Estimating Activity Cost

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BEHAVIORAL RESEARCH IN ACCOUNTINGVolume 19, 2007pp. 133159

Estimating Activity Costs:How the Provision of AccurateHistorical Activity Data from a

Biased Cost System Can ImproveIndividuals Cost Estimation Accuracy

Dan L. Heitger

Miami UniversityABSTRACT: An integral component of effective cost control and performance evalu-

ation is the ability to accurately estimate relationships between activities and overhead

costs (i.e., activity costs). Individuals using a single cost pool system often have to rely

on memory of historical activity data when estimating activity costs. If individuals recall

of data is representative of the historical data, then reliance on memory should not be

detrimental to cost estimation accuracy. However, individuals often possess incorrect

initial beliefs about activity costs. These incorrect beliefs are expected to serve as an

anchor from which individuals make insufficient adjustments when estimating activity

costs based on memory of historical activity data. Multiple cost pool systems frequently

provide biased standard rates; however, such systems also provide accurate historical

activity data when individuals estimate costs. I extend prior accounting research by

experimentally examining whether a multiple cost pool systems provision of accurate

historical activity data improves activity cost estimation for individuals with incorrect

cost beliefs even when the cost system also provides biased standard rates. The main

contribution of the study is its finding that the multiple cost pool systems provision of

historical activity data improves individuals adjustments from their incorrect initial cost

beliefs when estimating activity costs, thereby increasing their estimation accuracy. The

results suggest that this improved adjustment from incorrect initial cost beliefs occurs

because the provision of historical activity data improves individuals recognition of

how wrong their initial cost beliefs were in reality. This result is achieved even though

the cost system provides biased standard rates. The ability of flawed cost systems to

improve individuals activity cost estimation in other such ways has received little re-search attention and is important because of its potential for improving managerial

decision making.

Keywords: activity cost estimation; biased cost systems; multiple versus single cost

pool systems; activity-based costing; initial cost beliefs; anchoring and

adjustment.

This paper is based on my dissertation completed at Michigan State University. I express my appreciation to themembers of my dissertation committee, Susan Haka (Chair), Franklin Boster, Joan Luft, and Ronald Marshall fortheir assistance and guidance. I also thank Brian Ballou, Jacob Birnberg, Harry Evans, Joe Fisher, Les Heitger,Steven Kaplan, Marlys Lipe, Laureen Maines, Jamie Pratt, Michael Shields, Geoff Sprinkle, two anonymous re-viewers, and participants at the 2003 Managerial Accounting Research Conference, Auburn University and atIndiana University workshops for their valuable comments. In addition, I acknowledge Donna Booker, ElizabethConnors, and Andrea Drake for their many helpful suggestions. Financial support from Michigan State Universityis gratefully acknowledged


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134 Heitger

Data Availability: Data gathered in this study are available from the author upon

request.

INTRODUCTION

An integral component of effective cost control and performance evaluation is ac-curately estimating relationships between activities and overhead costs (Cooper andKaplan 1998; Bruns and McKinnon 1993; Cooper et al. 1992). This paper defines

activity cost as the amount by which total overhead costs increase for a one-unit increasein the activity. Accurate activity cost estimates are important inputs into numerous strategicand other managerial operational decisions (Ittner et al. 2002; Kaplan and Norton 2001;Kaplan and Cooper 1998; Anderson 1995). For example, individuals estimate activity costsat various times throughout the year to price and evaluate products, services, and projectsthat require different levels of activities (Cooper et al. 1992, 4), improve efficiency by re-engineering operating processes (Kaplan and Cooper 1998, 138), create budgets (Cooperand Kaplan 1998), perform customer profitability analyses (Krumwiede 1998), enhance

quality improvement initiatives (Armitage and Russell 1993) or other routine (e.g., make-or-buy) decisions (Hansen and Mowen 2003, 826). However, according to managers, ac-curate activity cost estimation is a difficult task (Pemberton et al. 1996; Cooper et al. 1992).Surprisingly, this task has received relatively little research attention. This study helps de-velop an understanding of how specific features of cost systems are associated with theaccuracy of activity cost estimates.

Callahan and Gabriel (1998, 423) note that, the impact of more accurate productcosting information on firm profitability is an unresolved and controversial issue as thecosts and benefits of more refined costing systems are still being debated in the literature.Ittner et al. (2002) echo this view, as do Foster and Young (1997), by observing that the

linkage between more accurate cost systems, various decisions, and overall firm profitabilityis an important accounting research issue, but that there is limited agreement among re-searchers about the basis for asserting that a new or more accurate costing system is betterthan an existing system. One issue that remains unclear is whether cost systems that provideinaccurate cost information can improve individuals judgments, in particular their judg-ments outside the context of product cost estimates. Gupta and King (1997) encourageresearch on how cost system accuracy affects other decisions, such as cost managementand control, strategy formulation, and strategic management in organizations. This papercontributes to this literature by examining whether a flawed cost system that providesaccurate historical activity data improves activity cost estimates for individuals with incor-rect cost beliefs.

Often individuals subjectively estimate activity costs for numerous reasons (Luft andShields 2001; Banker et al. 2000; Bruns and McKinnon 1993). Individuals cost estimatesare expected to be affected by several sources of information, three of which are examinedin this paper: historical activity and total cost data, initial cost beliefs, and standard rates.First, individuals generally estimate costs based on historical activity and total overheadcost data (i.e., data from all relevant previous periods). Under a single cost pool system,individuals have access to historical activity data for only a single activity and historicalactivity data often are unavailable from sources (e.g., information system, etc.) other than


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Estimating Activity Costs 135

the cost system when individuals estimate costs.1 Thus, individuals using a single cost poolsystem often must recall historical activity data for other activities if they are to be usedin estimating costs.

Second, individuals across numerous organizations and industries often possess initial

beliefs or knowledge structures about how activities impact costs (Cooper et al. 1992).Initial cost beliefs arise from previous experiences, outside consultants, or colleagues andoften are incorrect (Krumwiede 1998; Cooper et al. 1992). For example, individuals reportthat well designed, newly implemented activity-based cost (ABC) systems informed themof activities that were surprisingly or unexpectedly more or less costly than they hadformerly believed (Krumwiede 1998; Pemberton et al. 1996; Cooper et al. 1992, 5759,144, 171174). In order for individuals with incorrect initial cost beliefs to accuratelyestimate costs, they must realize that their beliefs are incorrect and make significant ad-

justments from those beliefs.Third, the cost system provides approximations of expected activity costs in the form

of standard rates. Initial cost beliefs are exogenous to the cost system and as examined in

this paper refer to individuals beliefs about activity costs prior to observing the actualactivity and total cost data. Standard rate(s) (i.e., cost rate) refers to the cost systemsapproximation of activity cost(s). One of the major benefits of a successful ABC system isthat it can provide managers with better estimates (i.e., standard rates) of the cost of variousimportant activities (Krumwiede 1998; Pemberton et al. 1996). However, prior researchshows that multiple cost pool systems sometimes suffer from design flaws that lead to theprovision of biased rates (Datar and Gupta 1994; Noreen 1991) that have led some re-searchers (Ittner et al. 2002, 713) to question the usefulness of such cost systems fordecision-making. However, flawed cost systems might improve individuals cost estimationin other ways. For example, multiple cost pool systems that provide biased rates often

accurately measure total activity (i.e., cost allocation base) data for multiple activities, whichis important for activity cost estimation where individuals must estimate the increase intotal costs for a one-unit increase in the activity.

The purpose of this paper is to examine whether a multiple cost pool systems provisionof accurate historical activity data for multiple activities increases cost estimation accuracyfor individuals who possess incorrect initial cost beliefs, even when the system providesbiased standard rates. It is unclear from prior research whether providing individuals withaccurate historical activity data improves their activity cost estimation. Datar and Gupta(1994) show analytically (in Proposition 3) that more accurately measuring the units ofeach activity used by individual products produces more accurate estimates of product costfrom the cost system.

