Costing Systems and the Spare Capacity Conundrum: Avoiding the Death Spiral

28 Pages Posted: 27 Mar 2012

See all articles by Ken Bates

Ken Bates

Victoria University of Wellington - School of Accounting and Commercial Law

John H. Bradshaw

Victoria University of Wellington - School of Accounting and Commercial Law

Date Written: December 2011

Abstract

We hear how firms have to become lean, eliminate non-value added activities and strive to maximise asset utilisation, but there are inevitably firms with excess capacity that need relevant information to manage the cost of the under utilisation of resources. In this paper we question whether cost system designers have been taking appropriate account of the capacity issue, and ask whether the costing systems employed are sufficiently adaptable for fluctuating levels of capacity utilisation. We note that the capacity issue has received diminishing attention in the literature since the 1960s, and identify the dangers of not identifying the cost of spare capacity. We demonstrate how improper cost system design or usage can draw the firm into the death spiral. This danger not only exists when moving into a recession but also when recovering and resuming growth. We describe two cases that demonstrate potential pitfalls and alternative approaches to the capacity issue. The manufacturing case is an SME with a traditional costing system that was hindering management’s pricing and product mix decisions. Fortunately the death spiral was avoided as it was recognised that significant spare capacity was distorting costs and prices when the firm continued to base overhead absorption on budgeted production volumes. The service case relates to a large financial services company that implemented a complex activity based costing system and gained a much greater understanding of resource consumption and capacity utilisation, and hence established more effective cost control in their back office operations.

Suggested Citation

Bates, Ken and Bradshaw, John H., Costing Systems and the Spare Capacity Conundrum: Avoiding the Death Spiral (December 2011). Available at SSRN: https://ssrn.com/abstract=2028699 or http://dx.doi.org/10.2139/ssrn.2028699

Ken Bates (Contact Author)

Victoria University of Wellington - School of Accounting and Commercial Law ( email )

New Zealand
+64 4 463 6474 (Phone)
+64 4 463 5076 (Fax)

John H. Bradshaw

Victoria University of Wellington - School of Accounting and Commercial Law ( email )

Faculty of Commerce and Administration
PO Box 600
Wellington
New Zealand

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