the core control system: planning, operations, specific products but with the very issue of how
measurement and evaluation-reward. This con- their organizations were structured. As Sloan
ceptualization may be used both in understanding (1965, p. xxiv) stated:
the effects and defects of control systems as well
as a guide to their evaluation and design. It should be recognized that competition takes various
forms: General Motors, for example, has competed with
Organizational structure as a component of other enterprises as a type of organization (decentralized)
control and in its long-range way of doing business (up-grading
The second component of the overall control the product), as well as usual day-to-day business activ-
system, shown previously in Fig. 1, is organiza- ities. The elder Henry Ford, on the other hand, believed
tional structure. As Otley & Berry (1980, p.232) more in centralized organization and in a static car model.
state: “Indeed, organization can itself be viewed
as a control process, occurring when groups of Organizational culture as a component of control
people feel the need to co-operate in order to The term “culture” is subject to many different
achieve purposes which require their joint definitions and denotations. Kluckhohm (195 1,
actions.” Similarly, Etzioni (1966) states that p. 6) stated that:
“organizations are social units deliberately con-
structed to seek specific goals.” Other organization “Culture consists in patterned ways of thinking, feeling
theorists have argued that organization structure is and reacting, acquired and transmitted mainly by sym-
developed as a response to the problem of control bols, constituting the distinctive achievement of human

(Blau & Scott, 1962; Hall, 1972; Perrow, 1977; groups, including their embodiments in artifacts; the
Thompson, 1967). essential core of culture consists of traditional (i.e.
Several structural dimensions contribute to the historically derived and selected) ideas and especially their
process of control including the degree of central- attached values.”
ization or decentralization, functional specializa-
tion, degree of vertical or horizontal integration In the organizational context, Ouchi (1979)
and the span of control. Some dimensions of refers to culture as the broader values and norma-
organizational structure (i.e. functional specializ- tive patterns which guide worker behavior,
ation or rules) facilitate control by reducing the practices and policies. In this paper, we shall refer
variability of behavior and, in turn, increasing its to organization culture as the set of values, beliefs
predictability. Other dimensions (i.e. centraliz- and social norms which tend to be shared by its
ation) facilitate control by direct influence over members and, in turn, tend to influence their
the decision making process for non-programmable thoughts and actions.
events. Although culture is shown as the third circle in
In contrast with the core control system, Fig. 1, it is, in fact, the starting point for the de-
organization structure is relatively static. It repre- sign of an organizational control system, because
sents a strategic response to the requirements of it determines (or at least ought to determine) the
 ACCOUNTING, BUDGETING AND CONTROL SYSTEMS IN THEIR ORGANIZATIONAL CONTEXT 159

nature of the other components. For example, in In brief, culture is a pattern of values, norms
an entrepreneurial organization the culture re- and beliefs shared by an organization’s members.
quired may be based upon the values of individual These dimensions of culture help influence the
initiative, flexibility, lack of bureaucratic control behavior of members of an organization. Once the
and independence of action. Given this culture, desired culture has been defined, the remaining
the required organizational structure ought to be elements of the organizational control system
characterized by decentralization rather than (structure and the core control system) help trans-
centralization; loosely defined roles rather than mit and reinforce the entity’s culture throughout
tight role definitions and minimal rules and stand- the organization to govern strategic and opera-
ard operating procedures rather than extensive tional decisions and actions.
rules and procedures. If not, there will be an
obvious incongruity between the organization’s Some preliminary implications
culture and its control structure. Similarly, the The meta-perspective of organizational control
entity’s core control system ought to be com- presented above suggests several preliminary impli-
patible both with the overall culture and the cations. These are presented below.
structure. The nature of the firm’s planning system
ought to be congruent with its culture. Budgeting and control. If we accept the notion
The dimensions of culture and structure also of the three part system of control, then the con-
have implications for the firm’s accounting ventional concept of a control system limited to
measurement system. Thus, the accounting system the accounting-measurement system is spurious.
in decentralized organization will simultaneously Statements such as “Through budgets, activities of
provide information to permit day-today deci- different parts of an organization can be coordi-
sions to be exercised by divisional managers while nated and controlled” (Bruns & Waterhouse, 1975,
also permitting overall coordination and control. p. 180)’ are technically incorrect or at least in-
In spite of the fact that it changes slowly and complete. It is possible that a budgetary system
typically with great difficulty, organizational may operate as though it were a complete control
culture is a variable. It is subject to design, and system if there are certain implied or perceived
can be the product of management decision. For connections between budgetary measures and
example, in early 1981 the Board of Directors of organizational rewards. This means that the
U.S. based RCA Corporation decided to replace budgetary system is a part of a control system
that company’s president, Edgar H. Griffiths, with configuration that achieves the fourth degree of
Thornton F. Bradshaw. According to an analysis control. However, without the complete con-
presented in Business Week (February 9, 1981: figuration the budgetary system may simply not
p. 72), Bradshaw was chosen explicitly to change fulfill the assertion by Bruns & Waterhouse
RCAs culture. His task is to change the value (among others) that through budgets “an organiza-
system in the company from one that stresses tion can be controlled”. In a subsequent section,
short-term projects and planning to long range we shall present a study of budgeting in an actual
goals. Business Week quoted an unidentified organizational context in which budgeting exists
“source close to the Board”, as stating that under independently of the evaluation-reward com-
Griffiths: “Long-term planning meant, ‘What are ponent of control and examine the consequences
we going to do after lunch?’ ” In addition, for effective organizational control.
Bradshaw “. . . must redirect the culture of the
company from one based on intense politicking Zntegration of control system elements. Given
to one that rewards performance.” the concept of a tri-part control system, it is