However, this paper differs from Datar and Gupta (1994) in three ways. First, the taskof a cost system estimating product cost is fundamentally different from the task of anindividual estimating activity costs. Second, Datar and Gupta (1994) employ an analyticalsetting to examine the cost systems estimate of product cost, which requires that totalactivity data be measured, as well as each individual products usage of each activity. This

1 A primary source for periodic activity data is informal communication, such as telephone or face-to-face con-versations with shop floor personnel (Bruns and McKinnon 1993). As a result, when activity costs are estimated,historical activity data often are unavailable from their primary source either because they are not recorded ina formal manner (McCarthy 1998; Pemberton et al. 1996; Cooper et al. 1992, 191) or because they are recordedbut are difficult or even impossible to access (Fickes 2002; Ward 2002). Although enterprise resource planning(ERP) systems are capable of recording activity data, a high failure rate (King and Wright 2002) and largeimplementation costs (Cruz 2002; Worthen 2002) prevent the majority of companies from possessing suchsystems


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136 Heitger

study employs an experimental setting in which individuals estimate the cost of variousactivities based on total activity (and total cost) data. Thus, this study extends prior researchby examining whether the cost systems provision of historical activity data affects indi-viduals estimates of activity costs.

Third, in demonstrating the finding described above, Datar and Gupta (1994) assumeno error in the cost allocation (i.e., standard) rates (i.e., zero error in measuring the costsfor each pool and the total units of each activity). Thus, this study also extends priorresearch by examining whether the provision of accurate historical activity data improvesindividuals activity cost estimation accuracy even when the cost system also providesbiased standard rates. Cost systems, like the one employed in the current study, that providebiased standard rates (i.e., activity costs at individual cost pools) can result in noisy butunbiased estimates of individual product costs, because the systematically overstated allo-cation to a product from one pool is offset by a systematically understated allocation fromanother pool (see Datar and Gupta [1994] and Foster and Gupta [1990] for further discus-sion and examples). As a result, examining biasedapproximations ofactivity costs (i.e., in

the form of the cost systems standard rates) is important in its own right, even if productcosts are unbiased, because activity costs are used in management decisions, such as theoptimal number and length of production runs or the optimal level of parts variety, etc.

I manipulate initial cost beliefs and cost systems to examine individuals cost estimationaccuracy and whether their recall of historical data anchors on initial beliefs. I manipulateinitial cost beliefs by varying whether the activity cost beliefs based on management ex-perience presented to individuals at the beginning of the experiment are correct or incorrect.Cost system is manipulated by varying whether the cost system provides individuals witha biased standard rate and accurate historical activity data for only one activity or allrelevant activities.

The results support the prediction that the multiple cost pool systems provision ofhistorical activity data for multiple activities increases cost estimation accuracy for individ-uals with incorrect initial cost beliefs. This finding occurs even though the cost systemprovides biased standard rates. Also, the results suggest that recall of historical data anchorson initial beliefs and that this anchoring effect is negatively associated with individualscost estimation accuracy. Finally, the results indicate that the provision of historical activitydata improves cost estimation accuracy by reducing the extent to which individuals recallof historical data anchors on their incorrect initial beliefs. Thus, this paper demonstratesthat cost systems do not have to provide accurate standard rates, which can be expensiveand quite difficult to generate, in order to improve individuals activity cost estimationaccuracy. This study has several implications for practice and future accounting research

involving cost system design and performance evaluation that are discussed in detail in thefinal section of the paper.

The next section of the paper develops the hypotheses. The third and fourth sectionsdescribe the experimental method and present the results, respectively. The final sectionprovides a conclusion and directions for future research.

DEVELOPMENT OF HYPOTHESESThe Activity Cost Estimation Process

Based on field research (Bruns and McKinnon 1993; McKinnon and Bruns 1992), Idepict the general activity cost estimation process as consisting of several steps (Figure 1,

AD). The process begins with the possession of initial beliefs, based on managementexperience, about the cost of activities (Figure 1, A). Individuals frequently (e.g., daily)observe activity data (Figure 1 B) albeit often from informal sources outside the cost


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FIGURE 1

The Activity Cost Estimation Process

Individual possesses initial

beliefs about the relationshipA between each activity

and total costs

Individual observesB periodic changes

in the levels ofactivity data

Individual calculates expectedchange in total costs based on

C initial cost beliefs and changein observed activity data

Individual observes actualD total costs and compares

calculated change in total coststo actual change in total costs

F

Individuals perception of how IndividualE close calculated changes in receives historical

total costs are to actual activity data forG changes in total costs multiple activities

Individual receivesa standard ratefor multipleactivities

Individual adjusts fromH initial cost beliefs to

estimate activity costs

Dashed rectangles denote that F and G are provided by the multiple cost pool system.

system (Bruns and McKinnon 1993). Periodically (e.g., monthly), individuals calculate achange in total costs for the current period based on their initial cost beliefs and the ob-

served changes in the levels of the activities (Figure 1, C). Individuals then refer to periodiccost reports containing actual total costs (and activity data for either a single or multipleactivities depending on the cost system) to compare how close their initial beliefs calculated


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138 Heitger

change in total costs is to the actual change in total costs, as a way to check the accuracyof their initial beliefs (Bruns and McKinnon 1993; Figure 1, D).

Individuals might proceed through Figure 1, processes B through D for a few or manyperiods, as depicted by the feedback loop, before estimating activity costs for a specific

purpose (e.g., budgeting at year-end). Prior research suggests that covariation estimatessimilar to parameter estimates (e.g., estimation of the cost of a given activity)are affectedby initial beliefs that are irrelevant to an objective (i.e., statistical) measure of covariation(Lipe 1998). However, except for general speculation (Broniarczyk and Alba 1994), theprocess by which initial beliefs affect cost estimation has received little empirical researchattention.

Individuals with incorrect initial cost beliefs should realize that, on average, there areactivity costs that, when combined with the monthly change in the levels of the activitydata, produce a change in total cost that is more similar (or closer) to the actual monthlychange in total costs than the calculated monthly change in total cost computed using theirincorrect initial beliefs. However, this study proposes that, rather than relying solely on

historical data to estimate activity costs, individuals treat initial cost beliefs as an anchorfrom which they make adjustments when they estimate activity costs. Initial cost beliefscan be relevant to cost estimation in a static production environment that remains completelyunchanged from the time when beliefs were formed to the time period for which activitycosts are to be estimated.

However, a more common scenario is one in which the plants production environmentchanges (due to technology advances, product mix changes, process re-engineering, etc.).As a result of this dynamic environment or numerous other reasons, managers cost beliefsare incorrect and, thus, their cost estimates should be based solely on the plants historicalactivity and total cost data from the relevant time period (e.g., past 12 months). Therefore,

as examined in this study, incorrect initial cost belief anchors, although salient, are irrelevantwhen individuals estimate costs. Individuals often focus their attention on salient, yet ir-relevant, anchors that are present in the task setting at the start of the judgment processand then make insufficient adjustments from these anchors when making a final judgment(Chapman and Johnson 2002; Hastie and Dawes 2001; Switzer and Sniezek 1991; Tverskyand Kahneman 1974). An anchor also can affect the nature of other information that issubsequently sought and retrieved at the time of final judgment (Chapman and Johnson2002; Hastie and Dawes 2001; Mussweiler and Strack 1999), such as the type of historicaldata recalled when estimating costs.

Based on prior nonbusiness-related research (Hastie et al. 1999; Wilson et al. 1996),an anchoring effect is expected in an activity cost estimation setting even when individuals

are instructed prior to estimating costs to ignore their initial cost beliefs and base their costestimates solely on the data. Given that individuals are expected to anchor on their initialcost beliefs, the accuracy of their cost estimates is expected to depend upon how well theyadjust from such beliefs (Figure 1, H). The presence of random error in actual total costsis expected to strengthen individuals reliance, or anchoring, on their initial cost beliefs.Specifically, individuals perception of the size of the monthly differences between theirinitial cost beliefscalculatedchange in total costs (i.e., cost change based on initial beliefs)and the actual change in total costs (Figure 1, E) is important in appropriately adjustingfrom incorrect cost beliefs when costs are estimated. As individuals consider these monthlycost differences, they must determine whether they are due to random error in actual total

costs orto the fact that their initial beliefs are incorrect. Attributing the difference to randomerror suggests that adjustments from initial beliefs are unnecessary. Thus, random error


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provides individuals with an easy way to partially explain away these differences withoutabandoning their initial beliefs and, as such, is expected to strengthen the effect of anchoringon initial cost beliefs.

