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Environmental considerations in product mix decisions using ABC and TOC: as environmental issues increasingly influence corporate performance, they need to be a standard part of management accounting systems.

Article Excerpt
One of the primary objections to the environmental movement is that it is too costly to businesses, which could place them at an economic disadvantage, especially when competing head-on with foreign companies unhampered by similar cumbersome and costly regulations. Increasingly, companies are faced with pressures from government, stockholders, and the public to improve their environmental records while achieving profitability goals to keep Wall Street happy. Some companies are finding, however, that going beyond regulatory compliance can create value for customers and shareholders alike. With so many pressures, how can management best make profitable choices between investing scarce resources to reduce environmental waste or to increase throughput and profit?

As environmental issues increasingly influence corporate performance, they need to be institutionalized in management accounting systems. (1) Manufacturers need information from their management accounting systems for maximizing profit, given environmental spending. A 1994 article in Management Accounting by Jerry Kreuze and Gale Newell supports the use of activity-based costing (ABC) in conjunction with life-cycle costing for allocating environmental costs to products to get a handle on what those costs are. (2) (Life-cycle costing tracks costs over the entire product life cycle "from cradle to grave.") Their article illustrates the implications on profitability analysis from using the theoretically more accurate ABC system to allocate environmental costs to products that generate those costs. The illustration, however, does not consider constraints in the production process, so the product mix decisions made from ABC information may not facilitate profit maximization goals.

COMPARISON of ABC and TOC
ABC TOC

Focus Cost control Profit maximization

Method(s) Reduce activities Maximize utilization
of the constraint
Simplify processes Simplify control
Reduce product Eliminate nonvalue-
offerings added activities/
actions

Treatment of Identifies unused Identifies resource
Capacity capacity if the usage on each resource
practical volume of and determines if a
the cost driver is constraint exists
used to calculate
rates
If anticipated or Focuses on the
normal capacity constraint, if
volumes are used for internal, by maximizing
the cost driver profit over the
rates, capacity is constraint through
ignored prioritization of
production given
throughput/(amount
needed per unit of
the constraint)

Cost Behavior All allocated costs Most costs are fixed
Assumptions are variable

Variable Cost Unit-, Batch-, and Only Unit-level costs
Product-level costs are variable
are variable

Step-Fixed As activity usage Step-fixed costs
Cost Behavior decreases, so does change only at the
the cost of the edges of the steps
activity

Catalysts for Allocating costs is Viewing fixed costs
Cost Control the best way to in a lump sum and
control the cost by expensing the cost in
encouraging the its entirety is a
reduction of the cost strong motivator to
to produce one unit control the cost

Timing of Expense most Expense most
Expenses production costs production costs in
when the unit is sold the period they are
incurred

Items that Sales and Production Sales levels impact
Impact Income levels can impact income
income


Two methods of evaluating product mix decisions given an environmental constraint include ABC and the Theory of Constraints (TOC). While ABC is important for understanding how environmental spending affects product cost, it does not necessarily help in making decisions to reduce the most environmentally damaging products from the mix. Under certain conditions, TOC may be the better choice for maximizing profit while minimizing the production of products causing the most environmental damage.

ABC, TOC, AND DIFFERING ASSUMPTIONS

Both ABC and TOC appeared in literature during the decade of the 1980s. Robin Cooper and Robert S. Kaplan popularized ABC to trace costs to products based on the way each product uses resources. (3) ABC recognizes...

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