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

implied that all of the three elements (the core the operation of such systems in their organiza-
system, structure and culture) ought to be de- tional context. In this section, three studies of
signed in concert. The organization’s culture de- accounting and budgetary systems in their organ-
termines what its structure ought to be and, in izational environment are presented and analyzed
turn, the nature of the required core-control from the perspective of the meta-framework. The
system. The failure to design a structure or core first deals with a traditional system for budgetary
control system which are consistent with the control that had been applied at a medium sized
organization’s value system is likely to create residential real estate company in a major metro-
resistance and produce a motivation to defeat the politan area of the United States. The second
purposes of the structure and/or core control study deals with the ability of an accounting
system. We shall examine this phenomenon in system to function as part of the overall organiza-
the context of an actual organization in a sub- tional control system in the control of a relatively
sequent section. small distributor of industrial abrasives. The final
study deals with an attempt to introduce a “zero-
Institutionalization of core control system as a base budgeting system” (Phyrr, 1973; Cheek,
vehicle of organizational change. The very process 1977) in a very large U.S. financial institution.
of designing a core control system can itself be Taken together, they will provide an opportunity
used as a vehicle of cultural change in an otganiza- to assess some of the preliminary implications of
tion. In an organization with two cultures engaged the control framework presented above as well as
in an invisible war, top management may wish to to develop additional insights about the operation
finesse the issue of cultural conflict and use the of accounting and budgetary systems in their
process of designing a core control system as a actual organizational milieu.
de facto mechanism to change the organization’s
value system. For example, in an entrepreneurial Conventional budgeting and control systems
culture the very idea of control being exercised on In this section we examine a study of the
a top-down basis may be anathema to divisional budgeting system of a mediumsized U.S. real
managers who accept the culture of autonomy and estate company located in a large metropolitan
the personal freedom it implies. area. The primary purpose is to use this field study
of a budgetary system in its actual organizational
Dominance of cultural traditions versus formal setting as a test of the question of whether: (1)
control systems. The traditions which characterize budgeting is a control system (the traditional view)
an organization’s culture may be an equally or or at least operates with the effect of a control
even more important factor in predicting behavior system; or (2) budgeting is a component of an
than the formal core control mechanisms. Faced overall control system and therefore does not
with a conflict between organizational traditions actually influence behavior unless it is linked to
and a “new” control mechanism, it is not clear other critical components of a control system.
which element of control will ultimately affect This issue is not merely a question of semantics.
actual behavior. We shall examine an actual There is a fundamental difference in the two views
instance of this conflict in the organization con- of budgeting as a control mechanism or as a
text of a “natural experiment” in a subsequent component of a control system. The issue is
section. significant because if budgeting is not equivalent
to a control system, then efforts to design effect-
ACCOUNTING, BUDGETING AND CONTROL ive systems of channeling human efforts toward
SYSTEMS IN THEIR ORGANIZATIONAL organizational objectives will fail if they follow
CONTEXT conventional orthodoxy and merely presume an
identity between budgeting and control.
The framework for organizational control
systems presented above can be useful in analyzing Nature of study. This field study involved an
 ACCOUNTING, BUDGETING AND CONTROL SYSTEMS IN THEIR ORGANIZATIONAL CONTEXT 161