Two Elements of Multiple Cost Pool Systems: Historical Activity Data andStandard Rates

In contrast to single cost pool systems, multiple cost pool systems provide historicalactivity data for multiple activities and provide a standard rate for each of the multipleactivities (Panel A of Figure 2). These two elements of multiple cost pool systems arediscussed separately. Hypothesis 1 examines the effect of providing historical multipleactivity data, and H2 examines the effect of providing multiple standard rates.

The Effect of Providing Historical Activity Data on Individuals CostEstimation Accuracy

As discussed in the first section, individuals using a single cost pool system often relyon memory of historical activity data when used in estimating activity costs. Althoughindividuals with incorrect beliefs are expected to estimate costs less accurately than indi-viduals with correct beliefs, the provision of historical data for multiple activities (Figure1, F) is expected to mitigate this tendency. When individuals are provided with historicaldata for multiple activities and total costs, they do not need to rely on memory of howlarge or small the difference was each month between the calculated change in total costsand the actual change in total costs. The provision of historical data for multiple activitiesis expected to help individuals learn or determine that their beliefs are incorrect (Figure 1,E). As individuals realize that their initial beliefs are incorrect, they are expected to updatetheir beliefs, thereby increasing their cost estimation accuracy.

However, anchoring on correct initial cost beliefs is expected to have no effect onindividuals cost estimation accuracy because individuals have no reason to update theirbeliefs. Thus, the multiple cost pool systems provision of historical data for multiple ac-tivities is not expected to affect individuals cost estimation accuracy when their initialbeliefs are correct. The following ordinal interaction between initial cost beliefs and thecost systems provision of historical activity data is predicted (Panel B of Figure 2).

H1: Relative to the control systems provision of historical activity data for onlya single activity, the multiple cost pool systems provision of historical ac-tivity data for multiple activities increases (has no effect on) activity cost

estimation accuracy for individuals with incorrect (correct) initial costbeliefs.

Regardless of the prediction in H1, there are reasons why the provision of historicaldata for multiple activities might have no effect on individuals cost estimation accuracy.For example, Klayman (1988) speculates that individuals performing a parameter-estimationtask (e.g., estimation of the cost of a given activity) might pursue a strategy where initialbeliefs are completely abandoned in favor of new beliefs when the data (e.g., actual costs)better fit the new beliefs. Individuals might apply this reasoning within a cost estimationsetting where random error exists such that it becomes clear to individuals early on that

their cost beliefs are inaccurate. Under this view, individuals would be quite effectiveon their own at recognizing that their initial cost beliefs are incorrect.


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FIGURE 2

Two Differences between Single and Multiple Cost Pool Systems: Providing a Standard Rate

and Historical Activity Data for a Single versus Multiple Activities

Panel A: Cost System Provision of Biased Standard Rates and Accurate Historical Activity

Data

SINGLE

COSTPOOL

CONTROLa

COSTSYSTEM

MULTIPLE

COSTPOOL

Biased Standard Rate for:[each month]

SingleActivity

MultipleActivities

MultipleActivities

Accurate Historical Activity Data for:[at year-end]

SingleActivity

SingleActivity

MultipleActivities

Panel B: Hypotheses 1 and 2

H2 H1d

Cost System

ActivityCost

EstimationAc

curacy

COR

INCA

B C

D

F

E

Single

Cost PoolControl Multiple

Cost Pool

c

b

a The control cost system possesses one (standard rate for multiple activities) of the two elements of the multiplecost pool system.

b A through F correspond to the six experimental conditions.c COR (INC) correct (incorrect) initial cost beliefs.d H1 compares the multiple cost pool condition to the control cost condition within each initial cost belief

condition (i.e., that F E and C B). H2 compares the control cost condition to the single cost poolcondition within each initial cost belief condition (i.e., that E D and B A).


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The Effect of Providing Biased Standard Rates on Individuals CostEstimation Accuracy

Prior research finds that providing individuals with accurate feedback about the param-eters they subsequently estimate (i.e., similar in nature to a standard rate) usually increases

estimation accuracy relative to when such feedback is not provided (Klayman 1988; Sniezek1986). Also, Gupta and King (1997) find that individuals incorporate the cost systems costforecasts into their cost estimates. Thus, standard rates are expected to affect individualsactivity cost estimation to some degree.

However, standard rates often are biased (Datar and Gupta 1994). The effect of pro-viding a biased rate for multiple activities on individuals cost estimation accuracy is ex-pected to depend on the accuracy of the rates relative to initial cost beliefs. For example,if the standard rate for a given activity is biased but still more accurate than the individualsincorrect initial cost belief for that activity (e.g., the standard rate of $1,500 is biased ascompared to the actual activity cost of $2,500 but is more accurate than the incorrect costbelief of $500), then any weight placed on the rate is expected to increase cost estimation

accuracy. Alternately, if the standard rate for a given activity is biased (e.g., $1,500) andless accurate than the individuals correct initial cost belief for that activity (e.g., $2,500),then any weight placed on the rate is expected to decrease cost estimation accuracy (i.e.,towards the relatively less accurate rate of $1,500 and away from the relatively more ac-curate correct cost belief of $2,500). Thus, the multiple cost pool systems provision of abiased standard rate for multiple activities (Figure 1, G) is expected to increase (decrease)cost estimation accuracy when the rates are more (less) accurate than the initial cost beliefs.Assuming that the biased rates are more (less) accurate than the incorrect (correct) initialcost beliefs, the following ordinal interaction between cost beliefs and the cost systemsprovision of biased standard rates is predicted (Panel B of Figure 2).2,3

H2: Relative to the single cost pool systems provision of a biased standard ratefor only a single activity, the control systems provision of a biased standardrate for multiple activities increases (decreases) activity cost estimation ac-curacy for individuals with incorrect (correct) initial cost beliefs.

Thus, the prediction in H2 is dependent on the assumption that the biased rates are more(less) accurate than the incorrect (correct) initial cost beliefs.

2 As discussed earlier, although initial cost beliefs and standard rates emanate from different sources, each canbe inaccurate to varying degrees. This paper examines the situation in which the magnitude of the bias in twoof the three standard rates is approximately half of the magnitude of the bias present in the incorrect initial costbeliefs (e.g., the actual activity cost for PRuns [Parts] is $500 [$2,500], the biased cost rate for PRuns [Parts]is $1,500 [$1,600] and the incorrect initial cost belief for PRuns [Parts] is $2,500 [$500]). I examine this setting,where the bias in incorrect beliefs is greater than the bias in standard rates, because beliefs typically arise fromless formal, less quantitative sources (e.g., individuals experiences and conversations with other employees[Krumwiede 1998]) than standard rates. Thus, the extent of bias in cost beliefs often is likely to be greater thanthe extent of bias in standard rates. If the relative magnitude of the biases were switched, such that standardrates were more biased than incorrect cost beliefs, then the predicted effect of biased standard rates on costestimation accuracy of individuals with incorrect cost beliefs would change.

3 Although individuals could anchor on standard rates, I believe that individuals are far more likely to anchor oninitial cost beliefs. It is relatively easy for individuals to realize when the cost system is flawed and producing

biased standard rates. In contrast, the only way to determine that ones cost beliefs are incorrect is throughcareful observation of historical data.


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EXPERIMENTAL DESIGNDesign, Participants, and Independent Variables

The experiment manipulated initial cost beliefs (correct and incorrect) and cost systems(single cost pool, multiple cost pool, and control cost system) between subjects in a 2 3

design. Participants were 50 M.B.A. and 57 undergraduate cost-accounting students at alarge midwestern university. Participants were informed that their pay was based on (i.e.,positively associated with) the accuracy of their activity cost estimates. Average pay was$18 for the one-hour experiment and was adjusted across conditions so that the averagepayment in each condition was approximately the same.

