A Framework for Conducting Numerical Experiments on Cost System Design. Anand, V., R. Balakrishnan and E. Labro (2018), Forthcoming at Journal of Management Accounting Research.
This paper aims to advance the use of numerical experiments to investigate issues that surround the design of cost systems. As with laboratory and field experiments, researchers must decide on the independent variables and their levels, the experimental design, and the dependent variables. Options for dependent and independent variables are ample, as are the ways in which we can model the relations among these variables. We provide a modular framework that provides structure to these variables, their definitions, and the modeling of the connections among them. Further, we offer some insights into the design and layout of output data files to allow easier data analysis. We also present tips on how to report the results from such numerical experiments effectively. Finally, we furnish online the source code in C# for many of these modules. We hope that the framework and guidance provided in this paper will help spur and focus further meaningful work in this important area of management accounting.
Obtaining Informationally Consistent Decisions When Costs Are Computed with Limited Information. Anand, V., R. Balakrishnan and E. Labro (2017). Production and Operations Management.
The support of IMA for this project is gratefully acknowledged.
We demonstrate the need to view in a dynamic context any decision based on limited information. We focus on the use of product costs in selecting the product portfolio. We show how ex post data regarding the actual costs from implementing the decision leads to updating of product cost estimates and potentially trigger a revision of the initial decision. We model this updating process as a discrete dynamical system (DDS). We define a decision as informationally consistent if it is a fixed-point solution to the DDS. We employ numerical analysis to characterize the existence and properties of such solutions. We find that fixed points are rare, but that simple heuristics find them often and quickly. We demonstrate the usefulness and robustness of our methodology by examining the interaction of limited information with multiple decision rules (heuristics) and problem features (size of product portfolio, profitability of product markets). We discuss implications for research on cost systems.
Management Accounting and Operations Management. Hemmer, T. and E. Labro (2017). Chapter 18 in Routledge Companion for Production and Operations Management, invited and edited by M. Starr and S. Gupta.
In this chapter, we would like to outline the benefits gained for practice from looking at the same Operations Management phenomenon through multiple angles, in particular by including an Accounting, performance measurement and incentives angle. Furthermore, we will explore the opportunities for inter-disciplinary contributions to both the academic Operations Management and Accounting literature. Accounting focuses on the role of accounting information in assessing, valuing and predicting performance of firms and individuals. Furthermore, Financial Accounting is concerned with the role of such information to improve external (to the firm) decision making such as lending decisions by banks and trading decisions by financial markets participants. Management Accounting, on the other hand, is focused on the role of accounting information internally within the firm. If the reader will allow us some sweeping generalizations (to which there are of course notable exceptions), we would characterize Managerial Accounting research as originally and up to the mid-sixties being very focused on the role of information to improve internal decision making (Kaplan 1984). Over time, the focus of this research has shifted to the role of such information in measuring performance within the firm and providing incentives to align employees’ actions with the firm’s strategy. We would argue, however, that the pendulum has swung out a little too far: While the majority of what we teach in our Management Accounting courses is decision-making oriented so as to prepare our students for their roles in the workforce, the amount of research to support our teaching needs and update our teaching materials on this front is much more limited. Operations Management research, on the other hand, has continued to study the role of information in decision making (e.g. how to reduce the bullwhip effect by improved information sharing), and it would be valuable to bring some of that focus back to Accounting research. On the whole, Operations Management has typically been much more concerned with decision-making and until fairly recently usually not considered the behavior of humans under incentives provided by performance measures (again – please permit us these sweeping generalizations). The main focus has been on accomplishing process and operations improvement by dealing with exogenously imposed challenges such as, for example, randomness of demand, outages and defects. Operations Management research and practice has not focused a lot on how to best measure aspects of an exogenously determined process and on the endogeneity that arises when measures are used not just to capture the properties of the process but to incentivize and inform decision makers that are responsible for managing the process (with of course some notable exceptions). As such, this perspective of Accounting research provides an important vantage point for thinking through the interactions among performance measurement options, the human’s behavior when responding to these incentives, and the resulting optimal structure of operations. Given the readership of the book, our chapter will focus on what an Accounting perspective can signify for Operations Management. We will argue that both areas are inseparable. In Section 2, we will discuss the importance of considering incentives and performance measurement in Operations Management. Using the illustrative cases of two typical Operations Management settings (throughput maximization and the choice between push and pull production), we will outline how the performance measurement perspectives adds a lot of tools to the tool box of the operations manager and how opportunities for joint optimization of operations and performance measurement arise. We will also discuss the role for Management Accounting in devising additional performance measures (such as those included in a Balanced Scorecard which typically reports performance measures for four different perspectives: financial, learning and growth, internal and operational) to which incentives can be linked, and how this affects how to best solve an operations problem. In Section 3, we take the opposite perspective and discuss how the organization of operations affects what can and cannot be measured by Accounting, with a focus on cost measurement techniques such as Activity-Based Costing and Time-driven Costing. We explain how Operations Management impacts the accuracy of such cost measurement. This will in turn impact the Operations Management decisions based on these reported costs, suggesting that Accounting and Operations Management are joined at the hip. To be clear, some practitioners and researchers are already wrestling with issues on this interface (such as many of the works referenced in this chapter), and we do not aim to provide an exhaustive reference list of those that do. Rather, we hope that our chapter will further stimulate Operations Management researchers and practitioners to consider Accounting and performance measurement issues and vice versa by outlining some avenues for research and practice which we believe will be most fruitful.
