Assessing the Costs and Benefits of Investing in Cost System Accuracy

• DOI: http://doi.org/10.1002/jcaf.21909
• Date: 01 November 2013
• Published date: 01 November 2013
• Author: Nathan V. Stuart

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© 2013 Wiley Periodicals, Inc.

Published online in Wiley Online Library (wileyonlinelibrary.com).

DOI 10.1002/jcaf.21909

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Nathan V. Stuart

This article presents a flowchart to help managers

determine whether the benefits of implement-

ing a multiple-cost-driver system to improve the

accuracy of reported unit costs will outweigh the

implementation costs. The flowchart disciplines

decision makers to consider whether the firm pro-

duces multiple products, whether those products

consume indirect resources in heterogeneous pat-

terns, and whether the firm’s competitive position

truly depends on more accurately reported cost

information. Careful use of this tool will increase

the likelihood that investments in cost system

accuracy will have positive net present values.

© 2013 Wiley Periodicals, Inc.

Assessing the Costs and Benefits of

Investing in Cost System Accuracy

There is a recent

and renewed inter-

est in promoting

activity-based cost sys-

tems as the right choice

for most organizations

(White et al., 2011). It’s

appropriate, therefore,

to recall that cost sys-

tems are investments

just like any other, and

that the costs and ben-

efits of more complex

cost systems differ from

one organization to the

next.

This article dis-

cusses the investment

choice in cost system accuracy

in clear cost-benefit terms.

While investing in accuracy so

that the marginal benefits of

additional accuracy equal the

marginal costs is nothing new

(Cooper, 1989; Turney, 2010),

this article introduces a flow-

chart that managers can use

to guide investment decisions

about improved cost systems in

a careful and systematic fash-

ion. Using this tool can help

ensure that investments in cost

systems such as activity-based

costing (and its more recent

offspring, time-driven activity-

based costing) create value for

the firm.

I begin by discussing the

purpose of developing unit cost

information. I next place the

investment choice in a microeco-

nomic equilibrium framework

and review the reasons why

the optimal level of accuracy

when the cost system was first

installed is unlikely to be the

optimal level of accuracy in

the future. Finally, I discuss the

ways companies can adapt cost

systems to improve the accu-

racy of reported unit costs, and

introduce the flowchart tool for

deciding whether the

benefits of invest-

ing in a multiple-

cost-driver system

(MCDS), such as

activity-based cost-

ing, outweigh the

costs.

THE PURPOSE OF

REPORTED UNIT

COSTS

Unit cost is the

estimate of the cost

of one (logically

appropriate) unit of

a product or service

and plays many important roles

in managerial decision making.

Companies can, for example, set

selling prices based on the unit

costs (e.g., a 20% markup), or

decide to exit a market because

the unit costs for their products

are greater than the price they

can obtain in the market. In

a health care setting, govern-

ment reimbursement rates can

depend, at least in part, on the

unit costs of particular treat-

ments or procedures. It is impor-

tant, therefore, to understand

(a) how organizations prepare

unit-cost information, and (b)