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MAJ
26,7 Management accounting and risk
management in Malaysian
financial institutions
566
An exploratory study
Received 30 March 2010
Reviewed 28 January 2011
Siti Zaleha Abdul Rasid
Accepted 15 March 2011 International Business School, Universiti Teknologi Malaysia,
Kuala Lumpur, Malaysia
Abdul Rahim Abdul Rahman
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Abstract
Purpose – The purpose of this paper is to examine the link between management accounting and
risk management. The paper measures the extent to which management accounting practices help in
managing risks and the extent of the integration between these two important managerial functions.
Design/methodology/approach – The study used a mail survey of financial institutions listed in
the Malaysian Central Banks’ web site. The respondents to whom 106 questionnaires were sent were
the chief financial officers; the response rate was 68 percent. A total of 16 post-survey semi-structured
interviews were also conducted with selected respondents to gain further insights into the survey
findings.
Findings – The findings from the survey indicate that analysis of financial statements was perceived
to contribute most towards risk management. The majority of the respondents were of the view that
the management accounting function was greatly involved in the organization’s risk management.
Consistent with the survey findings, the interviewees also perceived that budgetary control,
budgeting, and strategic planning played important roles in managing risk.
Research limitations/implications – This is a study conducted in Malaysian financial
institutions and thus, results may not be generalizable to other contexts. The findings of this study
strengthen the importance of both management accounting and risk management in complementing
each other to form part of the corporate performance management systems.
Originality/value – This paper contributes to the literature as very few studies have examined the
significant link between management accounting and risk management.
Keywords Management accounting, Risk management, Financial institutions, Malaysia
Paper type Research paper
ERM goes beyond compliance and has increasingly been seen as a source of competitive
advantage, as it is broad in scope and does not limit consideration to the specific items a
regulator may require (Platt, 2004). Under ERM, performance management of business
lines is integrated with risk management and risks are aggregated across different types
of risk and across business units to obtain enterprise-wide risk. Both are integral to
strategic planning and performance assessment in an organization. At the same time,
performance management is seen as the main task of the management accounting
function (Otley, 2001).
Additional empirical data are required to support the limited evidence of the linkage
between management accounting and risk management. Since the core business
function of financial institutions are managing risks (Bowling and Rieger, 2005;
Hakenes, 2004; Bowling et al., 2003), risk management should be an essential part of
the business processes. At the same time, MASs, which are essential for performance
management and control (Williamson, 2004), are also an important part of the business
processes. Hence, this study aims to contribute by exploring the linkages between
management accounting and risk management in the financial institutions.
This paper is organized as follows. The next section reviews the relevant literature
on the link between risk management and management accounting. The subsequent
section elaborates the research method for the study. The final section of the
paper covers the data analysis and discussion of the findings and conclusions of the
study.
Background literature
The International Federation of Accountants (IFAC, 1998) defines management
accounting as the process of identification, measurement, accumulation, analysis,
preparation, interpretation, and communication of information (financial and operational)
used for the planning, control, and effective use of resources by management. Thus,
management accounting becomes an integral part of the management process in an
organization. It provides information essential for:
.
controlling the current activities of an organization;
.
planning its future strategies, tactics, and operations;
.
optimizing the use of its resources;
.
measuring and evaluating performance; Malaysian
.
reducing subjectivity in the decision-making process; and financial
.
improving internal and external communication (IFAC, 1998). institutions
Management accounting is a tool for achieving high performance, as it provides a
measurement of performance, warning of risks, information for decisions, and data for
planning (Cole, 1988). Management accounting is also used as a tool to manage a firm’s 569
resources. Cole (1988) specifically argues that a good MAS does the following:
.
identifies the cost and profitability of doing business by organization, product,
and major customer;
.
avoids surprises;
.
allows all managers to explain their performance as it is reported;
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In stage 1, most companies focused on cost determination and financial control. Simple
management accounting techniques were used and the main sources of data were
financial statements consisting of income statements, balance sheets, and cash flow
statements. By 1995 (stage 4), it became important to identify the drivers of customer
value, shareholder value, and organizational innovation. Contemporary management
accounting techniques such as just-in-time, target costing, balanced scorecard (BSC),
and strategic management accounting (SMA) gained dominance during this period.