attempt to examine a firm’s system of motivating Firms’s culture, structure and budgeting prior
and controlling its manager’s performance because to study. Residential real estate firms in the U.S.
of the company’s president’s perceptions that are sales oriented. They tend to be entrepreneur-
these processes were not fully effective in assisting ships begun by one or a few people who were
the firm in achieving its goals. In the course of initially successful sales-persons themselves and
this study, we examined the nature and operation founded their own companies because of available
of the firm’s budgeting system, using the model business. Neither the owners or managers in
presented in Figs. 1 and 2 as a reference point for residential real estate firms typically have formal
evaluation. management training or managerial experience in
other industries. Thus the culture found in such
Nature of the research site. The organization firms may be characterized as a sales culture.
serving as a research site is a residential real estate Accordingly, the explicit and implicit value system
firm. The firm provides a full set of services of the firm emphasizes sales: “listing” of proper-
(brokerage, property management, leasing, etc.) ties to be sold and sales of properties.6 The culture
to buyers of residential real estate throughout a also states that sales is a “numbers game”. If you
relatively large metropolitan area in a major U.S. make so many calls, house showings, etc. you will
city. The firm’s organizational structure is shown get listings and sales and, in turn, earn income.
in Fig. 4. Branch managers tend almost exclusively to be

L I
I
I I I I
Property Mortgage Administratlon
management Sales
department department department
and IeasIng
department
1

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

At the time of the study, the firm had 12 sales former salespersons who have been promoted., Few
branches located throughout the metropolitan real estate firms have formal training programs for
area. Each branch was headed by a branch recently promoted managers. They are expected to
manager who was supposed to be responsible for learn on the job.
branch revenue and costs. Thus technically each Since the firms are entrepreneurial in style,
branch constituted a profit center. Branches there are not typically job descriptions for branch
typically had between lo-25 “sales associates” managers, or if role descriptions exist, they tend to
(sales personnel) and l-2 clerical personnel. The be vague. Accordingly, the branch manager tends
annual volume of residential real estate sold was to define his/her own job and, not surprisingly, the
approximately $300 millions. notion of the jobs often emphasize the sales

’ A “listing” is a contract between the principal (property owner) and agent (broker) for the latter to have exclusive
rights to sell the property.
162 ERIC G. FLAMHOLTZ

component or things which support sales, rather as consultants on complex transactions. Know-
than such administrative matters as budgeting, ledge of accounting and budgetary controls skills
planning, cost control, etc. are not explicitly viewed as part of the role and, if
Branch managers receive a base compensation present, are not highly valued.
of X thousand dollars per month. In addition, they
receive an “override” of 1% of “Company Dollars”, The core control system and budgetary control.
(Gross Commissions Income received by the firm The firm’s core control system was not explicitly
less the salesperson’s share). designed as such. There is a plan (budget), a
measurement system (the accounting system),
The control problem. The basic problem with feedback (budget reports and income statements)
respect to budgeting in this firm is that branch and an evaluation-reward system (performance
managers paid little or no attention to the budget appraisal and compensation systems). However,
or variances. They virtually ignored the income these components or subsystems have not been
statement. Stated simply, branch managers ignored designed either: (1) explicitly to lead to emphasis
variances, large or small. Many, if not all, hardly on profits and attention to variances from profit
looked at the budget or income statement. budgets or (2) to articulate with one another in an
The theoretical as well as practical managerial integrated fashion. The former problem concerns
question underlying this behavior may be stated the purposes of the system while the latter con-
quite simply: Why did the branch managers ignore cerns the system’s architecture or structure.
the firm’s income statement and budget variances? In the language of the firm’s culture, the branch
To answer this question we shall draw upon the managers do not perceive “ownership of the
control framework that has been outlined to budget”. It is not their budget, but top manage-
examine the elements of culture, organizational ment’s budget. There is also a problem with the
structure and core control system. Taken together, accounting system as it relates to providing in-
an analysis of these elements explains the rational formation for real time decisions and control. In a
behavior of branch managers in ignoring income sales culture such as this, the art of completing a
statements and budgets. contract of sale is the major point of psychological
closure for a salesperson and a branch manager.
Culture and budget control. The firm’s culture From both a legal and accounting point of view,
unintentionally mitigated against branch managers however, the transaction is not totally completed
paying attention to budgets, income statements (final) until the deal “closes” (that is, all the con-
and even profits; the culture emphasized SALES. ditions of the transactions have been satisfied and
The explicit value system as well as the informal money and deeds to property are exchanged).
socialization system all held the successful sales- A “closing” may occur 30-60-90 days or more
person in high regard. This carried over to success- after the deal has been reached, and by this time
ful branch managers; they were successful if they salespersons and branch managers are absorbed by
could attract, motivate and retain “top sales other potential transactions.
people”. To deal with the uncertainty in realization of
income, the firm’s accounting system either
Organizational structure and budgetary control. operates on an accrual basis with an “allowance
The role of sales manager emphasized selling rather for cancellations” which is similar but not identi-
than administration. In addition to the ability to cal to an allowance for uncollectables.’
recruit and manage personnel, the sales managers Thus there is a conflict between the psycho-
must be knowledgeable about real estate trans- logical mind set of branch managers with respect
actions both to train sales associates and to serve to income “earned” and the accounting definition