The experiment creates a setting in which three main activities are performed in theproduction plant that are measured by the number of machine hours operated, the numberof product parts handled and used in production, and the number of production runs per-formed for separate batches of products. Based on empirical studies documenting significantpositive linear associations between each activity and overhead costs (Banker et al. 1995;Banker and Johnston 1993), I adopt the following linear model:

y b b x b x b x , (1)o 1 1 2 2 3 3

where y total overhead costs, bo fixed costs, x1, x2, and x3 the number of machinehours (MHs), parts in production (PARTS), and production runs (PRuns), respectively, forall products during the period, and b1, b2, and b3 the cost of a MH, Part, and PRun,respectively, for all products during the period. represents random error. The three activ-ities are independent and are the activities for which cost estimates are determined. Table1 presents the cost function and monthly activity levels used in the production and costreports.

Initial cost beliefs are manipulated by varying the information given to participants onan information sheet at the beginning of the experiment concerning the change in totalcosts that should be expected from a one-unit change in each of three activities: MHs,PARTS, and PRuns. (The information sheet is available from the author upon request.) Initialcost beliefs has two conditions: correct and incorrect. Figure 3 displays the initial costbeliefs for both conditions, along with the actual activity costs and standard rates. In thecorrect condition, the initial cost belief is the same (i.e., correct) as the actual activity costfor all three activities. In the incorrect condition, the initial cost belief is different (i.e.,incorrect) from the actual activity cost for PARTS and PRuns and the same as the actualactivity cost for MHs. Thus, as in reality, some participants possess incorrect initial beliefsabout the activity costs they subsequently estimate.

The cost system variable has three conditions that vary whether participants are pro-vided with (1) a standard rate for a single activity orall three activities each month, and(2) historical activity data for a single activity orall three activities at year-end. The singlecost pool system each month provides a standard rate for a single activity (MHs) and atyear-end provides historical activity data for only a single activity (MHs). The multiple costpool system each month provides a standard rate for multiple activities (MHs, PARTS andPRuns) and at year-end provides historical activity data for multiple activities (MHs, PARTSand PRuns) [Panel A of Figure 2]. The third cost system condition, control, is a crossbetween the other two conditions in that each month it provides a standard rate for multipleactivities (MHs, PARTS, and PRuns) and at year-end provides historical activity data for

only a single activity (MHs). Thus, this third condition controls for the effect of providinga standard rate for multiple activities on cost estimation accuracy. As a result, a direct testof the incremental effect of providing historical activity data for multiple activities on cost


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TABLE 1

Cost Function and Activity Levels Used in Creating the Production Reports

and Cost System Reports

Month FixedCosts MHsX1

PartsX2

PRunsX3

RandomError TOTAL OHCOSTSa

Jan $15,000 480 30 30 $2,000 $163,000

Feb $15,000 360 30 30 $3,000 $153,000

Mar $15,000 300 42 12 $2,000 $165,500

Apr $15,000 480 30 30 $2,000 $163,000

May $15,000 300 48 48 $1,000 $195,500

Jun $15,000 360 30 30 $3,000 $153,000

Jul $15,000 300 24 18 $3,000 $118,500

Aug $15,000 300 12 42 $1,000 $104,500

Sep $15,000 300 30 36 $2,000 $147,500

Oct $15,000 240 30 30 $3,000 $132,000

Nov $15,000 300 24 24 $1,000 $125,500

Dec $15,000 120 30 30 $1,000 $119,000

a The cost function used to generate TOTAL OVERHEAD (OH) COSTS $15,000 $125X1

$2,500X2

$500X3

R, where R represents random error, which is uniformly distributed and varies independently of thelevel of X

1, X

2, and X

3.

The OLS estimate of the cost function $15,000 $125X1

$2,500X2

$500X3

e, where e represents theindependent random error term.R2 .989.

FIGURE 3

Comparison of Actual Activity Cost, Initial Cost Belief, and Standard Rate for each Activity

ActivityActual

Activity Cost

Initial Cost Beliefs

Standard

Rates

CORa INC

SINGLE

COST POOLSYSTEM

b

CONTROL

COSTSYSTEM

MULTIPLE

COST POOLSYSTEM

MHc $125/MH $125 $125 $453 $162 $162

Part $2,500/PART

$2,500 $500 $1,500 $1,500

PRun $500/PRun $500 $2,500 $,1600 $1,600

a COR (INC) correct (incorrect) initial cost beliefs.b

The three cost system conditions.cMH machine hour; PART part; PRun production run.


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FIGURE 4

Standard Rates for Each Cost System

Budgeted Total Budgeted Standard

SINGLE COST POOL SYSTEM: Activity Overhead Costsa

Activity Level Rateb

MH $1,740,000 3,840 $453

Assigned portion

of Budgeted Total Budgeted Standard

MULTIPLE COST POOL SYSTEM Activity Overhead Costsc

Activity Level Rated

& CONTROL SYSTEM: MH $623,784 3,840 $162

PART $540,168 360 $1,500

PRun $576,048 360 $1,600

$1,740,000

a Budgeted total annual overhead costs, budgeted total annual fixed costs, and budgeted total annual machine

hours are assumed to equal actual total annual overhead costs, actual total annual fixed costs, and actual totalannual machine hours, respectively.b Standard rate(s) are determined at the beginning of the year based on budgeted total annual overhead costs and

budgeted total annual level of the activity(s). To arrive at the standard rate for the single activity (MH),budgeted total annual overhead costs are divided by budgeted total annual machine hours.

c Budgeted total annual overhead costs, budgeted total annual fixed costs, and budgeted total annual machinehours, parts, and production runs are assumed to equal actual total annual overhead costs, actual total annualfixed costs, and actual total annual machine hours, parts, and production runs, respectively.

d To arrive at the standard rate for each activity, budgeted total annual overhead costs minus budgeted totalannual fixed costs are assigned to the three cost pools in the following erroneous manner: approximately 36percent are assigned to the MHpool, 31 percent to the PARTS pool, and 33 percent to the PRuns pool. Theaccurate assignment of costs would be 31 percent to MH, 58 percent to parts, and 11 percent to PRuns.Finally, budgeted total annual fixed costs are assigned evenly to each of the three cost pools.

For example: [($1,740,000 $180,000) .3614] [(1/3) $180,000] equals the portion of budgeted total

overhead costs (variable fixed) assigned to the MHcost pool under the multiple cost pool and controlsystems.

estimation accuracy is achieved by comparing estimation accuracy between the multiplecost pool and control systems.

Cost system manipulates these two cost system differences using two types of reports:monthly cost system reports and the year-end cost report. First, the monthly cost reports in

the single cost pool condition provide activity data and a standard rate only for MHs. Inthis condition, all costs are combined into a single cost pool, which causes the standardrate to be biased. The monthly cost reports in the multiple cost pool and control conditionsprovide activity data and a standard rate for all three activities. A common cost systemdesign flaw, error in measuring overhead costs, is incorporated into the multiple cost pooland control conditions, which leads to an inaccurate allocation of costs into cost pools and,thus, the generation of biased standard rates for MHs, PARTS, and PRuns (Datar and Gupta1994). Figure 4 details the computation of the standard rates for each condition. Themonthly cost reports in all conditions provide actual total costs for the current month andthe previous month. All activity and total cost data are accurate.

Second, the year-end cost report in all conditions provides historical actual total cost

data. However, the year-end cost report in the single cost pool and control conditionsprovides historical activity data only for MHs. Thus, in these two conditions, participantsuse of historical PARTS and PRuns activity data when they estimate costs at year-end is


13/28


restricted to their memory of such data. The year-end cost report in the multiple cost poolcondition provides historical activity data for all three activities. Thus, participants in themultiple cost pool condition do not need to rely on memory of historical data when theyestimate costs at year-end.