These management accounting tools and techniques are capable of considering a broad
spectrum of information that can be used for decision making, planning, and control.
An MAS is part of the management control system (Chenhall, 2003) and “it is inept to
consider management control as being distinctly separate and independent from risk
management or corporate governance concerns” (Bhimani, 2009, p. 3).
Although the linkage between management accounting and risk management is
recent, it is rapidly growing. Some authors (Williamson, 2004; Collier et al., 2004; Soin,
2005; Collier and Berry, 2002; McWhorter et al., 2006; Mikes, 2006) have explored this
linkage. Williamson (2004) proposed that management accounting and management
control can contribute to the practice of ERM. Williamson (2004) argued that
management accountants have expertise in identifying, analyzing, and communicating
management information for planning, control, performance measurement, and decision
making and should, therefore, be able to help develop techniques for ERM. In addition,
with an understanding of organizational, behavioural as well as economic implications,
management accountants should be able to better interpret and communicate risk
management information. Furthermore, risk-based management accounting can be
carried out in which assessed risks are compared to objectives, standards, forecasts,
budget, and actual performance. Subsequently, the risk implications can be considered
in strategy; planning; control; management of revenue; costs and cash flow; and
management of value drivers. Hence, management accounting is seen as supporting risk
management and control, whether by quantifying objectives; estimating the
consequences of potential outcomes from risk events; analyzing the cost and benefits
of risk management processes; or comparing actual performance to risks faced
(Williamson, 2004).
Some empirical studies on risk management and management accounting have
been conducted. Soin (2005) investigated the contribution of management accounting
and control information on the practice of risk management in the UK financial Malaysian
services sector. Consistent with Williamson (2004), she argued that management financial
accounting has a potential role in supporting risk management. Soin (2005) examined
whether current MASs support the changing patterns of demand for information about institutions
risk by corporate stakeholders. However, the study suggested that risk management
systems in the financial services sector were not utilizing management accounting
techniques and that there was no clear role for management accountants in risk 571
management. The lack of emphasis on management accounting control systems in the
financial services sector was cited as the reason for the findings. There was some
emphasis on budgeting, cost control, and performance measurement, but not in relation
to risks. Similarly, Collier et al. (2004) found that there was very little integration
between risk management and management accounting. The study found that the
systems and controls that were in place in the UK financial services sector were very
closely matched to the requirements set out by the regulator (Soin, 2005).
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Mikes (2006), on the other hand, examined both risk management and management
accounting control as multiple control systems in an organization. She conducted a case
study to explore the changing context and internal dynamics of a multiple control
system acting as the divisional control in a financial services organization. Based on a
political and institutional perspective, the study showed how two control systems,
namely, firm-wide risk management system and accounting controls, complemented
each other (as the contingency theory suggests), as well as competed with each other for
relevance and attention from top management. Accounting control has been found to
possess institutional appropriateness compared to risk control (ERM) and was
extensively used in decision making (Mikes, 2006).
In another study, Woods (2009) conducted a case study on the risk management
control system in a public sector organization. Contingent variables that affected the
risk management system at the operational level were central government policies,
information and communication technology, and organizational size. The most
important contingent variable was central government policies as many of the strategic
objectives were driven by government policy and resources were also determined by the
central government (Woods, 2009). This is similar to financial institutions where
government regulation drives the risk management system.
The issue of risk and management accounting was also examined in manufacturing
and not-for-profit organizations (Collier and Berry, 2002). They conducted an
exploratory case study to understand the relationship between risk and budgeting.
The budgeting process is a formal method by which plans are established for future time
periods, thereby implying a consideration of risk. However, there was a separation
between budgeting and risk management. Despite managerial perceptions of risk, in
which each organization faced some sort of risk, there was no explicit regard to risk in
the budgeting process or the content of the budget document. Budgeting did not appear
to be a tool used in managing risk (Collier and Berry, 2002).
In another study, Collier et al. (2007) investigated the roles of management
accountants in managing risk. Similar to Williamson (2004) and Soin (2005), they
viewed that management accountants – who have skills in analysis of information,
systems, performance, and strategic management – should play a significant role in
developing and implementing risk management. The survey results show that there
was little integration between management accounting and risk management and that
MAJ the involvement of management accountants in risk management was only marginal.
