Asymmetric Effects of Activity-Based Costing System Cost Reallocation

Abstract

Despite the many proposed benefits of activity-based costing (ABC), many managers oppose implementing it. One important reason for this resistance that has generally not been addressed in the literature is the effect of cost reallocations on managers’ evaluations and compensation. This study examines how the impact of installing an ABC system on managers’ bonuses affects their support for ABC implementation. Because ABC systems usually allocate costs in different proportions than traditional systems, some products may appear to be more profitable while others may appear less so. This, in turn, causes the business units responsible for the products to appear to be more or less profitable.

Based on prospect theory (Kahneman & Tversky (1979). Econometrica, 47, 263–291; Tversky & Kahneman (1992). Journal of Risk and Uncertainty, 5, 297–323), we predict that the negative effect on managers’ support for ABC in business units reporting less profit is greater than the positive effect on managers’ support in the more profitable units. The results of an experiment support this prediction. Since management support is critical to successful system implementation, this asymmetric effect has implications for cost management system changes.

Citation

Fennema, M.G., Rich, J.S. and Krumwiede, K. (2005), "Asymmetric Effects of Activity-Based Costing System Cost Reallocation", Arnold, V. (Ed.) Advances in Accounting Behavioral Research (Advances in Accounting Behavioural Research, Vol. 8), Emerald Group Publishing Limited, Leeds, pp. 167-187. https://doi.org/10.1016/S1475-1488(04)08007-X