Experimental Procedure

The experiment follows the same general order of events as the activity cost estimationprocess depicted in Figure 1. Prior to the experiment, an introductory lecture explainedmanagers desire to estimate activity costs and the general cost estimation process. Partic-ipants completion of two practice rounds familiarized them with this process, which thenwas used in the experiment.

Participants were randomly assigned to experimental conditions. The experiment beganby providing participants with the information sheet that provides information concerninginitial cost beliefs and an explanation of their role as plant manager and the cost systemsstandard rates.4 The information sheet also explains that actual total costs contain an elementof randomness. Participants kept the information sheet until the exit questionnaire washanded out. Participants were told that they were going to look at several monthly produc-tion reports and cost reports, one month at a time. As in the practice rounds, they wereinstructed to determine each month the calculated change in total costs, given the cost beliefinformation about each activitys impact on total costs and the monthly change in the levelof each activity. Participants also were instructed to compare the calculated change in totalcosts to the actual change in total costs shown on the monthly cost report to see how closethe two cost changes are to one another.5 Finally, they were told to pay careful attentionto the reports and their contents because they would later be asked several questions aboutthem.6

The first months (February) production report and cost report then were distributed.The production reports represent the informal (and exogenous to the cost system) sourcefrom which individuals often observe activity data. The production reports contain the actuallevel of MHs, PARTS, and PRuns for the current month and the one month prior to thecurrent month (see Figure 5). The monthly change in each activity level also is shown.Each production report instructs participants to compute and write down, on the line pro-vided, the calculated change in total costs from the previous month to the current monthbased on the initial cost beliefs and the monthly change in MHs, PARTS, and PRuns.Februarys reports were collected when participants finished examining them as instructed.The following months reports were distributed and collected in the same manner throughDecember. Thus, participants in all conditions were given the same monthly productionreports, containing the same accurate activity data. Participants then completed a demo-graphic data form to clear working memory.

Next, participants performed the cost differences recall task based on the eleven dif-ferences between calculated and actual monthly changes in total costs. The year-end costreport and activity cost estimation form then were handed out, and participants performedthe activity cost estimation task. Although all participants encountered the same monthlyactivity data, the year-end cost report provided historical activity data either for all three

4 The information sheet explained to participants that, for various reasons, the cost systems standard rates mightnot be accurate. Participants also were informed that the activity data and total cost data are accurate.

5 Participants were provided with simple calculators for use in determining calculated cost changes and thedifference between the calculated and actual cost changes each month.

6 This statement was made to participants to be consistent with other studies examining memory recall (Libbyand Trotman 1993; Choo and Trotman 1991; Dellarosa and Bourne 1984; Srull 1981; Graesser et al 1982)


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146 Heitger

FIGURE 5

Monthly Production Report

Totals

Production Department Report

March 1998

Changes in

Activity Feb98 Mar98 Activity Levels

Number of machine hours 360 300 60

Number of parts in production 30 42 12

Number of production runs 30 12 18

Given the change in the level of each of the three activities and the beliefs provided on the Information

Sheet about each of the activities impact on total overhead costs, what should be the predicted change

in total overhead costs? $___________

activities or for only a single activity. The year-end cost report, activity cost estimationform, and information sheet then were collected. The order of the cost differences recalltask and the cost estimation task is counterbalanced. Participants who performed the costdifferences recall task before the cost estimation task then performed the same cost differ-ences recall task a second time after completing and turning in the activity cost estimationform and year-end cost report. The experiment concluded with the exit questionnaire.

Description of the Three Tasks and Dependent Variables

Participants perform two main tasks: a cost differences recall task and an activity costestimation task. The cost differences recall task measures participants recall of how closetheir initial cost beliefs calculated change in total costs was to the actual change in total

costs each month. Column 4 (6) of Figure 6 displays these eleven cost differences forparticipants with incorrect (correct) initial cost beliefs. For example, Marchs change inMHs, PARTS, and PRuns is a decrease of 60, an increase of 12, and a decrease of 18,respectively (Table 1). The calculated cost change is a decrease of $46,500 [( 60)($125) (12)($500) (18)($2,500)] for incorrect initial cost beliefs and an increase of $13,500[(60)($125) (12)($2,500) (18)($500)] for correct initial cost beliefs (columns 3and 5 of Figure 6, respectively). Thus, the cost difference between the incorrect (correct)initial cost beliefs calculated cost change and the actual cost changea $12,500 increaseis $59,000 ($1,000).

Variability in the cost differences for individuals with incorrect initial cost beliefs was

intentionally chosen so that some cost differences are small (e.g., seven differences arebetween only $1,000 and $7,000) and some are large (e.g., four differences are between$49 000 and $68 000 with each being more than an order of magnitude greater than the


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FIGURE 6

Differences between Calculated and Actual Monthly Changes in Total Costs for Incorrect and

Correct Initial Cost Beliefs

1 2 3 4 5 6

MONTH

ACTUALCOST

CHANGEa

CALCULATED

COST CHANGE[ForIncorrect

Initial Cost Beliefs]b

COST DIFFERENCE

[ForIncorrect

Initial Cost Beliefs]c,d

(Column 3Column 2)

CALCULATED

COST CHANGE[For Correct

Initial Cost Beliefs]b

COST DIFFERENCE[For Correct

Initial Cost Beliefs]c,d

(Column 5Column 2)

Feb $10,000 $15,000 $5,000 $15,000 $5,000

Mar $12,500 $46,500 $59,000 $13,500 $1,000

Apr $2,500 $61,500 $64,000 $1,500 $4,000

May $32,000 $31,500 $1,000 $31,500 $1,000

Jun $42,500 $46,500 $4,000 $46,500 $4,000

Jul $34,500 $40,500 $6,000 $28,500 $6,000

Aug $14,000 $54,000 $68,000 $18,000 $4,000

Sep $43,000 $6,000 $49,000 $42,000 $1,000

Oct $15,500 $22,500 $7,000 $10,500 $5,000Nov $6,500 $10,500 $4,000 $10,500 $4,000

Dec $6,500 $4,500 $2,000 $4,500 $2,000

aACTUAL COST CHANGE the actual monthly change in total costs.b CALCULATED COST CHANGE the calculated monthly change in total costs given incorrect (column 3) or

correct (column 5) initial cost beliefs and the change in the levels of the three activitiesMHs, PARTS, andPRuns.

c COST DIFFERENCE the difference between the incorrect (column 4) or correct (column 6) initial costbeliefs calculated monthly change in total costs and the actual monthly change in total costs.

d The average absolute value of the cost differences between the calculated and actual monthly cost changesacross all eleven monthly cost differences for participants with incorrect (correct) initial cost beliefs is $24,455($3,364). The greatest absolute value of the cost differences between the calculated and actual monthly cost

changes across all eleven monthly differences for participants with incorrect (correct) initial cost beliefs is$68,000 ($6,000).

mean [$4,143] of the seven small differences). By having both relatively large and smallcost differences, it is possible to examine whether participants recall focuses more on thesmaller differences where the calculated cost changes were relatively close to the actualcost changes. Such a focus, as evidenced by recalling the differences between calculatedand actual cost changes as being smaller than they were in reality, would indicate a tendencyto overemphasize those months in which their initial cost beliefs calculated cost changewas closer (i.e., more similar) to, rather than further (i.e., more dissimilar) from, the actual

cost change.The cost differences recall task asks participants at year-end to recall the average and

greatest of the eleven monthly differences between the calculated change in total costs andthe actual change in total costs. Participants were told to disregard the sign of the differencesand consider the absolute value. RECAVGD (RECGRTD) is defined for each participant asthe actual average (greatest) absolute value of the cost differences minus the participantsrecalled average (greatest) absolute value of the cost differences. A positive RECAVGD(RECGRTD) indicates that the participant recalls the average (greatest) cost difference tobe smaller than it is in reality. Thus, RECAVGD (RECGRTD) provides a measure of theextent to which participants anchor on their initial cost beliefs when recalling the average


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148 Heitger

(greatest) cost difference between calculated and actual changes in total costs and is usedin supplementary analyses in the Results section.7

The activity cost estimation task asks participants at year-end to estimate the activitycost for MHs, PARTS, and PRuns for use in the following Januarys budget. Participants

were instructed to base their estimates solely on the twelve months of activity and totalcost data and to ignore the initial cost beliefs provided on the information sheet. They alsowere told that fixed costs were projected not to change. Only the information sheet and theyear-end cost report were available to participants for this task.