26,7 However, results from post-survey interviews indicated that management accountants
did actually play an important role in risk management, especially in analyzing the
impact of risks to support risk managers. The finance director was identified as having
a pivotal role in risk management (Collier et al., 2007), and, in most organizations,
management accounting functions are normally under the responsibility of the finance
572 director.
Integration between management accounting and risk management is more likely
in the area of performance measurement. There has been a call for integrating the
BSC as a strategic performance measurement system and ERM as a proposed best
practice for risk management (Ballou et al., 2006; Scholey, 2006; Beasley et al., 2006;
McWhorter et al., 2006). The scorecard can be enhanced by including goals and
objectives for risk management and by capturing performance-based risk metrics. The
BSC has four perspectives, namely, learning and growth for employees, internal
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Research method
Data were collected using postal questionnaires survey and post-survey semi-structured 573
interviews. This study selected the whole population of finance and insurance
companies listed on the Malaysian Central Bank web site. The choice of a single industry
in this study will minimize environmental heterogeneity (Moores and Yuen, 2001).
Questionnaires were sent to 106 financial institutions (including commercial banks,
Islamic banks, merchant/investment banks, discount houses, development financial
institutions (DFIs), and insurance companies). The questionnaire was mailed to the
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chief financial officer (CFO, or the most senior position in the finance department) of
each firm.
Questionnaire development
A questionnaire was developed to seek the respondents’ perception on the extent to
which management accounting practices help in managing operational risks based on
a Likert scale of 1 (not at all) to 5 (to a very great extent). The management accounting
practices were listed based on the IFAC’s (1998) framework, which is also used by the
National Award for Management Accounting (NAfMA)[2] Award Organizing
Committee. However, only practices relevant to the services industry, particularly
the financial services industry, were selected for this study. Footnotes explaining some
of the practices were also included in the questionnaire.
Operational risk is a type of risk that measures the potential loss due to any disruption
in the firm’s operational processes (Marshall, 2001). The Basel II definition of
operational risk is “the risk of direct or indirect loss resulting from inadequate or failed
internal processes, people and systems or from external events”. “It covers all
organizational malfunctioning, of which consequences can be highly important and,
sometimes, fatal to an institution” (Bessis, 2002, p. 12). Global operations, with the
emergence of more complex products and services, and consequent increase in volume
and volatility of transactions, lead to greater operational risk (Marshall, 2001). In the
context of operational risk management, the main function of management accounting is
to provide information for internal decision making relating to business processes,
people, and investment in systems. Relevant information provided by MASs will help
managers to make more effective decisions, which, in turn, help to prevent unexpected
loss. According to IFAC (1998), management accounting information consists of both
financial and operational information. This information will provide indicators on the
performance and actions that could be taken to improve future performance. Thus, this
study only focuses on the operational risk as it is assumed to be more directly related to
the management accounting information function compared to other types of risk such
as credit and market risk. Andersen (2008) asserted that accounting and management
control systems are important tools in managing operational risks. Strategic business
planning and a well-organized budgeting process and consistent follow-up with any
operating variances to budget can limit unexpected losses due to operational deficiencies
(Marshall, 2001).
MAJ The respondents were also asked to indicate on a Likert scale of 1 (strongly disagree)
26,7 to 5 (strongly agree) whether there is great involvement of financial and management
accounting functions in risk management. Respondents were also asked to state whether
risks were considered in formulating budgets and also whether risk measures were
integrated into their performance measurement systems. The purpose of these questions
was to measure the extent of management accounting functions in managing risk. These
574 items were adapted from Collier et al. (2006).
The questionnaire was first pre-tested on seven academicians from the local
universities. They were either expert in management accounting and financial systems
or expert in research methodology. Pilot testing is important to ensure validity and
reliability of research instruments (Sekaran, 2000). Pilot testing was also conducted
with two senior finance managers and six managers from the financial institutions.
A revised draft of the questionnaire was prepared accordingly.
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Questionnaire administration
The questionnaire was mailed to the CFO (or the most senior position in the finance
department) of each firm. The CFOs (or the most senior position managers) were chosen
because they are responsible for management accounting and are directly involved in
risk management in the organizations. According to Rodeghier (1996), in survey
research, contacts are very important and at least three contacts with the sample, each
slightly different in tone and content, are necessary to ensure a high return. Thus, one
week after the survey packets were sent, phone calls were made to ensure that the
organizations had received the packets. Five weeks after the first mailing, another set of
questionnaires was sent to the non-respondents. Follow-up was again made through
email and telephone calls after the second mailing.