The importance of the internal information environment for tax avoidance. Gallemore, J. and E. Labro (2015). Journal of Accounting and Economics.
We show that firms’ ability to avoid taxes is affected by the quality of their internal information environment, with lower effective tax rates (ETRs) for firms that have high internal information quality. The effect of internal information quality on tax avoidance is stronger for firms in which information is likely to play a more important role. For example, firms with greater coordination needs because of a dispersed geographical presence benefit more from high internal information quality. Similarly, firms operating in a more uncertain environment benefit more from the quality of their internal information in helping them to reduce ETRs. In addition, we provide evidence that high internal information quality allows firms to achieve lower ETRs without increasing the risk of their tax strategies (as measured by ETR volatility). Overall, our study contributes to the literature on tax avoidance by providing evidence that the internal information environment of the firm is important for understanding its tax avoidance outcomes.
Health Care Costs: Discussion of “The Impact of Changes in Regulation on Cost Behavior”. Labro, E. (2015). Contemporary Accounting Research.
In this discussion, I use Holzhacker, Krishnan, and Mahlendorf (2015), hereafter HKM, as a point of departure from which to discuss the current state of the two research areas to which they contribute. I will present some big-picture thoughts on research opportunities in their source literatures—the literature on financial management in health care and the literature on cost stickiness—and speculate as to where these literatures might go in the future.
Journey of Managerial Accounting Research. Labro, E. (2015). Journal of Management Accounting Research, special issue on JMAR’s 25th anniversary.
I have yet to decline an opportunity to ride some of my favorite hobby horses in managerial accounting research, so the invitation by Ranjani Krishnan to participate in the Journal of Management Accounting’s 25th Anniversary Panel at the 2014 Management Accounting Section Midyear Meeting in Orlando was very welcome. The below summarizes my thoughts expressed during the panel. I hope to stir the pot and perhaps get management accounting researchers to think somewhat differently after reading this piece about where we are as a field and where we need to be going to be successful in the next 25 years.
Using Simulation Methods in Accounting Research. Labro, E. (2015). Journal of Management Control.
The use of simulation methods is not very common in accounting research, even though several authors have pointed to the advantages these methods offer in addressing accounting research questions. In this position paper, I discuss the difficulties encountered when applying simulation methods in accounting research. These roadblocks are the problem of seeing the forest for the trees, the difficulty in designing the model and assessing which variables to include, issues with calibrating simulation models with relevant parameter values to guarantee external validity, and the unfamiliarity of the accounting readership with simulation methods. For each of these obstacles, I give some practical advice on how to overcome them from my experience as an author as well as a reviewer.
Cost Structure and Sticky Costs. Balakrishnan, R., E. Labro, and N. Soderstrom (2014). Journal of Management Accounting Research.
Beginning with Anderson, Banker, and Janakiraman (2003), a rapidly growing literature attributes the short-run asymmetric cost response to activity changes (i.e., sticky costs) as resulting from short-run managerial choices. In this paper, we are agnostic on the theory of sticky costs. Rather, we focus on empirical tests of cost stickiness. We show that past decisions on cost structure, which determine the magnitude of costs controllable in the short-term, induce non-stationarity in the elasticity of Sales, General and Administrative costs, affecting the interpretation of estimates from the standard specification used in the literature. We develop suggestions for how future research might control for the effects of cost structure. Empirically, we find that cost structure confounds results usually interpreted as cost stickiness reflecting short-run managerial actions. After adjusting for the effects of fixed costs, we find that the results are unstable across alternate sub-samples. Our results provide evidence that long-run cost structure decisions impact our ability to detect short-term cost management decisions.
