Effect of Mental Accounting on Corporate Profitability Anolam, O.M.1, Okoroafor S.N.2 and Ajaero O.O.3 1.Hezekiah University, Umudi Phone: 08033264366, [email protected] 2.3Alvan Ikoku Federal College of Education Phone: 08132087701; Phone: 08036771270, [email protected] Abstract This paper focuses on the impact of mental accounting on the performance of corporate organizations, using selected corporate entities in Owerri metropolis. The core objective of the study centres on the extent to which the components of mental accounting (including transaction utility, categorization process, and choice bracketing) affect the profitability of corporate entities. The survey research design approach was employed in generating data using structured questionnaire, while the Statistical Package for Social Sciences (SPSS) was employed in testing the formulated hypotheses at 5% level of significance. The reliability of the instrument was measured using cronbach test, and a coefficient reliability of 95.6% was obtained. It was found that no significant relationship exists between transaction utility (TU), choice bracketing (CB), and corporate profitability, while a significant relationship exists between categorization process (CP) and corporate profitability. Furthermore, the F-test shows that all the three components of mental accounting jointly affect corporate profitability significantly the recommendation therefore follows that every economic transaction ought to be ideally classified in the books of accounts irrespective of the perception or mentality of the person/organization involved in the transaction. Again, cost- benefit analysis is indispensable amid mental accounting practices to ensure that risks are adequately matched against associated returns. Key Words: Mental Accounting, Transaction Utility, Categorization Process, Choice Bracketing, Mental perception. 1.0 Introduction The term ‘Mental Accounting’ refers to an process of decision-making (13). Rather than economic concept, established by economist rationally viewing every money as identical, [21], which contends that individuals divide mental accounting helps explain why many their current and future assets into separate, investors designate some of their income as non-transferable portions [26]. The theory “safety capital” which they invest in low-risk purports that individuals assign different investments, while at the same time treating levels of utility to each asset group, which their “risk capital” quite differently. The joy affects their consumption decisions and other of transaction is the value received from an behaviours. The importance of this theory is exchange, and it is defined as the difference illustrated in its application towards the between the paid price and the goods’ economic behaviour of individuals, and thus reference price [1]. This paper intends to entire populations and markets, and even evaluate the impact of mental accounting on corporate organizations. corporate profitability, as well as how In mental accounting, we try to understand decision-making or reason-based choice is the influence of human emotions on the influenced by mental accounting. West African Journal of Industrial & Academic Research Vol.14 No.1 June 2015 100 Purpose of The Study Components of Mental Accounting The broad objective of this study is to There are three interrelated components of investigate the impact of mental accounting on mental accounting (21). These are: corporate profitability. His broad objective is A. Transaction Utility: The first to be achieved through specific objectives. component captures how outcomes are Hence, this study specifically seeks to: framed and experienced, and how i. Evaluate the relationship between decisions are made and subsequently transaction utility, categorization evaluated. The accounting system process, choice bracketing, and provides the inputs to do both ex ante corporate profitability (21) and ex post cost-benefit analysis . ii. Evaluate the extent to which the For instance, compared to money components of mental accounting earned through hard work, an jointly affect cooperate profitability. equivalent amount that is won in a lottery may be perceived as Research Questions Based on the objective of this study, the unexpected, less serious, and costless following research question shave been posed; (14). i. What is the relationship between B. Categorization Process: The second transaction utility, categorization component of mental accounting process, choice bracketing, and involves the assignment of activities to corporate profitability? specific accounts. Here, both the ii. To what extent does the component of sources and uses of funds are labeled mental accounting affect corporate in real as well as in mental accounting profitability? systems; expenditures are grouped into categories and spending is sometimes Hypotheses constrained by implicit r explicit H01: There is no significant relationship budgets. For example, consumers tend between transaction utility, to label both resources and categorization process, choice consumption, and group them into bracketing, and corporate profitability. accounts such as regular income versus H02: The components of mental accounting do not jointly affect corporate windfall gains and necessary profitability. consumption. Moreover, consumers have systematic preferences for 2.0 Review Of Related Literature matching certain mental accounts, such The Concept of Mental Accounting as when they prefer to pay for The concept, first named by (21), mental luxurious consumption with “windfall accounting attempts to describe the process whereby people code, categorize and evaluate gains” (21). economic outcomes (25). One detailed C. Choice Bracketing: Finally, the third application of mental accounting, the component concerns the frequency behavioural life cycle hypothesis (20), posits with which mental accounts are that people mentally frame assets as belonging evaluated (e.g. daily, weekly, yearly) to either current income, current wealth or and whether they are defined narrowly future income and this has implications for their behaviour as the accounts are largely or broadly. This, according to (15), non-fungible and marginal propensity to might suggest that consumers who consume out of each account is different. “balance” their accounts every week, West African Journal of Industrial & Academic Research Vol.14 No.1 June 2015 101 as opposed to once a month, are more More specifically, reasons and principles likely to spend lottery winnings on may function as antecedents of consumer luxuries during the same week the choice (e.g. “never purchase the cheapest brand”), as consequences of choice (e.g., money was won than a week later. dissonance and self-perception), or even as the targets of choice (e.g.) choosing the most Mental Accounting, Utility, Value and defensible reason rather than the best option). Transaction In the case of frivolous consumption, a good In mental accounting theory, framing rule of thumb (reason) can be to constrain it to means that the way a person subjectively “windfall” accounts. Thus, reason-based frames a transaction in their mind will choice and mental accounting may work determine the utility they receive or expect. together, as when reasons help determine the This concept is similarly used in prospect matching of different mental accounts. theory, and many mental accounting theorists [15] point out that when consumers make adopt that theory as the value function in their purchases they often experience an immediate analysis. Another very important concept used pain of paying, which can weaken the pleasure to understand mental accounting is that of derived from consumption or even prevent it modified utility function. There are two values altogether. The pain of paying, no doubt, has attached to any transaction – acquisition value an important role in consumer self-control. and transaction value. Acquisition value is the For example, it counteracts biases in the money that one is ready to part with for assessment of costs and benefits at the time of physically acquiring some good [2] purchase, biases that otherwise might lead to Transaction value is the value one attaches to habitual overspending [16] having a good deal. If the price that one is The pain of paying might be most acute for paying is equal to the mental reference price spending on luxuries, which are often difficult for the good, the transaction value is zero. If to justify, because by definition such the price is lower than the reference price, the expenditures are not essential. This transaction utility is positive. proposition is supported by the reason-based A mental accounting cost or mental choice conception which seeks to explain transaction cost, a kind of transaction cost, is consumer preferences based on reasons that the cost of making a useful decision, are constructed to justify decisions (19). This especially of a consumer making a useful framework considers how the reasons that decision to buy, and may set a lower bound on enter into people’s thinking about a choice useful price granularity in a market. influence their decision. Such a process can be termed as implicit reasoning, because under Mental Accounting and Reason-Based this analysis “reasons” describe the factors Choice and motives that affect decision, whether or The tendency to psychologically match the not they can be articulated or recognized by purchase of luxuries with unexpected and the decision-maker. windfall monetary