Descriptive statistics were used in analysing the findings. Mean scores on the
management accounting practices perceived to be useful in managing risks were
calculated and the scores were ranked accordingly. However, this analysis will look into
the presence of management accounting in risk management but not the magnitude of
management accounting in risk management. Nevertheless, considering that this study
is exploratory in nature, the analysis would be sufficient as the interview findings have
further elaborated the linkages between management accounting and risk management.
Descriptive analysis was also used in identifying the extent of integration between
management accounting and risk management function.
in determining the capital requirement for operational risks, namely, basic indicator
approach (BIA), the standardised approach (TSA), and advanced measurement
approach (Dun & Bradstreet, 2007). Under BIA, the capital charge is equal to a fixed
percentage of the gross income. Under TSA, a fixed percentage will be multiplied with
the gross income of each business line (Dun & Bradstreet, 2007). Hence, the gross income
information becomes important information in calculating the capital charge for
operational risk (Basel Committee on Banking Supervision, 2004). It becomes an
indicator for overall operational risk exposure. The capital adequacy ratio can be
computed by dividing total capital by total risk-weighted assets. Financial information
from the financial statement is used as a proxy in measuring operational risk.
The income-based model and the expense-based[3] model, for example, used financial
statement information to measure operational risk.
The next three items that were perceived to help the most were budgetary
control and budgeting, business planning, and business strategy. This is expected as
a well-organized budgeting process, and consistent follow-up of any operating variances
analyzing the operational risk over time and thus focusing the operation manager’s
attention on problems before they get out of hand (Marshall, 2001). Quality
programmes, such as total quality management (TQM), assume that managers control
process outputs through the careful selection of the inputs and that many loss events
are the result of a poor-quality resource or process. Thus, TQM and other quality
management programmes seem to help in managing operational risks by changing the
risk profile of operational processes and resources. This is done by improving the
availability, quality, relevance, flexibility, reliability, conformance, and sustainability
of various process inputs and outputs (Marshall, 2001).
The three practices that were perceived as the least important in managing
operational risks were economic value added (EVA), activity-based
costing/management (ABC/ABM), and standard costing. Traditionally, management
accountants have always used standard costing in which predetermined costs of some
activities are determined at the beginning of the period, and these costs are then
compared with the actual costs at the end of the period to determine variances, known as
accounting or operating variances (Marshall, 2001). These variances are in fact one
measure of operational risk (Marshall, 2001). These three practices may not be widely
used in financial institutions, as they were not perceived to help directly in managing
operational risks. EVA is a relatively new concept of performance measures (Bardia,
2008) and the issue of whether the use of EVA for performance measures will lead to
improved shareholder value is still inconclusive. ABC/ABM is still not widely practiced
(Hussain, 2000; Chenhall and Langfield-Smith, 1998; Abdul Rahman et al., 1998; Innes
and Mitchell, 1995). Unlike manufacturing companies (Maliah et al., 2004; Abdul
Rahman et al., 1998) where the time taken to manufacture a certain product is quite
standardized and measurable, the time taken to render a particular service may not be
standardized causing difficulties in measurement and thus hinder the use of standard
costing. The fact that these practices are not widely used can also be attributed to the
lack of importance of these practices in managing operational risks. Nevertheless, the
overall relatively high mean scores for all the practices can be attributed to the fact that
financial institutions are highly regulated. The financial industry is required to comply
with all rules and guidelines issued by regulatory authorities.
In exploring whether management accounting and risk management functions are
integrated, the respondents were also asked whether financial and management
MAJ accounting functions were involved in risk management in general, whether risks were
26,7 considered in budgeting and whether risk measures were integrated into their
performance measurement systems. The results are presented in Table IV.
