Economic Implications of Single Cost Driver Systems

We subject claims about the benefits of activity-based costing systems to the scrutiny of analytical models incorporating rational behavior by users of product costing systems. We find that a monopolist Is almost always strictly better off using multiple cost drivers as in an activity-based costing (ABC) system even when the system makes measurement errors in assigning overhead costs to activities. More importantly, we show that this result replicates for firms competing in an oligopoly when the cost and demand parameters are in steady state. The firms are strictly better off using a direct labor based single cost driver (SCO) system, however, if the demand for the overcosted labor intensive product is expected to grow sufficiently relative to the demand for the undercosted setup intensive product. This suggests that, facing imperfect competition, it is sometimes optimal for firms to persist in using a single cost driver system rather than switching to an activity-based cost system. • u>