Reporting of overhead variances: a cost management perspective

In this paper we argue that if cost management is the primary purpose of a costing system, as opposed to external reporting, then it is often appropriate to report overhead variances as a period cost, rather than prorating these variances to various accounts. Further, we argue that reporting variances as a period cost may be appropriate in some situations even if external reporting considerations underlie the design of the cost system. However, a review of the accounting treatment of overhead variances in major cost/managerial accounting textbooks indicates a clear preference for proration of overhead variances between product costs and period expenses, compared to reporting the entire variance as a period cost (expensing). Textbooks typically argue that proration is theoretically more correct and expensing is only acceptable where the variance is immaterial.     

Competitive Pricing in Markets with Different Overhead Costs: Concealment or Leakage of Cost Information?

This paper experimentally investigates how leaders and followers in a duopoly set prices for two product markets that have different overhead costs. In a fully crossed two-by-two design, we manipulate the participants' private cost report quality as either low or high, representing the extent to which these reports reveal that product markets have different overhead costs. We show that when only the leader is given a high-quality cost report, private cost information of higher quality is better incorporated into market prices (that are observable to participants). Both the leader and follower improve in profits and their prices better reflect the differences in overhead costs because the follower infers information from the leader's prices (information leakage). In contrast, when only the follower receives a high-quality cost report, the leader's profits and prices do not improve. This occurs because the follower conceals cost information when the leader has a low-quality cost report.     

The fallacy of the overhead quick fix

Facing pressure from a few large, low-cost competitors, Thornton, an old-guard specialty-equipment manufacturer, fought back by eliminating overhead. Over two-years, it outsourced components and consolidated operations. But instead of cutting overhead, it added more and became still more uncompetitive. Thornton is not alone in either its predicament or its failed reaction. Many large manufacturing companies are finding themselves at a cost disadvantage in markets they have dominated for years. One reason is excessive overhead structures, the result of an unchecked buildup of indirect employees needed to control rising organizational complexity. Another reason is the emergence of the "robust" competitor, comparable in size and product scope but able to produce at a lower unit overhead cost. Data collected from more than 100 manufacturing plants worldwide illustrate the differences between overhead cost structures of bureaucratic, niche, and robust companies. The gulf between these groups highlights the need for action by bureaucratic companies, and, in some cases, by niche companies. But high-overhead companies are doomed if they cut overhead out of the system either by outsourcing or downsizing. If they expect to retain their size and also become more cost competitive, they must rethink their manufacturing systems. Well-designed and well-controlled processes mean higher product quality, faster cycle time, improved flexibility, and lower overhead costs. Sustainable overhead reduction means a commitment to continuous improvement. This includes segmenting, mapping, and measuring existing processes and then working to improve them.(ABSTRACT TRUNCATED AT 250 WORDS)     

The causes of misapplied capacity related manufacturing costs and corresponding reporting implications: A conceptual perspective

To meet external financial reporting requirements, fixed (i.e., capacity related) manufacturing overhead costs are typically applied to inventory via the use of a predetermined overhead application rate. However, textbooks do not consider all appropriate conceptual issues regarding the setting of the overhead application rate nor how these issues influence the causes of misapplied capacity costs (under/over-applied fixed manufacturing overhead) typically reported as the Production Volume Variance. Specifically, discussion is lacking related to those misapplied capacity costs potentially caused variously by the presence of capacity that is not explicitly planned to be used, capacity that is currently unused but in the longer-term is planned to be used (due to anticipated growth), and capacity that is currently unused but in the shorter term is planned to be used due to seasonality. Determining if any of these three causes are contributing to misapplied capacity costs is critical, as there are important managerial accounting and financial accounting reporting implications associated with each. And while the relevant literature to be discussed offers support for these causal constructs, this paper extends this literature by developing a parsimonious and conceptually-based approach to permit a simultaneous partitioning of misapplied capacity costs into these causal categories. Further, this paper will identify the important conceptual differences among these three causes, how these differences warrant unique approaches for the managerial and financial reporting of information related to capacity costs and utilization, and needed changes to Generally Accepted Accounting Principles to facilitate more appropriate financial reporting in this area.     