The majority of the respondents agreed (from moderately agreed to strongly agreed)
that there was a great involvement of both financial and management accounting
functions in the organization’s risk management. This is expected as based on a survey
578 in the UK, Collier et al. (2007) found that finance directors had a major role in analysing,
assessing, reporting, and monitoring risk and that they were identified with more
aspects of risk management compared to other job titles. The accounting functions are
normally headed by the finance director of the organization. Furthermore, as financial
institutions are required to comply with Basel II the finance units are expected to
collaborate with the risk units in order to deliver accurate profitability numbers to
management (Alexander and Hixon, 2005). In fact, a survey on the benefits of Basel
II cited that it brings closer alignment of the risk and finance functions (Alexander and
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Hixon, 2005). This closer alignment will improve the quality of the data that supports
decision making, particularly through a more risk-sensitive approach to profitability
analysis and capital management (Alexander and Hixon, 2005).
About 88.7 percent of the respondents agreed (from moderately agreed to strongly
agreed) that risks were identified and factored in when formulating budgets.
This percentage was slightly higher than the findings by Collier et al. (2004). In their
study, it was found that 35 percent of the respondents said that risks were considered
to some extent in formulating budgets and another 47 percent said that risks were fully
considered, which made up a total of 82 percent. The majority of the respondents also
agreed (from moderately agreed to strongly agreed) that risk measures are integrated
into the organization’s performance measurement systems. It is very important for
financial institutions to incorporate their risk measures into their performance
measurement systems. Risk-based performance management is essential for long-term
survival of the institutions. Bessis (2002) highlights that financial institutions focus on
risk-based practices for three main reasons – to provide a balanced view of risk and
group finance, group strategy, strategic business units really takes the time of the CEO [. . .]
It is not just a presentation, but it is a thought process [. . .] First, is to have a quick view of
what you did last year, what went wrong, what went right, where do you get the pluses,
where do you get the minuses [. . .] Now the planning is becoming more intense [. . .] We look
at all the possible risks and how to mitigate [. . .] After the planning stage, you implement [. . .]
then we have the annual management dialogue [. . .] This will be the time the CEO will deliver
his message, the CFO will present the year’s performance, the budget and what each business
unit should strive for.
On the role of budgeting and planning that specifically relates to risk management,
the senior manager finance of an Islamic bank stated:
Budgeting and forecasting relate to risk management because budgeting or forecasting
figures will affect the risk [. . .] If we change the budget, the risk will be lower and higher
depending on how you look at the budget. If we want to offer more overdraft facilities, for
example, then you will be exposed to higher risk because you have no collateral attached to it.
So if the budget moves this way, we have to capture the risks associate with it and then look
at how we can mitigate it.
The budget is also used as a control mechanism to ensure that an organization will not
go into high-risk activities. In explaining how budgeting contributes to risk
management, the assistant general manager finance of one cooperative bank stated:
Each branch has budget disbursement. Due to this budget, branches that exceed the
disbursements have to give explanation [. . .] Certain branches are very robust in giving
financing, so it relates to risk [. . .] Variances also give indicators on the risk standing.
Consistent with the survey findings, it was found that budgetary control, budgeting,
and strategic planning were perceived to contribute more towards risk management.
Risks are always considered in the budgeting and planning processes and this is
consistent with the findings of Collier and Berry (2002) that risks are considered but
not modelled and are excluded from the budget document.
The linkage between management accounting and risk management is always
existent in an organization that is practicing a BSC framework for performance
management. One particular bank that adopted a BSC framework for its performance
management also had key performance indicators (KPIs) for each perspective and
conducted risk analysis on the KPIs. The head of finance of one bank said:
For each KPI we identified the risk factor. We identified the likelihood that the KPI might not Malaysian
be achieved [. . .] then we can identify the related key risk indicators (KRIs). Then initiatives
to meet the KPIs will be determined [. . .] And also the owner of the KPIs [. . .] financial
The combination of both BSC measures and risk management measures increase the
institutions
likelihood of organizations’ strategic objectives to be met (Beasley, 2006).
581
Conclusion
This paper seeks to answer two research questions:
RQ1. Are management accounting techniques and tools being used in managing
risks?
RQ2. What is the extent of the integration between management accounting and
risk management functions?
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The findings from the survey indicate that analysis of financial statement was
perceived to contribute most towards risk management. Consistent with the survey
findings, it was found that budgetary control, budgeting, and strategic planning
played important roles in managing risk. As for the second research question, the
study showed that management accounting and risk management functions are highly
interrelated as both are intended to help organizations in making decisions.