For each of the three activity cost estimates, the estimated activity cost was subtractedfrom the actual activity cost, which produced an error for each estimate. The absolute valueof the estimation error was then taken so that errors in either direction were treated in thesame way and did not offset each other. Finally, the absolute value of the estimation errorwas subtracted from 3,000 in order to convert the measure from one of error to one ofaccuracy. Discussing the results in terms of accuracy, rather than error, is more straight-forward and is consistent with the second section. A perfect cost estimate would be equal

to the actual activity cost, thereby yielding no error and an accuracy measure of 3,000.Total estimation accuracy for each participant is the sum of the three accuracy scores. Giventhat there are three activity cost estimates, the maximum activity cost estimation accuracyscore for any individual is 9,000. Table 2 shows the procedure for determining the accuracyof each cost estimate. Total estimation accuracy serves as the dependent variable in testsof the hypotheses.

RESULTSManipulation Checks

To examine the initial cost beliefs manipulation, the exit questionnaire asked partici-

pants to identify from a list of four alternatives ($125, $500, $2,500, and unsure) the costbelief for each activity that was provided on the information sheet. Ninety-nine percent ofparticipants selected the appropriate initial cost belief for all three activities. Also, theywere asked to recall the experiments first month and report, on a scale from $0 to $2,500,the amount they expected total costs to change for each one-unit change in each activity.Table 3 reports the results of t-tests that were employed to examine participants responsesto the manipulations. Participants responded as expected for each activity (questions 13,Table 3). For example, the t-test results for questions 13 illustrate that between the correctand incorrect initial cost beliefs conditions, participants beliefs did not differ regardingMHs, but did differ regarding PARTS and PRuns. Thus, the initial cost beliefs manipulation

was successful.To examine the cost system manipulation, participants were asked about the standardrates on their monthly cost reports and the historical activity data on their year-end costreport. First, they were asked about the likelihood on a scale from 0 (strongly disagree) to100 (strongly agree) that their monthly cost reports provided a standard rate for MHs,PARTS, and PRuns and whether the cost systems standard rate(s) was accurate. Participants

7 After the cost differences recall task, participants were presented with actual total costs and MHs for all monthsand were asked to recall PARTS and PRuns for each month. The purpose of this brief exercise was to determinewhether participants in the single cost pool and control conditions, where historical activity data was providedonly for MHs, were able to recall significant quantities of historical data for the other two activities. As wouldbe expected, participants were unable to recall significant quantities of historical data for either PARTS or PRuns.

Thus, as anticipated, historical activity data were available to participants at year-end when they estimated costsonly if they were provided by the multiple cost pool system.


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TABLE 2

Total Activity Cost Estimation Accuracy:a Descriptive Statistics

COST SYSTEM

SINGLECOST POOL CONTROL

MULTIPLECOST POOL

INITIALCOST

BELIEFS

CORb A8,641c

(287)[18]

B8,323(661)[18]

C8,201(613)[18]

8,388(568)

INC

D5,498(717)[18]

E6,105(824)[18]

F7,192

(1,058)[17]

6,248(1,108)

7,070

(502)

7,214

(742)

7,697

(829)

7,328

(1,385)a Total activity cost estimation accuracy the sum of the accuracy of each of the three individual activity cost

estimates, with each being calculated as follows:

3,000 actual activity cost estimated activity cost.

Thus, the maximum total accuracy score is 9,000, which results if there is no difference between the actualactivity cost and the estimated activity cost for any of the three activity cost estimates.

b COR (INC) correct (incorrect) initial cost beliefs.c Cells contain means, (standard deviations), and the [number of observations].

responded as expected for each rate (questions 410, Table 3). Also, participants appro-priately reported that they understood the rate(s) might have been inaccurate (mean responseof 75.82). Thus, participants generally understood which activities did and did not have astandard rate provided on their monthly cost reports.

Second, participants were asked about the likelihood on the same 0 to 100 scale thattheir year-end cost report provided the actual number ofMHs, PARTS, and PRuns for allmonths. Participants responded as expected for each activity (questions 1116, Table 3).Thus, participants understood which activity data were and were not provided on their year-end cost report. Participants also reported on the same scale that they generally understoodthe activity data provided on the production reports and cost reports were accurate (mean

response of 72.05). Finally, participants reported on the same scale that they understoodthat actual total costs contained an element of random variation (mean response of 86.88).Thus, the cost system manipulation was successful.

Two Elements of Multiple Cost Pool Systems: Historical Activity Data andStandard Rates

Table 2 presents descriptive statistics for cost estimation accuracy.8 Panel A of Table 4reports the ANOVA results. The ANOVA results show a significant main effect for initialcost beliefs. The ANOVA results also show a significant main effect for cost system. Most

8 No order effects were detected; therefore, all data are combined and analyzed collectively regardless of taskorder. Similar tests indicated that order has no effect on recall of the average or greatest cost differences.


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150 Heitger

TABLE 3

Results of Manipulation Checks

1

Questionb

2a

Mean ComparisonBetween:

3

t-stat.c

4

p-value

1. At the beginning of the firstmonth, by what amount did youexpect total overhead costs wouldchange for each one-unit changein Machine Hours?(scaled from $0 to $2,500)

CORd

$192(116)[54]

INC$170(139)[53]

.88 .380

2. At the beginning of the firstmonth, by what amount did youexpect total overhead costs wouldchange for each one-unit change

in Parts?(scaled from $0 to $2,500)

COR$2,296(556)[54]

INC$585(263)[53]

20.28 .001

3. At the beginning of the firstmonth, by what amount did youexpect total overhead costs wouldchange for each one-unit changein Production Runs?(scaled from $0 to $2,500)

COR$607(406)[54]

INC$2,283(588)[53]

17.19 .001

4. My Monthly Cost Reportscontained a Standard Cost Ratefor MHs.(scaled from 0 to 100)

SINGLE92.92

(16.92)[36]

50 15.22 .001


CONTROL85.81

(27.11)[36]

50 7.93 .001


MULTIPLE78.86

(29.08)[35]

50 5.87 .001

7. My Monthly Cost Reportscontained a Standard Cost Ratefor Parts.(scaled from 0 to 100)

SINGLE28.47

(38.49)[36]

MULTIPLE78.86

(29.08)[35]

6.21 .001

8. My Monthly Cost Reportscontained a Standard Cost Ratefor Parts.(scaled from 0 to 100)

SINGLE28.47

(38.49)[36]

CONTROL85.81

(26.58)[36]

7.36 .001

9. My Monthly Cost Reportscontained a Standard Cost Ratefor PRuns.(scaled from 0 to 100)

SINGLEc

29.03(39.09)

[36]

MULTIPLE78.86

(29.08)[35]

6.08 .001

10. My Monthly Cost Reportscontained a Standard Cost Ratefor PRuns.(scaled from 0 to 100)

SINGLE29.03

(39.09)[36]

CONTROL85.81

(26.58)[36]

7.21 .001

(continued on next page)


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TABLE 3 (Continued)

1

Question

2a

Mean ComparisonBetween:

3

t-stat.b

4

p-value

11. My Year-end Cost Reportcontained the actual number ofMHs for each month.(scaled from 0 to 100)

MULTIPLE74.57

(34.59)[35]

SINGLE81.94

(29.45)[36]

.97 .340

12. My Year-end Cost Reportcontained the actual number ofMHs for each month.(scaled from 0 to 100)

MULTIPLE74.57

(34.59)[35]

CONTROL84.94

(25.63)[36]

1.44 .160

13. My Year-end Cost Reportcontained the actual number ofParts for each month.

(scaled from 0 to 100)

MULTIPLE69.43

(38.80)

[35]

SINGLE21.94

(32.14)

[36]