7 Some residential real estate firms use a cash basis under which income is realized and commissions paid when
escrow closes.
 ACCOUNTING, BUDGETING AND CONTROL SYSTEMS IN THEIR ORGANIZATIONAL CONTEXT 163

of income earned as well as the financial reporting an accounting system is insufficient to guarantee
of such income. This difference has led the that accounting information will be used to fulfill
managers to reject and ridicule accountants and the managerial function of control.
accounting systems while still being forced to The ability of an accounting system to function
accept their dictates. Consequently, the numbers as part of a control system depends to a consider-
generated by the accounting system as reported able extent upon an organization’s culture. The
in Company income statements are viewed as validity of this notion shall be illustrated below as
irrelevant to managers for action tuking purposes. we examine the role of accounting in the actual
The numbers affect the timing of the managers context of a U.S. distributor of industrial abrasives.
compensation but are not seen as useful.
In addition, the most relevant numbers concern Nature of the research site. The organization
sales revenues not net profit, because the com- serving as a research site serves as a distributor of a
pensation system provides for an override (bonus) full set of industrial abrasive products (“loose”,
based upon sales not branch profits. This is con- “bonded”, “coated”, and “precision”) for in-
gruent with the sales-oriented culture of the firm. dustrial firms which use the products in their own
It is an instance of what Kerr (1975) has referred manufacturing processes. “Loose abrasives” in-
to as “the folly of rewarding A, while hoping clude such things as sand or grain; “bonded
for B”. abrasives” refer to materials which have been
bonded into grinding wheels; “coated abrasives”
Implications. The operation of budgetary con- include products such as sand papers; and
trol system at this real estate company is a “precision abrasives” refer to such things as
dramatic illustration of the fallacy that budgeting diamond vitrified bonded abrasives.
per se is a control system. For a complex set of At the time of the study the firm’s corporate
reasons, including the nature of the firm’s headquarters as well as its major distribution
culture, structure and accounting system, branch facility was located in a major metropolitan city
managers paid very little attention to budgets; in the U.S. The firm also had one satellite branch
were not concerned when budgeted profit targets office in another major city. The firm’s sales
were missed and tended to disregard income state- volume exceeded $12 million annually and the
ments for their branches. In other words, the firm employed approximately 75 persons.
budget was not integrated with the overall control
system. These observed behaviors are contrary to Firm’s culture and structure. Although the
managerial accounting theory but are rational in firm had been founded more than twenty years
view of the firm’s actual organizational context. prior to this study, for most of its history it had
These findings support the broader view of a remained relatively small in terms of sales volume
control system presented in this paper as well as and personnel. Beginning in 1976, the firm had
the notion that the design of an effective control experienced rapid growth in sales volume attribu-
system must explicitly consider the relationship table to favorable economic conditions, its full
between culture, structure and the core control range of products, sales force and ability to meet
system. customer service requirements. During the period
1976-1978 the firm increased in size from $3%
Accounting and control systems millions to more than $12 millions.
In discussions of the nature and purpose of The firm was owned by a single family and
accounting, scholars and text-book writers typical- three family members (father and two sons) ran
ly state that the functions of accounting include the firm along with other family members. As
the ability to control operations, or, at the least, typical in firms of this size, responsibilities were
accounting can play a significant role in organiza- not formally defined and tended to be overlapping.
tional control (see, for example, Anthony & The firm had been successful, at least in part,
Reece, 1979, pp. 4-S). Yet the mere existence of because of competitively priced products and skill
164 ERIC G. FLAMHOLTZ