Product costs as decision aids: An analysis of alternative approaches (Parts 1 and 2). Balakrishnan, R., E. Labro and K. Sivaramakrishnan (2012). Accounting Horizons, 26(1), pp.1-20 and 21-41.
This paper is awarded the 2013 Greatest Potential Impact on Practice Award by the Management Accounting Section of the American Accounting Association. The award is sponsored by the AICPA, CIMA, and CMA-Canada, and the winner is selected by representatives of these professional organizations.
We develop a common platform to characterize several popular approaches for computing product costs. We describe four popular product costing systems: traditional volume-based costing systems, activity-based costing systems, time-driven activity-based costing systems and resource consumption accounting. We employ a continuing numerical example to illustrate commonalities and differences among these systems. We compare the approaches along three dimensions: (1) the cost of system implementation and maintenance, (2) the ability to provide decision-relevant data, and (3) the provision of incentives to manage the demand for resources. As no system clearly dominates, we show how future approaches might blend the best features of current systems.
Evaluating Heuristics Used when Designing Product Costing Systems. Balakrishnan, R., Hansen, S. and E. Labro (2011). Management Science, 75(3), pp. 520-541.
This paper is awarded the 2014 Greatest Impact on Practice Award by the Management Accounting Section of the American Accounting Association. The award is sponsored by the CGMA joint venture between the AICPA and CIMA, and the winner is selected by representatives of these professional organizations.
The support of IMA for this project is gratefully acknowledged.
The academic and practitioner literature justifies firms’ use of product costs in product-pricing and capacity-planning decisions as heuristics to address an otherwise intractable problem. However, product costs are the output of a cost reporting system, which itself is the outcome of heuristic design choices. In particular, because of informational limitations, when designing cost systems firms use simple rules of thumb to group resources into cost pools and to select drivers used to allocate the pooled costs to products. Using simulations, we examine how popular choices in costing system design influence the error in reported costs. Taking information needs into account, we offer alternative ways to translate the vague guidance in the literature to implementable methods. Specifically, we compare size-based rules for forming cost pools with more informationally demanding correlation-based rules, and develop a blended method that performs well in terms of accuracy. In addition, our analysis suggests that significant gains can be made from using a composite driver rather than selecting a driver based on the consumption pattern for the largest resource only, especially when combined with correlation based rules to group resources. We vary properties of the underlying cost structure (such as the skewness in resource costs, the traceability of resources to products, the sharing of resources across products, and the variance in resource consumption patterns) to address the generalizability of our findings and to show when different heuristics might be preferred.
On the Optimal Relation between the Properties of Managerial and Financial Reporting Systems. Hemmer, T. and E. Labro (2008). Journal of Accounting Research, 46(5), pp. 1209-1240.
This paper received the 2007 Best paper award of the American Accounting Association conference (Management Accounting section) in Chicago.
We develop a theoretical model of the firm that links properties (stewardship vs. valuation focus) of financial reporting regimes with the informational properties of optimal managerial accounting systems. We show that, contrary to the standard textbook proposition, properties of management and financial accounting systems are not independent. We provide an explicit connection between (somewhat) exogenous and observable properties of a firm’s information system and the quality of the economic decisions made by its manager(s). As the latter can also be inferred from publicly available data, our theory generates new opportunities for empirical managerial accounting research on large non-proprietary samples. Further, by being able to identify enhanced performance due to improved managerial accounting information, our theory provides opportunities to gain a better understanding of the link between particular managerial accounting practices and the quality of the information produced.
Practitioners and academics hypothesize that when there is high diversity in resource consumption patterns, costing systems are more sensitive to errors. Given firms’ resources to enhance costing accuracy are typically constrained, it is argued that costing system refinement efforts should be focused on such cases, where they are likely to be most effective. However, little guidance is available on how to identify those situations where costing system refinement efforts (such as introducing an ABC system) are likely to pay off most in terms of increased accuracy. Further, to our knowledge, the existing guidance provided by this high diversity rule of thumb has never been empirically tested. Using a simulation method, we address these issues in this paper. Specifically, we model various aspects, and degrees, of diversity in the resource consumption patterns to be reflected by the costing system and find that more diversity in resource consumption patterns only leads to increased costing system sensitivity to errors for some of the aspects of diversity studied. We also identify situations in which allocating costing system refinement resources to cases characterized by high diversity in resource consumption patterns is detrimental to improved accuracy.