This study provides empirical support for the theoretical argument put forward by
Collier et al. (2004), Williamson (2004) and Soin (2005) that management accounting
supports risk management. The study further supported that the management
accounting function has an important role to play in producing analyses of the impact
of risks to support risk managers (Collier et al., 2007). MASs are considered as part of a
wider management information system (Upchurch, 2002; Bouwens and Abernethy,
2000) and very important in managing risk. The information consists of both financial
as well as operational information. Financial information is normally used in
measuring market, credit and operational risks, and considerable operational
information is required in mitigating operational risks. Although Collier et al. (2007)
initially found that management accountants were not that involved in managing risk,
later, in further interviews, they found that management accountants were actually
undertaking risk management. Both management accounting and risk management
are considered as part of the integral activities of strategic planning and performance
assessment of the organization (Bhimani, 2009; Collier et al., 2007; Mikes, 2006;
Beasley et al., 2005). This is particularly true where nowadays the many functions of an
organization are being integrated under a common system known as the enterprise
management system (Brignall and Ballantine, 2004). In fact, under the ERM system,
where risks are aggregated across different types of risk and across business units to
obtain an enterprise-wide risk situation, financial institutions are integrating their
business lines performance management with risk management, thereby enhancing
the link of management accounting and risk management. Both management
accounting and risk management can be considered as the integral management tools
and internal control systems that complement each other to form part of the corporate
performance management system for financial institutions. In fact, the blurring
of functional boundaries, where the segregation of duties according to functions is
becoming less visible and teamwork is becoming more important, management
MAJ accounting and risk management functions are more integrated with other core
26,7 functions in the organization.
Although previous studies found that there was no clear role for management
accountants in managing risk (Soin, 2005), this study found that management
accounting actually plays a very important role in risk management, which is
consistent with the findings of Collier et al. (2007). As shown in previous studies Collier
582 and Berry (2002) budgeting did not function as a tool in managing risk, however, in
this study budgeting was found to contribute towards managing risks. This could be
attributed to the nature of financial institutions where managing risk is one of their
core functions (Bowling and Rieger, 2005; Hakenes, 2004; Bowling et al., 2003).
The findings of this study provide avenues for further examination on the link between
management accounting and risk management by looking at the effect of fit between
the two functions. Future studies should also examine the intricate details of the
emerging relationships.
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Notes
1. Generally, the financial system in Malaysia can be categorized into banking institutions and
NBFI. The banking institutions are the central bank – BNM, the commercial banks, the
Islamic banks, the investment banks, the money brokers and other financial institutions. The
NBFI consists of provident and pension funds, insurance companies (including Islamic
insurance), DFI, saving institutions and other financial intermediaries such as unit trusts,
Pilgrims Fund Board, leasing, factoring and venture capital companies (BNM, 1999).
2. NAfMA – award given to companies in Malaysia for management accounting best
practices. The organizers and the awarding bodies are the Malaysian Institute of
Accountants and the Chartered Institute of Management Accountants.
3. Income-based models analyze historical income or losses in terms of specific underlying risk
factors. Expense-based models associate operational risk with fluctuations in historical
expenses (Marshall, 2001).
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Further reading
Cobb, I., Helliar, C. and Innes, J. (1995), “Management accounting change in a bank”,
Management Accounting Research, Vol. 6, pp. 155-75.
1. GhasemiReza, Reza Ghasemi, Azmi MohamadNoor, Noor Azmi Mohamad, KaramiMeisam, Meisam
Karami, Hafiz BajuriNorkhairul, Norkhairul Hafiz Bajuri, AsgharizadeEzzatollah, Ezzatollah Asgharizade.
2016. The mediating effect of management accounting system on the relationship between competition
and managerial performance. International Journal of Accounting & Information Management 24:3,
272-295. [Abstract] [Full Text] [PDF]
2. Zairul Nurshazana Zainuddin, Suzana Sulaiman. From Information Provider to Value Creator: The
Evolution of Management Accounting Profession in a Malaysian Case Study Organization 193-203.
[CrossRef]
3. Karen Benson, Peter M Clarkson, Tom Smith, Irene Tutticci. 2015. A review of accounting research in
the Asia Pacific region. Australian Journal of Management 40:1, 36-88. [CrossRef]
4. Michele Rubino, Filippo Vitolla. 2014. Corporate governance and the information system: how a
framework for IT governance supports ERM. Corporate Governance: The international journal of business
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