Reviews the book "Cost Determination: A Conceptual Approach," by Joel S. Demski and Gerald A. Feltham.

ABSTRACT: Methodologically this paper represents a synthesis and a critique of various probabilistic approaches to "return on investment" (ROI) and "residual income" (RI). Starting with assumed normality of basic underlying variables, the paper proceeds to consider more complex circumstances revolving simulation and alternatives thereto. RI is judged more versatile than ROI. Assuming normality of basic underlying variables, RI always can be assumed normal, whereas ROI cannot. This facilitates determining probability intervals through analytically derived means and variances. In more complex cases, frequency distributions available with simulation contain data for constructing probability intervals. Where simulation is not used, it is concluded that the real world applicability of Kolmogorov-Smirnov and Cramer-von Mises goodness-of-fit tests, and especially Tchebycheff-type inequalities, can be limited. Thus, high, medium and low estimates of ROI and RI are considered viable alternatives to estimating specific probability intervals.

The article focuses on the American Accounting Association (AAA) that has exercised some influence on the Uniform Certified Public Accountants (CPA) Examination through its Committee on CPA Examinations. One of the recommendations made by the 1948 committee was that there should be established a special or standing committee of AAA to cooperate with the Board of Examiners and the Director of Education of AAA Committee on CPA Examinations. The best way to evaluate the kinds of activities taken on by the Committee on CPA Examinations and the results achieved is to consider some of the conclusions, results and unanswered questions left in the wake of twenty years of activity. Somewhat related to its distinction between general and special knowledge and abilities is the 1961 Committee's conclusion that as soon as feasible a fifth year of study in accountancy and related areas should become a requirement. The committee felt that such use of a fifth year would yield greater assurance that the candidate's degree is reliable evidence of his general knowledge.

The essential conclusion of this paper is that investment and financing decisions must be kept separate. The ability to identify specific sources of funds with specific investment proposals is, at best, an illusion. This point of view is supported by an argument analogous to that applicable to many joint-cost problems of accounting as well as by the "pool of projects" and the "pool of funds" concepts. Investment decisions should be evaluated by the usual cash-flow techniques, as illustrated in this paper. The decision to finance by alternative methods should be based on the rate of interest to be charged which could legitimately be adjusted for differences in restrictions inherent in alternative sources of borrowed funds. Great care must be exercised to avoid the pitfall of constructing illusory discounted cash-flow differentials which are based upon apparent but not real differences in the amount of borrowings. As for leasing, the essential features of a long-term, non-cancellable lease must be understood; it is partially a method of financing and partially a method of investing. For proper evaluation, the financing aspects should be eliminated at the lowest rate of interest available to the company. With financing eliminated, the lease can then be compared to an outright purchase to determine which is the least costly method of acquiring the services of the equipment or facilities under consideration.

The article focuses on two points of view concerning the cost categories relevant to income measurement. The ultimate conclusion of the argument is that the fixed costs of production are costs without service potential since their incurrence in one period has no effect on whether they will be incurred in the future. Variable production costs on the other hand do have service potential since their incurrence today will overcome the need for their incurrence in the future. The essence of the argument seems to be contained in the idea that the only costs, which will be reduced in the future because they are incurred today, are variable costs since the fixed costs will remain the same with or without the production of goods, which are included in the inventory. In other words, the value of the inventory is determined only by the extra costs occasioned by producing the inventory. These costs are variable costs of production since the fixed costs of production would be the same with or without the production of the inventory. The idea of opportunity costs is certainly much broader in its possible impact on accounting theory than its position in the Sorter-Horngren thesis of "relevant costing."

Income can be measured properly only when every attempt is made to segregate and allocate overhead costs to units of output so that costs of products may be matched or associated with the revenues derived from the sale of merchandise. To accomplish this task the generally accepted fixed-variable cost breakdown should be discarded for income measurement purposes. The straight-line amortization of costs associated with fixed assets should also be discarded. In place of straight-line amortization, a unit-of-output amortization plan or an approximation thereto should be used. The approximation would be the cycle overhead concept. The fixed cost portion of semi-variable cost inputs should be reassociated with their variable counterparts and then allocated to the output for which they were absolutely necessary elements of production. Finally, unit costs should be allowed to fluctuate with volume within the range for which semi-variable cost inputs are absolutely necessary costs of production.

The purpose of the article is to set forth the general view that there is no such thing as a loss due to idle capacity for purposes of income measurement. In order to illustrate this point of view the fixed or capacity costs of manufacturing will be classified as capacity costs related to fixed assets and capacity costs related to semi- variable costs. In each case the concept of an idle capacity loss will be shown to be inconsistent with the process of income measurement. The portion of fixed manufacturing overhead costs related to fixed assets should be allocated to production under a unit-of-output amortization plan which cannot yield an idle capacity loss. The portion of fixed manufacturing overhead costs related to semi-variable cost inputs should be allocated to whatever output is produced within the range for which these costs are absolutely necessary, therefore they cannot yield an idle capacity loss on the basis of changes in production volume. Since there are no other categories of fixed manufacturing overhead costs and variable overhead costs are allocated to actual output, idle capacity as a loss does not really exist.

Reviews the book "Implementing Activity-Based Cost Management: Moving From Analysis to Action," by Robin Cooper, Robert S. Kaplan, Lawrence S. Maisel, Eileen Morrissey and Ronald N. Oehn.

Reviews the book "Cost-Effectiveness Analysis: New Approaches in Decision-Making," edited by Thomas A. Goldman.

The period cost concept divides cost data into two broad categories, firstly, "Period" costs which are those costs related to time, i.e., those costs which expire with the passage of time rather than with the volume of business activity, and secondly, "product" costs which include those costs which relate to the product being produced, i.e., those costs which are directly affected by the volume of business activity. Under the period cost concept as it relates to income measurement only variable manufacturing costs are considered inventoriable while fixed manufacturing costs as well as selling and administrative costs are period costs. In general the accounting profession does not accept for income measurement purposes the treatment of fixed manufacturing costs as period costs. Conversely the accounting profession has accepted for many years a period cost approach to the handling of selling and administrative costs. In this article the authors will show that the period cost concept is not appropriate for purposes of income measurement. It is the intention of this article to show that categorizations of cost such as period costs vs. product costs are not relevant to the process of income measurement.