at selling by family members and the sales staff. In brief, there was not a formal system or
None of the members of the family as well as control in this firm and the accounting system did
virtually all other “managers” had been formally not perform any of the control functions ordinari-
trained in management. The firm did have a ly associated with it. Indeed, the firm’s financial
“Controller”, who was a CPA. statements were virtually ignored except to deter-
mine whether or not a profit had been made.
The accounting system and organization If this organization’s firm were merely an
control. The firm did not have any formal system illustration of an isolated firm that lacked sophisti-
of management control as has been defined above. cated management, it would be of little signific-
As an organizational function, “control” was ance. However, this firm is, I believe, typical of
exercised by the personal involvement of family many entrepreneurships which have experienced
members in the day-to-day activities of the firm, rapid growth but have not yet responded to
rather than through formal planning, measure- their changed circumstances. Rather than being
ment, performance appraisal and reward systems. atypical, it is the prototype of a great many
In this respect, the firm was probably quite typical successful firms of its size in a variety of
of most organizations with its type of history: industries.
rapid growth as an entrepreneurship.
The firm’s accounting system produced an Impact of culture upon utilization of account-
annual income statement and balance sheet. An ing and control. What explains the firm’s lack of
illustrative income statement is shown in Fig. 5 to formal organizational control system as well as its
indicate the format used; the numbers have been failure to use accounting information to facilitate
modified but are illustrative of the key variables. organizational control? The key is in the organiza-
These financial statements were prepared at the tion’s culture.
end of each year to determine the firm’s yearly The firm is an entrepreneurship. It was success.
income and financial position both for ownership ful because it could do certain operational things
and tax purposes; but they were not used other- very well: buy product, sell it, deliver it and
wise in day-to-day management of the business. service customers. Personal attention to the
As seen in Fig. 5, the income statement format business and an open-ended commitment by
is very simple. Expenses are listed alphabetically family members and many employees made the
rather than by functional categories (selling, firm prosper and grow. However, the firm lacked
administrative, warehouse, etc.). Although the a professional management orientation. It did no
firm has four different product lines, there is no formal planning and there was not even informal
attempt at product line profitability analysis and long range planning; rather, the firm reacted tc
this did not occur in any other way in the firm.’ changing events and circumstances. Organizational
In neither this income statement nor any supple- roles were not defined explicitly. People did whal
mentary analysis was there any attempt to classify work had to be done. There was no budget but the
costs as “fixed” or “variable”, “controllable” or controller paid attention to cash flow. Because thr
“uncontrollable”. As noted above, the income firm was growing sales revenues were sufficient tc
statement was prepared annually and therefore cover expenses and the firm had a line of credil
was not available for periodic monitoring during sufficient to cover short term cash requirements
the year. In addition there was no budget or profit The firm was sales and product+riented. It:
plan. Thus, there was neither an attempt to set owners were skilled in personal selling and because
profit goals nor to assess the variance of actual of good interpersonal skills they were also able tc
profit in relation to goals. 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, the culture responded, explicitly More appropriately, the accounting literature
and implicitly, by saying “So we’ll have to go out ought to indicate that accounting systems are
and get some more business”.g potentially useful as tools of control in an appro-

Years ending September 30,

Sales
Cost of Goods Sold

GROSS PROFIT ON SALES

OPERATING EXPENSES

Advertlslng
Bad debt provision
Car expense
Commlsslons
Cantrlbutlons
Data processing service
Depreclatian
Entertainment
Freight out
Insurance - officer’s 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 OPERATING EXPENSES

INCOME FROM OPERATIONS

Other income (Expense)

INCOME BEFORE INCOME TAXES

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

hplications. In the kind of culture that charac- priate organizational culture. This suggests that
terizes the industrial abrasives firm described accounting must be viewed more as a component
above, the notion of using accounting as a control of a socio-technical system rather than merely as a
mechanism is something alien. This observation of technological control mechanism that operates in
the actual low degree of use of accounting in its isolation of an organization’s particular values,
organizational setting is in sharp contrast to the beliefs and norms. An accounting system can
statements sometimes found in accounting litera- exist in an organization and not function as a
ture that accounting systems are tools of control. control mechanism. In a culture characterized as