5.62 .001

14. My Year-end Cost Reportcontained the actual number ofParts for each month.(scaled from 0 to 100)

MULTIPLE69.43

(38.80)[35]

CONTROL24.39

(38.00)[36]

4.94 .001

15. My Year-end Cost Reportcontained the actual number ofProduction Runs for each month.(scaled from 0 to 100)

MULTIPLE69.71

(38.46)[35]

SINGLE25.56

(35.01)[36]

5.06 .001

16. My Year-end Cost Reportcontained the actual number ofProduction Runs for each month.

(scaled from 0 to 100)

MULTIPLE69.71

(38.46)

[35]

CONTROL24.39

(38.00)

[36]

5.00 .001

a Column 2 contains means, (standard deviations), and [number of observations].b For questions 416, participants indicated whether they agreed (100) or disagreed (0).c All t-tests are two-sample, two-tailed in nature except for those pertaining to questions 46, which are one-

sample, one-tailed.d COR (INC) correct (incorrect) initial cost beliefs; SINGLE single cost pool condition; CONTROL

control cost condition; MULTIPLE multiple cost pool condition.

importantly, as predicted in H1 and H2, the results show a significant interaction betweeninitial cost beliefs and cost system. Preplanned comparisons were employed to analyzewhether the nature of the interaction is consistent with that predicted in H1 and H2. Spe-cifically, four two-sample, one-tailed t-tests were conducted to examine the four individualtwo-cell comparisons involved in H1 and H2. Panel B of Figure 2 graphically shows thesix cells (AF) involved in these four comparisons. The results of these preplanned com-parisons are reported in Panel B of Table 4.

Consistent with H1, for individuals with incorrect beliefs, the multiple cost pool sys-tems provision of historical activity data for multiple activities increases cost estimationaccuracy relative to the provision of historical activity data for only a single activity [meanaccuracy in cell F is greater than in cell E (t 3.40, p .01)]. Also consistent with H1,for individuals with correct beliefs, the multiple cost pool systems provision of historical

activity data for multiple activities has no effect on cost estimation accuracy relative to the


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152 Heitger

TABLE 4

Total Activity Cost Estimation Accuracy: Results of ANOVA and Preplanned Comparisons

Panel A: 2 3 (ICB CSYS) ANOVA

FactorSum ofSquares df Mean Square F-stat p-value

ICBa 120,529,294 1 120,529,294 228.01 .001

CSYS 7,618,373 2 3,809,187 7.21 .001

ICB CSYS 20,309,406 2 10,154,703 19.21 .001

Explained 148,457,073 5 29,691,415 56.17 .001

Residual 53,390,134 101 528,615

Total 201,847,207 106 1,904,219

Panel B: Preplanned Comparisons to Test H1 and H2

1b

Mean Comparison Between:2

Hyp.3

t-stat.d4

p-value5df

6c

r

F (INC, MULTIPLE)e

7,192(1,058)

[17]

E (INC, CONTROL)6,105(824)[18]

H1 3.40 .01 33 .510

C (COR, MULTIPLE)8,201(613)[18]

B (COR, CONTROL)8,323(661)[18]

H1 .57 .29 34 .098

E (INC, CONTROL)

6,105(824)[18]

D (INC, SINGLE)

5,498(717)[18]

H2 2.36

.01 34 .375

B (COR, CONTROL)8,323(661)[18]

A (COR, SINGLE)8,641(287)[18]

H2 1.88 .03 34 .307

aICB initial cost beliefs; CSYS cost system.b Column 1 contains means, (standard deviations), and [number of observations].c Column 5 presents r as a measure of effect size (Rosenthal and Rosnow 1985).d All t-tests are one-tailed.e A through F refer to the six experimental conditions shown in Table 2 and Panel B of Figure 2. COR (INC)

participants with correct (incorrect) initial cost beliefs. SINGLE, CONTROL, and MULTIPLE

the costsystem conditions.

provision of historical activity data for only a single activity [mean accuracy in cell C isnot different from that in cell B (t .57, p .29)].9

Consistent with H2, for individuals with incorrect beliefs, the multiple cost pool sys-tems provision of a biased standard rate for multiple activities increases cost estimation

9 It is possible that some participants made informal adjustments to their initial cost beliefs during one or moremonths, such that their year-end cost estimates were a result not only of their year-end adjustments from theirinitial cost beliefs but also their monthly adjustments from their initial cost beliefs. Measuring and testing thisdistinction would be of interest for future research


21/28


accuracy relative to the provision of a biased standard rate for only a single activity [meanaccuracy in cell E is greater than in cell D (t 2.36, p .01)]. Also consistent with H2,for individuals with correct beliefs, the multiple cost pool systems provision of a biasedstandard rate for multiple activities decreases cost estimation accuracy relative to the pro-

vision of a biased standard rate for only a single activity [mean accuracy in cell B is lessthan in cell A (t 1.88, p .03)].10 Thus, the results support both H1 and H2.11

Supplementary AnalysisAnchoring on Initial Cost Beliefs

As discussed in the Hypothesis Development section, I expected individuals to anchoron their initial cost beliefs when estimating costs. Individuals anchoring on their initialbeliefs are expected to perceive the monthly differences between their initial cost beliefscalculated change in total costs and the actual change in total costs as being smallerthanthey were in reality. Thus, individuals recall of the average (and greatest) of these elevenmonthly cost differences is examined. Table 5 displays the descriptive statistics for mean

RECAVGD and RECGRTD. Mean RECAVGD for participants with incorrect beliefs is$12,463, indicating that they recalled the average cost difference to be significantly less(i.e., almost 50 percent smaller) than the actual average cost difference of $24,455 (t 12.660, p .001). Also, mean RECGRTD for participants with incorrect beliefs is$48,163, indicating that they recalled the greatest cost difference to be significantly less(i.e., 29 percent smaller) than the actual greatest cost difference of $68,000 (t 8.406,p .001). Further, 94 percent and 92 percent of participants recalled the average andgreatest cost differences, respectively, as being smaller than they were in reality. Thus, asexpected, participants with incorrect beliefs appear to anchor on their beliefs as evidencedby their misperception of the size of the monthly differences between their calculated costs

changes and actual costs changes.

The Relationship between Anchoring on Initial Cost Beliefs and CostEstimation Accuracy

The extent to which participants adjust from their initial cost beliefs when estimatingcosts likely is based on the extent to which they believe that such beliefs are incorrect.Thus, the smaller the recalled monthly cost differences, the more that individuals are likelyto anchor on their initial beliefs and make fewer adjustments from such beliefs when es-timating costs. Reduced adjustment from initial beliefs is detrimental to cost estimationaccuracy when individuals beliefs are incorrect. Therefore, the relationship between par-ticipants anchoring on initial beliefs, as measured by their year-end recall of the average

monthly cost differences, and their cost estimation accuracy is examined. For participantswith incorrect beliefs, RECAVGD is negatively correlated with cost estimation accuracy [r .203, p .074 (one-tailed)].12 Thus, as expected, the smaller the recalled average cost

10 Participants in the experiment correctly reported that they understood that the standard rates might be inaccurateand were provided with twelve months of data over which to observe the degree of inaccuracy in the rates.However, it is possible that participants might have been better in recognizing the degree of inaccuracy in therates had they been given additional monthly data.

11 ANCOVA analyses indicate that SAT scores, ACT scores, GMAT scores, and GPA are not associated with costestimation accuracy and do not alter the relationship between cost estimation accuracy and either initial costbeliefs or cost system. Also, ANOVA analyses indicate that the number of completed statistics courses, yearsof business experience (the 50 MBA participants possessed a mean [maximum] of four [ten] years of professionalbusiness experience), academic degree, and gender are not associated with cost estimation accuracy. Thus, theresults do not appear to be driven by these potential covariates.