This paper is awarded the 2011 Greatest Potential Impact on Practice Award by the Management Accounting Section of the American Accounting Association. The award is sponsored by the AICPA, CIMA, and CMA-Canada, and the winner is selected by representatives of these professional organizations.
The support of CIMA for this project is gratefully acknowledged.
Although time estimates are used extensively for costing purposes, they are prone to measurement error. In an experimental setting, we research how measurement error in time estimates varies with: (1) the level of aggregation in the definition of costing system activities (aggregated or disaggregated); (2) task order (the extent to which the activities that require time estimates present themselves systematically or mixed); and (3) when notice is given that time estimates will be required (in advance or after the fact), that is, whether participants know that time estimates will be required before they perform the activities. We also test on response mode (estimates in percentages or absolute time units). The results suggest an important trade-off between the level of aggregation and measurement error: disaggregation of activities leads to higher measurement error. Also, advance notification reduces measurement error, especially in settings with aggregated activities or mixed tasks. Finally, we find a strong overestimation bias when participants provide time estimates in minutes, which may be problematic for Time-Driven Activity-Based Costing that advocates the use of estimates in minutes. These results are relevant to accountants and decision makers who want to assess and control the measurement error in their current costing system and to professionals in related areas that make use of time estimates (e.g. billing, tendering).
This paper is awarded the 2011 Notable Contributions to Management Accounting Literature Award by the American Accounting Association.
Activity-based costing (ABC) as well as other cost accounting systems provide accurate costs only under stringent conditions. However, we know little about the nature, level, and bias of costing errors. This paper reports the results of a simulation study of a two-stage costing system that provides the following main insights: 1) partial improvement in the costing system usually increases the overall accuracy of reported product costs except in certain cases identified in this paper where errors have an offsetting effect, most notably when there is aggregation error on the activity cost pools and measurement error on the resource drivers; 2) the impact of Stage II costing errors on overall accuracy is stronger than that of Stage I errors, so any system refinements should focus on Stage II; and 3) the introduction of aggregation and measurement errors usually results in relatively more products being under- than overcosted, with high amounts of overcosting for a few “big-ticket” (large dollar size) products, and small amounts of undercosting for a larger number of less expensive (small dollar size) products.
Is a focus on collaborative product development warranted from a cost commitment perspective? Labro, E. (2006). Supply Chain Management: an International Journal, 11(6), pp. 503-509.
Supplier involvement in cost reduction efforts has been concentrated mainly in the product development phase of the product’s life cycle. Often this concentration on the early phases of the product life cycle is defended with referral to the 80/20 rule or the so called “Blanchard (1978) statistic” that says that 80% of the manufacturing costs are determined or committed during product design and development. This paper finds that empirical evidence in the literature for this 80/20 rule is only anecdotal. Therefore it is even more surprising that I find in my extensive survey of the literature that, compared to the literature on cost reduction in design phases, the literature on cost reduction efforts in later stages of the product life cycle is rather limited. On top of that, this literature often takes a perspective internally to the firm and ignores possibilities for supplier/buyer collaboration, which leads to numerous potential value sources in the supply chain remaining untapped.
Constructing a Total Cost of Ownership Supplier Selection Methodology based on Activity Based Costing and Mathematical Programming. Degraeve, Z., E. Labro and F. Roodhooft (2005). Accounting and Business Research, 35(1), pp. 3-27.
In this paper we elaborate on a Total Cost of Ownership (TCO) supplier selection methodology that we have constructed using real life case studies of three different industrial components groups in a firm. These case studies are presented in this article. Analyzing the value chain of the firm, data on the costs generated by the purchasing policy and on supplier performance are collected using Activity Based Costing (ABC). Since a spreadsheet cannot encompass all these costs, let alone optimize the supplier selection and inventory management policy, a mathematical programming model is used. For a specific component group the combination of suppliers is selected that minimizes the TCO. TCO takes into account all costs that the purchase and the subsequent use of a component entail in the entire value chain of the company. The TCO approach goes beyond minimizing purchase price and studies all costs that occur during the entire life cycle of the item in the organization. Possible savings of between 6 and 14% of the total cost of ownership of the current purchasing policy are obtained for the three cases. ABC is not an optimization tool as such, but provides important accurate input to the optimizing mathematical program, whereas the Operations Research literature usually only distinguishes between variable and fixed costs. We show that the integration of both delivers better results in the setting we have studied.
The Cost Effects of Component Commonality: a Literature Review through a Management Accounting Lens. Labro, E. (2004). Manufacturing & Service Operations Management, 6(4), pp. 358-367.
