Academic journal article Journal of Managerial Issues

Evaluating the Economics of Short- and Long-Run Production-Related Decisions [*]

Academic journal article Journal of Managerial Issues

Evaluating the Economics of Short- and Long-Run Production-Related Decisions [*]

Article excerpt

The role of activity-based costing (ABC), like any accounting system, is to provide information for assessing the economic consequences of resource allocation decisions. The primary focus of ABC involves measuring the cost of the resources used to produce a firm's products (Cooper and Kaplan, 1992). This is accomplished by treating the cost of an activity's resources as proportional to the capacity of the services it provides. The cost of an activity's resources is then traced to products based on the quantity of its services used in a product's production. ABC reflects a long-run perspective of production, in which the cost of labor and overhead resources is a variable cost. However, many of the firm's labor and overhead resources are contracted in advance of usage, such as rent on factory equipment, or influenced by management policies, such as retaining workers in periods of excess labor capacity. Equally important, in the short run, the capacity of the firm's support and production activities is limited. Therefore, when the demand for an activity's service exceeds its supply, a bottleneck is created that restricts the firm's production and creates an opportunity cost that affects the economics of production-related decisions. However, ABC ignores constrained activities and the opportunity cost of using these activities' resources in the firm's operations. ABC's failure to reflect the cost of resources that are fixed and to incorporate the effect of constrained activities in the short run led Theeuwes and Adriaansen (1994) to state that ABC is unsuitable for operational decision making.

The deficiencies of ABC led Bakke and Hellberg (1991) to propose using the theory of constraints (TOC) for making short-run resource allocation decisions. Conversely, Woods (1992) and Christensen and Sharp (1993) proposed modifying ABC to reflect the short-run variable and fixed costs of a firm's resources. Similarly, Kaplan and Atkinson (1998) suggested that an activity's cost may be separated into its short-run flexible and committed components. This enables ABC to measure the incremental cost of resources used by products, customers, or other objects of interest in the near term. However, short-run decisions made with the TOC and modified ABC models are problematic. The TOC incorporates only direct materials as a variable cost. However, even in the shortest of time horizons, some labor and overhead resources, such as temporary workers, power, and supplies, are a variable cost. Therefore, the TOC may underestimate the cost of a product and may lead to suboptimal resource allocation decisions. The modificati on of ABC proposed by Woods (1992), Christensen and Sharp (1993), and Kaplan and Atkinson (1998) ignores constrained activities that restrict the firm's production opportunities in the short run. Therefore, it excludes the opportunity cost of using a bottleneck activity and may result in suboptimal production-related decisions.

The TOC and ABC, based on short-run variable or flexible costs, are both designed to evaluate the economics of short-run production-related decisions. However, advocates of the TOC and ABC, based on short-run cost, provide little or no guidance as to how decisions made with these models may be coordinated with longer-term decisions. Failure to coordinate short- and longer-term decisions may lead to a series of short-run decisions that become the firm's long-term strategic plan by default. The problem with this ad hoc approach to strategic planning is that a series of short-run decisions may be suboptimal relative to a decision made initially from a longer-term perspective. Conversely, long-term decisions frequently have near-term implementation issues. Failure to understand and act on these issues may delay and/or impair the implementation of longer-term decisions. Consequently, short- and long-run decisions must be integrated and coordinated to make resource allocation decisions that are optimal in the shor t, as well as the long term. …

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