12 Individuals recalled greatest difference between calculated and actual changes in total costs (RECGRTD) is notassociated with activity cost estimation accuracy (r 165 p 121)


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154 Heitger

TABLE 5

RECAVGDa and RECGRTDb: Descriptive Statistics

COST SYSTEM


MULTIPLECOST POOL

INITIALCOST

BELIEFSCORc

ARECAVGDd

2,992(1,669)

BRECAVGD

3,085(1,538)

CRECAVGD

3,206(2,101)

3,090(1,739)

RECGRTD8,139

(5,067)[18]

RECGRTD7,444

(4,728)[18]

RECGRTD10,156(9,387)

[16]8,519

(6,575)

INC

D

RECAVGD11,859(6,240)

E

RECAVGD14,306(8,568)

F

RECAVGD11,118(5,064)

12,463(6,830)

RECGRTD50,000

(15,379)[17]

RECGRTD44,778

(18,448)[18]

RECGRTD49,912

(17,472)[17]

48,163(17,017)

7,299(6,319)

8,695(8,318)

7,282(5,569)

7,777(6,839)

28,471(23,974)

26,111(23,121)

30,636(24,516)

28,341(23,697)

a The average absolute value of the cost difference between the calculated monthly change in total costs and theactual monthly change in total costs across all months is $3,364 ( CORsee Figure 7, column 6) and $24,455(INCsee Figure 7, column 4). The mean recalled average cost difference (RECAVGD) is $3,090 (COR) and$12,463 (INC).

b The greatest absolute value of the cost difference between the calculated monthly change in total costs and theactual monthly change in total costs across all months is $6,000 (CORsee Figure 7, column 6) and $68,000(INCsee Figure 7, column 4). The mean recalled greatest cost difference (RECGRTD) is $8,519 (COR) and$48,163 (INC).

c COR (INC) correct (incorrect) initial cost beliefs.d Cells contain means, (standard deviations), and [number of observations].

difference between calculated and actual changes in total costs, the less accurate the activitycost estimates. This finding suggests that participants cost estimation accuracy decreasesas the extent to which they anchor on their incorrect initial beliefs increases, which isimportant in establishing that recall of historical data plays a significant role in costestimation.

Reducing Anchoring on Initial Cost Beliefs by Providing Historical Activity DataThe multiple cost pool systems provision of historical data for multiple activities (Fig-

ure 1, F), together with historical total cost data, allows individuals to observe once againthe monthly differences between calculated changes in total costs (based on their initial

cost beliefs) and actual changes in total costs. For individuals with incorrect initial beliefs,this observation is expected to lead them to realize that these differences are greater thanthey had recalled thereby increasing the extent to which they make adjustments from their


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156 Heitger

TABLE 6

Change inRECAVGD: RECAVGDa

COST SYSTEM


MULTIPLECOST POOL

INITIALCOST

BELIEFSCORb

A3,000c

(5,963)[t 1.509]{p .170}

8

B2,955

(6,753)[t 1.384]{p .200}

9

C40

(1,970)[t .064]

{p .950}9

1,964(5,300)

INC

D250

(2,937)[t .269]{p .794}

9

E5,389(11,033)

[t 1.465]{p .181}

8

F4,722

(4,777)[t 2.966]d

{p .009}8

304(7,921)

1,289(4,785)

997(9,759)

2,258(4,225)

850(6,753)

a RECAVGD is the change in participants recall of the average difference, measured both before (Pre) theactivity cost estimation task and after (Post) the activity cost estimation task. Specifically, RECAVGD PostYear-end Cost Report RECAVGD Pre Year-end Cost Report RECAVGD. RECAVGD is a within-subjectsmeasure and pertains only to participants who perform the cost differences recall task before the activity costestimation task. A positive RECAVGD indicates that RECAVGD is larger after seeing the year-end cost reportthan before seeing the year-end cost report.

b COR (INC) correct (incorrect) initial cost beliefs.c

Cells contain means, (standard deviations), [t-statistics], {p-values}, and

degrees of freedom

.d A directional expectation about RECAVGD is present only for cell F. Thus, a one-tailed test is used in cell Fwhile a two-tailed test is used in the other five cells.

and outsourcing. This study examines the effects of initial cost beliefs and type of costsystem on individuals activity cost estimation accuracy. Understanding how these twofactors affect individuals cost estimation accuracy is important because individuals oftenpossess incorrect initial beliefs about the costs they subsequently estimate and operate undera multiple cost pool system that provide biased standard rates. However, such biased costsystems often provide accurate historical activity data that is predicted to improve individ-uals adjustments from their incorrect initial cost beliefs when they estimate costs, thereby

increasing their cost estimation accuracy.As expected, the results show that the multiple cost pool systems provision of accurate

historical data for multiple activities improves activity cost estimation accuracy, relative toa single cost pool system that does not provide such data, for individuals with incorrectcost beliefs. This benefit to cost estimation accuracy occurs even though the multiple costpool system provides biased standard rates for each activity. The provision of historicalactivity data has no effect on cost estimation accuracy for individuals with correct costbeliefs. Also, the multiple cost pool systems provision of biased standard rates for multipleactivities increases cost estimation accuracy for individuals with incorrect cost beliefs, anddecreases cost estimation accuracy for individuals with correct cost beliefs. This result

occurs because the biased rates are more accurate than individuals incorrect beliefs butless accurate than individuals correct beliefs. Thus, combining the effects of these two costsystem elements (historical activity data and biased standard rates) the biased multiple cost


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pool system increases cost estimation accuracy for individuals with incorrect beliefs butdecreases cost estimation accuracy for individuals with correct beliefs.16

In addition, the results of supplementary analyses provide some evidence as to whythe multiple cost pool systems provision of historical activity data improves cost estimation

accuracy for individuals with incorrect initial cost beliefs. The results indicate that whenestimating activity costs, individuals recall of historical activity data anchors on their in-correct initial cost beliefs. Further, for individuals with incorrect cost beliefs, the extent towhich recall is anchored on initial beliefs is negatively associated with cost estimationaccuracy. Finally, the analyses suggest that the multiple cost pool systems provision ofhistorical activity data improves cost estimation accuracy by reducing the extent to whichindividuals recall of historical data anchors on their incorrect initial beliefs when estimatingactivity costs.

This study extends prior research on the judgment effects of cost system design byshowing that multiple cost pool systems can improve individuals cost estimation accuracyby mechanisms other than the provision of accurate standard rates. Specifically, the papers

main finding that the provision of accurate historical activity data improves cost estimationaccuracy for individuals with incorrect cost beliefs has implications for the tradeoff thatfirms face in designing alternate cost systems. For example, when designing a multiple costpool system, firms may need to decide how to allocate limited resources between a systemthat provides accurate historical activity data versus one that provides accurate standardrates. Given the results of this study, greater emphasis might be placed on designing asystem that provides individuals with accurate historical activity data when they estimatecosts, especially when they are likely to possess incorrect cost beliefs. Future research mightexamine other mechanisms by which multiple cost pool systems, and their specific features,affect cost estimation accuracy. In so doing, future research should consider this papers

finding that the judgment effects of flawed cost systems might depend on the cost beliefsheld by managers, as well as other environmental factors not examined in this study.Finally, it is interesting to note that the most accurate cost estimates are produced by

individuals with correct initial beliefs in the single cost pool system. Future research mightexamine why individuals with correct initial beliefs use biased standard rates (that arerelatively less accurate than their beliefs) from a multiple cost pool system to makeaccuracy-decreasing adjustments to their initial cost beliefs even when they understand thatthe rates might not be accurate. Such research could help individuals better understand theconditions under which to use the cost systems standard rates in estimating costs and whento ignore such rates.

Like all research, this study is subject to limitations. The cost of storing, accessing,

and providing individuals with historical activity data might be considerable but is ignoredin this study. Also, this study assumes that the activity data provided to individuals areaccurate, which is not always true in reality. Future research might examine how accuratelyfirms measure activity data, as well as the costs and technology necessary to measure suchdata accurately.

16 Thus, the examination of correct cost beliefs is important because it helps demonstrate empirically that a biasedcost system can have a beneficial or detrimental effect on individuals cost estimation accuracy depending uponwhether their cost beliefs are incorrect or correct. As such, future research should consider that the judgmenteffects of flawed cost systems might depend on the cost beliefs held by managers, as well as other environmentalfactors not examined in this study


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158 Heitger

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