In this paper I review the component-commonality literature through a management-accounting lens, focusing on the cost effects of an increase in the use of the same version of a component across multiple products. The bulk of this literature is of a theoretical nature; e.g. analytical models, programming models, or conjectures based on casual observations of practice. Some of this literature purports, especially in their introductions to the topic, that cost is generally decreasing with increasing commonality. However, based on a review of the theoretical literature using an Activity Based Costing (ABC) framework, and, distinguishing between cost-driver and cost-rate effects, I will conclude that the cost picture is more subtle. In other words, it is too early to make any general statement about the effect of increasing commonality on total costs. When I then move to the limited empirical literature on the topic, consisting of case studies (sometimes combined with simulation) and empirical research on larger data sets, we will conclude that there is even more room for future research.
Total Cost of Ownership Purchasing of a Service: the Case of Airline Selection at Alcatel Bell. Degraeve, Z., E. Labro and F. Roodhooft (2004). European Journal of Operational Research, 156(1), pp. 23-40. Special Issue: EURO Excellence in Practice Award 2001.
This paper was a finalist for the 2001 EURO Excellence in Practice Award and the winner of an IPSERA bursary.
The multiple objective problem of purchasing for business falls into two broad categories: the purchasing of components for manufacturing and the purchasing of services. Several supplier selection models have been suggested in the literature for the purchasing of production-related components. To our knowledge, no supplier selection model for the purchasing of services has been published. In this paper we elaborate on a mathematical programming model that selects suppliers of a multiple item service and simultaneously determines market shares of the suppliers selected. The methodology is based on the collection of Total Cost of Ownership (TCO) information, quantifying all the costs associated with the purchasing process throughout the entire value chain of the firm. We apply this methodology to the real life case study of selecting airlines for 56 destinations at Alcatel Bell and have obtained TCO savings of 19.5%.
On Bringing More Action into Management Accounting Research: Process Considerations based on Two Constructive Case Studies. Labro, E. and T.S. Tuomela (2003). European Accounting Review, 12(3), pp. 409-442.
The constructive research approach (CRA) was originally proposed by Kasanen et al. (1991; 1993) as a specific opportunity for management accounting researchers to engage in solving problems relevant to managers. While the advocates of the CRA have argued in favor of its theoretical contribution potential and have shown that it satisfies the requirements of valid applied research, only very few studies using this particular approach have been published in major research journals. Our objective is to discuss the CRA methodology, both from a descriptive as well as from a prescriptive or normative perspective. We examine the research processes of two very different CRA studies, Degraeve et al. (2000b) and Tuomela (2000a), using the seven-step model suggested by Lukka (2000). We give practical exemplary methodological guidance for other researchers who wish to try out the CRA or obtain a better understanding of this methodology. While doing so, we also show that the CRA can provide researchers with interesting results obtained in a reliable and valid manner. In this way, we enhance the legitimacy of the CRA.
A Review of Methods Supporting Supplier Selection. De Boer, L., E. Labro and P. Morlacchi (2001). European Journal of Purchasing and Supply Management, 7(2), pp. 75-89.
In this paper we present a review of decision methods reported in the literature for supporting the supplier selection process. The review is based on an extensive search in the academic literature. We position the contributions in a framework that takes the diversity of procurement situations in terms of complexity and importance into account and covers all phases in the supplier selection process from initial problem definition, over the formulation of criteria, the qualification of potential suppliers, to the final choice among the qualified suppliers. Moreover, we propose decision methods and techniques that previously have not been suggested in a purchasing context. The proposed methods specifically accommodate for buying situations for which few or no decision models were published so far. This paper extends previous reviews by Weber, Current and Benton (1991), Holt (1998) and Degraeve, Labro and Roodhooft (2000a) in that it classifies the models in a framework developed by De Boer (1998) which recognizes more steps in the buying process than only the final among qualified suppliers and accommodates for the diversity of procurement situations.
An Evaluation of Vendor Selection Models from a Total Cost of Ownership Perspective. Degraeve, Z., E. Labro and F. Roodhooft (2000). European Journal of Operational Research, 125(1), pp. 34-59.
Many different vendor selection models have been published in the purchasing literature. However there has been no systematic approach to compare the relative efficiency of the systems. In this paper we propose to use the concept of Total Cost of Ownership as a basis for comparing vendor selection models. We illustrate the comparison with a real life data set of the purchasing problem of ball bearings at Cockerill Sambre, a Belgian multinational company in the steel industry. From a Total Cost of Ownership perspective mathematical programming models outperform rating models and multiple item models generate better results than single item models for this specific case study.