On the interpretation of the estimated intercept in a regression of overhead cost on volume

When regressing overhead cost on units produced, it may be necessary to obtain separate estimates of fixed and variable overhead cost. However it has been suggested in the accounting literature that the constant term in the regression is only a non-interpretable Y-intercept. This note suggests that the constant term of a cost activity regression is fixed cost associated with the relevant range of activity. Furthermore, if changes in variable unit costs occurred within the period of observation, then the use of disaggregated data is required to obtain an unbiased estimator of fixed costs.     

The cost of capital and optimal financing policy in a dynamic setting

This paper revisits the Modigliani–Miller propositions on the optimal financing policy and cost of capital in a dynamic setting. In an environment without taxes and bankruptcy costs, the results are generally consistent with the Modigliani–Miller Propositions 1 and 2. However, the first proposition should be presented and interpreted more carefully, as given firm characteristics, there is only one optimal capital structure. Thus, a firm’s capital structure is relevant. A relaxation of assumptions about either taxes or bankruptcy costs leads to conclusions that are generally different from those in Modigliani and Miller (1958). The model predicts that leverage and sales-to-capital ratios decrease but firm size and capital stock increase with the subjective discount factor of the firm’s manager if there are taxes and bankruptcy costs. The empirical analysis supports these predictions.     

Optimal level of fraudulent disclosure when litigation is costly

In this article, we show that the effects of a legal system depend on the cost of litigation. For very low levels of legal costs, an equilibrium exists where the manager always fraudulently reports firm quality (i.e., always reports “good news”) and the investors bring suit any time firm earnings are low. For an intermediate range of legal costs, there exists an equilibrium where the frequency of fraudulent reporting is an increasing function of the costs of litigation. In this equilibrium, investors will follow a mixed strategy of bringing suit. With high legal costs, the manager always issues fraudulent disclosures and the investors never bring suit. When legal costs are not high, the threat of lawsuits removes moral hazard and adverse selection problems. The dead-weight loss from lawsuits creates a demand for auditing and may cause the manager to manipulate the amount of retained ownership.     

Cost uncertainty and budget overspending: A safety-first perspective

In this study we model a cost center manager's decision about how to achieve a required level of output. The spending plan that the manager adopts is expected to result in successful performance, but at an uncertain cost. The uncertainty associated with the spending plan is inversely related to the expected cost. The analysis presented in this article suggests that a manager who exhibits Safety-First behavior and wishes to avoid large budget deviations is more likely to exceed what he or she perceives to be the overspending limit rather than the underspending limit. That manager will tend to incur costs in excess of the budget. This mathematical result has an intuitive appeal; a manager is willing to pay a certain “risk premium” to avoid the risk of large budget deviations and accompanying adverse consequences. This result has implications for both performance evaluation and budget setting, particularly in the public sector. Under the circumstances that we describe, using budgets in evaluating managerial performance may be misleading. Another application of our study relates to the “budget creep” phenomenon and how, under particular circumstances, its size can be reduced.     

Vital truths about managing your costs

Four truths apply to every business situation: 1. It is essential to be a lower cost supplier. 2. To stay competitive, inflation-adjusted costs of producing and supplying products and services must trend downward. 3. The true cost and profit pictures for each product/market segment must always be known, and traditional accounting practices must not obscure them. 4. A business must concentrate as much on cash flow and balance-sheet strengths as it does on profits. In order to ascertain exactly what your costs are, you must carefully isolate and assign various costs to specific products, accounts, or markets. Managers often do this badly, working on the basis of "average" costs. This ignores important differences among products and the fact that different products, different markets, and different customers incur different overhead costs. Most manufacturing companies' most important expense categories are R&D, sales, and general and administrative costs, but surprisingly, they generally don't get the attention they should. Neither do two crucial ratios-gross margin and the percent of assets employed per dollar of sales. Gross margins should usually not be less than 40%, and for most manufacturing companies, assets should not be over 60% of annual sales. Wrong deviation from these ratios will undermine profit targets. Once your costs are known and clearly assigned to product lines, markets, and key customers, they should be widely shared in the organization so that everyone will feel committed to cost management and know when deviations occur.     

