Do Different Cost Systems Make a Difference

A SURVEY OF 130 U.S. MANUFACTURING COMPANIES FINDS FEW DIFFERENCES IN THE INTERNAL AND EXTERNAL ENVIRONMENTS OF ABC, TRADITIONAL, AND VARIABLE-COST SYSTEM USERS, BUT ABC AND VARIABLE-COST SYSTEMS BETTER SERVE USERS' NEEDS. Many articles have been written about activity-based costing (ABC) since it was introduced in the United States during the mid-1980s. ABC is often described as the only cost system that accurately portrays product cost in complex environments. It is also portrayed as a system that identifies nonvalue-added activities and highlights areas where costs can be reduced. Linked with activity-based management (ABM), ABC is one means of connecting a company's strategic objectives with its product costing system. If ABC systems provided the advantages touted by their proponents, it seems likely that most companies would have adopted ABC over the last 15 years. Survey results, however, indicate that the use of ABC is not widespread. In one study, only about 20% of firms reported they had adopted ABC, and another study reported a 21% adoption rate.1 Why do so many companies continue to use other types of cost systems? One possibility is that there are differences in the nature and scope of information generated by each system. For example, the cost systems may differ in their ability to provide information about performance measurement, revenue enhancement, or cost-reduction efforts. Given the internal and external pressures a company faces, one cost system may be better suited to serve its needs than another. Factors such as the complexity of the production process, frequency of operation at capacity, or the nature of competition may favor the adoption of a particular type of cost system. If this is the case, we would expect to see systematic differences in both the quality of information provided by cost systems and the frequency of usage across industries. To determine if such a relationship exists and whether managers within companies that use different cost systems believe the information provided by those systems differs, we surveyed accounting personnel at U.S. manufacturing companies. The results indicate that most managers believe their cost systems are adequate for decision making. In certain circumstances, managers evaluated their cost systems as more effective than those using other cost systems. Activity-based costing systems were evaluated as somewhat more useful, but we found no evidence that either the external or internal environment of the firm was correlated with the choice of cost system. COST SYSTEMS AND COSTING ISSUES Product costing is simple when there is no overhead. Material and labor can be traced more easily to specific products than can overhead costs that benefit many products and product lines. Unfortunately, overhead often comprises a significant percentage of product costs. For example, one survey found that overhead equaled 34.6% of product costs.2 How this overhead is assigned to the various products significantly changes the product costs and has the potential to influence product promotion, pricing, and production decisions. Different costing systems approach the overhead allocation decision in very different ways. Traditional costing systems allocate the overhead using some simple measure, for example, total labor or machine hours. ABC systems rely on cost pools and cost drivers that separate and assign costs to products in a way that approximates their usage. Unlike traditional and ABC cost systems, variable-costing systems do not assign overhead; in these systems, overhead is treated as a collection of costs that are incurred to support all operations. In economic terms, these competing approaches to overhead allocation can be thought of in terms of shortrun versus long-run analysis. In the short run, all that matters is variable cost when determining the tactical production and pricing strategies. Fixed costs are ignored as managers think at the margin in determining whether or not to produce one more unit or change their price slightly. …