Absorption Versus Direct Costing : The Relevance of Opportunity Costs in the Management of Congested Stochastic Production Systems

This paper investigates the relative performance of absorption versus direct costing procedures. Traditionally absorption costing procedures have been defended on the basis of them acting as a proxy for hard to measure opportunity costs. We question the validity of this traditional defence by explicitly considering the extent to which absorption costing based accounting calculations actually provide good proxies. Our analysis shows that in some situations absorption costing so over estimates opportunity costs that it would be preferable to use direct costing even though this implicitly assumes opportunity costs are zero. Thus, given that we establish that one can not always use the existence of opportunity costs as a defence for the adoption of absorption costing procedures we next identify specific conditions for which if satisfied, we can unambiguously defend the adoption of absorption costing. We develop an quot;open acceptance conditionquot; which if satisfied insures that a production system directed by absorption costs out performs a system based upon direct costs