The Accuracy of Proportional Cost Models: Evidence from Hospital Service Departments

Using data from hospitals in the state of Washington, we examine the time-series behavior of overhead costs. We find that more accurate predictions of changes in costs are usually generated by assuming a cost will not change at all (except for inflation) than by assuming that the cost will change in proportion to changes in activity. We also find that nearly all of the effect of a change in activity on costs appears to occur in the same year as the change in activity. Finally, using a multi-period regression model we find that the proportion of variable costs in the hospital overhead accounts is apparently very modest. These results suggest that costing systems, such as activity-based costing, that assume costs are proportional to activity, will grossly overstate relevant (i.e., incremental) overhead costs for decision-making and performance evaluation purposes.     

Locked Up by a Lockup: Valuing Liquidity as a Real Option

Hedge funds often impose lockups and notice periods to limit the ability of investors to withdraw capital. We model the investor's decision to withdraw capital as a real option and treat lockups and notice periods as exercise restrictions. Our methodology incorporates time-varying probabilities of hedge fund failure and optimal early exercise. We estimate a two-year lockup with a three-month notice period costs approximately 1% of the initial investment for an investor with constant relative risk aversion utility and risk aversion of three. The cost of illiquidity can easily exceed 10% if the hedge fund manager can arbitrarily suspend withdrawals.     

Liquidity and firm investment: Evidence for Latin America

This paper explores the relationship between firms' investment and stock market liquidity. Using a panel of Latin American firms, I find evidence that a higher trading volume and a higher industry-adjusted trading volume are associated with higher firm investment (PPE, Total Assets, and Inventory). This relationship is higher in episodes where the firm decides to issue shares, and it is also greater for firms with tighter financial constraints and better investment opportunities. This evidence is consistent with a mispricing channel, where firms issue and invest the proceeds to take advantage of low cost of capital, or with a cost channel, where liquidity is associated with lower issuance costs. Also, it is less related with an informational channel, where a liquid market helps a manager to take more efficient decisions, since this channel does not necessarily predict an increase in investment, but only more efficient investment.     

Capital budgeting, information timing, and the value of abandonment options

This paper investigates how an abandonment option influences the optimal timing of information in a sequential adverse selection capital budgeting model. While the divisional manager has imperfect private pre-contract information, headquarters can time whether the manager obtains perfect project information before (timely information) or after (delayed information) the contract is signed. In the absence of the abandonment option, headquarters favors timely (delayed) information if the investment costs are high (low). The presence of the abandonment option favors delayed information because under the timely information regime the value of the abandonment option is zero, whereas under the delayed information regime the value of the option is positive.     

Time-driven activity-based costing

In the classroom, activity-based costing (ABC) looks like a great way to manage a company's limited resources. But executives who have tried to implement ABC in their organizations on any significant scale have often abandoned the attempt in the face of rising costs and employee irritation. They should try again, because a new approach sidesteps the difficulties associated with large-scale ABC implementation. In the revised model, managers estimate the resource demands imposed by each transaction, product, or customer, rather than relying on time-consuming and costly employee surveys. This method is simpler since it requires, for each group of resources, estimates of only two parameters: how much it costs per time unit to supply resources to the business's activities (the total overhead expenditure of a department divided by the total number of minutes of employee time available) and how much time it takes to carry out one unit of each kind of activity (as estimated or observed by the manager). This approach also overcomes a serious technical problem associated with employee surveys: the fact that, when asked to estimate time spent on activities, employees invariably report percentages that add up to 100. Under the new system, managers take into account time that is idle or unused. Armed with the data, managers then construct time equations, a new feature that enables the model to reflect the complexity of real-world operations by showing how specific order, customer, and activity characteristics cause processing times to vary. This Tool Kit uses concrete examples to demonstrate how managers can obtain meaningful cost and profitability information, quickly and inexpensively. Rather than endlessly updating and maintaining ABC data,they can now spend their time addressing the deficiencies the model reveals: inefficient processes, unprofitable products and customers, and excess capacity.     