’ 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 don’t 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 emphasizes informal rela- be generalized to organizations irrespective of size.

tionships and freedom from restraints, the idea of
accountability may be alien. Similarly, the idea Nature of zero-base budgeting. The term “zero-
that accounting can be a useful tool of organiza- base budgeting” refers to proposals by Pyhrr
tional control may be perceived as not relevant to (1973); Cheek (1977) et al. to modify the tradi-
entrepreneurial managers. Thus, the mere exist- tional budgeting process in organizations in which
ence of the accounting systems does not insure budgeting is to a great extent an incremental pro-
that it will be used in control. As a prerequisite, cess in relation to the prior year’s actual expendi-
it may be necessary to change the organization’s tures. Under the traditional or conventional pro-
culture so that the idea of accountability is in- cess, managers are not required to justify their
corporated as a positive value. Once this cultural total budget; rather, they are merely required to
change has occurred, there may be an increased justify the incremental portion that exceed the
readiness to utilize accounting as a control actual expenditures or budget from prior years.
mechanism. In this sense, the use of accounting In contrast, the proposed ZBB process requires
as a control mechanism is part of a socio-technical each manager to justify his/her budget request as
system, becuase it involves change in the social though the organizational functions were starting
or cultural system which interacts with the from “ground zero”. Hence the term “zero-based
accounting technology. This, in turn, also supports budgeting”. The process requires clarifying the
the broader concept of control argued for in this goals of an organizational unit as well as identify-
paper. ing the functions and projects it proposes to per-
form in order to achieve its goals. These activities
Organizational culture and zero based budgeting are then ranked in order of importance. Ranking
as a control mechanism of activities (functions and projects) priority is
In the two previous sections we have examined intended to be a representation of the organiza-
some aspects of accounting, budgeting and control tional unit’s management’s judgement of their
in the context of small and medium-sized organiza- relative importance. Then if higher levels of
tions. This section presents a study of a quasi- management desire to reduce the total budget
experiment designed to implement the notion of request, they are rationally able to choose the
“zero-based budgeting” (ZBB) as a mechanism of projects with the greatest relative degree of
organizational control in the context of a very perceived value to the firm.
large U.S. corporation.
Our purpose is to provide another test of the The research study. The study was intended
question of whether: (1) budgeting per se is a as an action research project to test the applic-
control system or (2) budgeting is merely a com- ability of ZBB on a pilot basis in one department.
ponent of an overall control system and therefore There were several related objectives: (1) to de-
does not influence behavior unless it is linked to velop a budget for the personnel department
other critical system components. A related pur- from the ZBB process; (2) to obtain information
pose is to study the effects that cultural traditions on the benefits and problems of applying ZBB and
play in relation to more formal mechanisms of (3) to make recommendations as to future uses of
control such as the budget in influencing the ZBB in the firm.
behavior of people in an actual organizational In the course of this study, an opportunity
setting. emerged for a quasi-experiment. Specifically,
In addition, the size of the particular firm used deteriorating economic conditions caused the
here as a research site provides an interesting com- firm to initiate a request to all departments
plement to the prior two studies. For it will permit including the personnel department) to re-
us to assess, at least to some extent, whether the commend reductions in their proposed 1980
phenomena described previously operate only in budget. This request occurred just after the ZBB
firms of relatively small size, or whether they can pilot study had been completed. Thus, a natural
 ACCOUNTING, BUDGETING AND CONTROL SYSTEMS IN THEIR ORGANIZATIONAL CONTEXT 167