Unobservable transfer price exceeds marginal cost when the manager is evaluated using a balanced scorecard

This study investigates the optimal level of transfer prices chosen by managers in a divisionalized firm when they are evaluated based on a balanced scorecard. A unique assumption of our model is that transfer prices are unobservable to a competing firm's managers. In contrast to the findings in several studies that examine strategic transfer pricing, this research shows that a manager who is evaluated using a balanced scorecard chooses a transfer price that exceeds marginal cost given a market competitor in a specific economic environment. This result is caused mainly by our model's assumption that a manager considers the competitor's profit in his/her in decision-making when the objective is to maximize long-term profit. This study makes a significant contribution to the strategic transfer pricing literature by showing that even if the transfer price is unobservable to rivals, the optimal transfer price exceeds marginal cost when the final product market is characterized by price competition, something not shown in previous analytical accounting research.     

Restatement costs and reporting bias

Financial restatements are costly, but frequent, events and many firms restate several times. We explore why rational managers engage in misreporting despite the costly consequences. To guide our analysis, we build a parsimonious model of reporting bias and the cost of restating. In our model, the observed cost of a restatement conveys information about the true cost of biasing financial statements, which the manager incorporates into the optimal choice of bias. A restatement hence offers managers an opportunity to learn about the true cost of reporting bias, which allows them to update their biasing strategy if the observed cost differs from the expected. We test the model's predictions by analyzing how firms' accruals quality changes after observing the costs attached to restating, which we measure as the market loss following a restatement scaled by the restatement's net income effect. We find that future accruals quality is increasing in the cost of restating and the change in the cost of restating. Consistent with our stylized model, our results indicate that rational managers use the insights from prior restatements to improve their future bias strategy.     

Liquidity: Considerations of a Portfolio Manager

This paper examines liquidity and how it affects the behavior of portfolio managers, who account for a significant portion of trading in many assets. We define an asset to be perfectly liquid if a portfolio manager can trade the quantity she desires when she desires at a price not worse than the uninformed expected value. A portfolio manager is limited by both what she needs to attain and the ease with which she can attain it, making her sensitive to three dimensions of liquidity: price, timing, and quantity. Deviations from perfect liquidity in any of these dimensions impose shadow costs on the portfolio manager. By focusing on the trade-off between sacrificing on price and quantity instead of the canonical price-time trade-off, the model yields several novel empirical implications. Understanding a portfolio manager's liquidity considerations provides important insights into the liquidity of many assets and asset classes.     

CVP under uncertainty and the manager's utility function

Cost-volume-profit analysis has focused on the firm's short-run output decision assuming that the manager maximizes the firm's objective function rather than his or her own. This study argues that the decision problem facing the manager is to determine not only the level of output, but also the level of investment in risky assets in such a way that the expected utility of the manager's own end-of-period wealth can be maximized when the manager's wealth function is dependent on vested interests both within and outside of the firm, possibly in competition with the firm. Through analytical work, it is demonstrated that a change in fixed costs of the firm affects not only the production decision of a manager, but also his orher decision to invest in risky assets. The direction of this fixed cost effect depends on the particular type of risk aversion displayed by the manager. From the analytical work, five propositions are developed for empirical investigation in the future.The most helpful comments of Professor Cheng-few Lee are greatly acknowledged. We wish to thank anonymous referees who's comments have improved the paper. Furthermore, participants at the seminar at the University of Massachusetts Lowell also provided helpful comments.     

银行信贷过程中的客户融资渠道策略分析

现代银行产品的营销策略已经从"以产品为中心"逐渐发展成为"以客户为中心"的层面,即以客户需求为导向,通过信贷客户经理和企业间的"博弈",在达到营销银行产品目的的同时使企业融资达到最优化.现代意义的客户经理不仅要熟悉原有的贷款操作流程,更多的是要扮演企业融资策划师的角色.本文试从银行信贷客户经理的角度出发,对我国现有不同融资渠道成本进行比较,并在此基础上对企业的融资方案做出具体的情景分析,以揭示银行客户经理对各种融资渠道特征的了解和融资规划的最优化设计在信贷营销过程中的重要作用,力求为银行信贷产品的营销提供一条新思路.     

Consumer obfuscation by a multiproduct firm

This article shows that a multiproduct firm has incentives to obfuscate its products by using search costs to induce consumers to search through its products in a particular order. The consumers who draw high valuations of the first product terminate their search earlier than the consumers who draw low valuations. Thus, the firm has incentives to raise the price of the earlier searched product. The optimal search cost for an obfuscated product is such that consumers inspect the product only if the match values of the previously searched goods have been very poor.