experimental condition existed in which it was Results of the natural experiment. As part of
possible to compare the actual proposals for the pilot test of ZBB, each division head in the
budgetary reductions with the list of priorities personnel department was required to prepare a
included in the ZBB pilot study. budget which listed all of the divisions activities,
their total cost and rankings. Total cost of the
Nature of the research site. The organization activity included compensation expense and other
serving as a research site was a large U.S. bank. At operating expense, classified separately. For each
the time of the study the firm’s assets exceeded activity, a “budget allocation request” form was
$18 billion, ranking the firm as one of the ten prepared. These forms required the division to
largest U.S. banks. specify: (1) the activity’s goals, (2) consequences
The study was conducted within the bank’s of “non-performance” (failure to perform the
personnel department. This department was activity), (3) alternatives for performing each
thought to be well suited to be a site for pilot test- activity, (4) the recommended alternative, (5) the
ing ZBB, because it had a mix of ongoing func- current method and (6) the costs and benefits of
tions (employment, compensation, etc.) and pro- each alternative.
jects (management development, research, etc.). Although each division was required to list its
Thus this firm is quite different from the priorities in preparing the budget, when the
entrepreneurships described above. It is a large, divisions were faced with an actual request to
professionally managed firm. It provides a variety reduce the budget in the profit planning process,
of banking services ranging from very simple to the stated priorities in the ZBB budget were not
quite sophisticated. Most members of manage- adhered to in making the required budget reduc-
ment, especially senior management, have had tions. As stated in the final report to the com-
formal training. The firm is used to budgeting and pany’s management: “This means that the prior-
has a regular annual profit planning cycle. As part ities developed in the ZBB pilot study were merely
of its budgeting process the Controller’s depart- nominal and not real priorities. This may be be-
ment provides management’s assumptions and a cause the bank’s history prior to the ZBB study
set of “guidelines” for justifiable increases in has not tended to result in actual budgetary cuts.
“compensation” and “other operating expenses”. The division heads may not seriously have been
concerned with establishing real priorities and
The firm’s culture and budgeting. In spite of viewed it (ZBB) as an exercise. It appears that
these differences, the firm’s culture plays a crucial managers at the bank are not used to thinking
role in budgeting in this type of organization just in terms of real budgetary cuts based on their
as it did in the real estate and industrial abrasives priorities.”
companies. Specifically, one unwritten norm is
that “Thy budget request shall not exceed ‘guide- Implications. The aim of budgeting, whether
lines’ without punishment”. This means that the zero-based budgeting or the more conventional
so-called guidelines for “compensation” and variety, is typically to provide a mechanism for
“other operating expense” are quasi-officially effective planning and control in organizations.
sanctioned limits for incremental increases in When asked to do an in depth analysis of their
budget proposals. So long as a budget request stays operations, to state their goals, and then to pre-
within guidelines, it is likely to be approved. How- pare a budget in relation to those goals, the
ever, if a request exceeds guidelines, the managers managers in a large, professionally managed,
must pay a serious price by undergoing a rigorous sophisticated firm executed the process. Yet when
budget scrutiny and request for justifications. A asked to make real budget cuts, this analysis was
corollary to this norm is a tradition that budget virtually ignored. Clearly, this suggests a great deal
proposals within guidelines tend to be approved. about the nature of the firm’s culture. It may, for
Thus the firm’s conventional budgeting system was example, indicate that the division heads thought
clearly not a zero-based approach. the ZBB budget ought to be prepared in a way
168 ERIC G. GLAMHOLTZ

that they perceived would be acceptable to senior essential prerequisites of a control system are not
management. It strongly suggests that we are naive adequate, then the system may not fulfil its
to presume that the mere act of preparing a zero- intended functions.
based budget will provide top management with In addition, we have observed the crucial role
the information it needs to exercise effective not only of the formal core control system but
control over costs. also of an organization’s culture as a mechanism of
control. If a firm’s culture and its core control
system are not synchronized, it is not likely that
CONCLUSIONS even a well integrated core control system will
actually influence behavior in its intended ways.
This paper has examined some aspects of the Our appreciation of the complex process of
relationship between accounting, budgeting and organizational control is probably still in its in-
control in its actual organizational context from a fancy. This paper has tried to develop a different
theoretical as well as an empirical perspective. orientation to the role that accounting and budget-
We have seen that the process of exercising control ing plays in the control process as well as a broader
in an organization is significantly more complex concept of control itself. The number of empirical
than conventional managerial accounting theory studies of accounting, budgeting and control in
would have us believe. action in an organization is relatively few. Al-
We have also seen that budgeting and even an though studies of the type presented here are not
accounting system can not be viewed as a control without difficulties I believe that such studies are
system per se ; rather they must be seen as a part of an essential prerequisite to fu&re progress in
a carefully designed total system of organizational understanding the role of control in complex
control. If the linkages between budgeting or an organizational settings.
accounting measurement system and the other

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