Reviewed by Eric Brucker University of Delaware
This collection of eighteen articles, including ten written by Wells, addresses three controversies in managerial accounting: the allocation of overhead costs, the establishment of internal transfer prices, and the amortization of deferred charges. Wells analyzes the various viewpoints within the context of a profit maximizing theory of the firm and the associated marginal conditions. Overall the author clearly succeeds in meeting his self-imposed goal of stimulating the reader to “think a little more about what accounting is, and what it could or should be.
The stage is set by reviewing the competing theories of the firm. Machlup’s 1967 classic, “Theories of the Firm: Marginalist, Behavioral, Managerial,” provides an excellent overview. Machlup primarily defends marginalism on grounds of its superior predictive power rather than on the realism of the profit maximizing assumption. However, in two empirical articles examining managers’ motivations, Wells suggests that the assumption may be realistic. While Wells presents interesting data, Machlup’s justification remains the more convincing.
With the case for marginalism stated, Wells presents well rea-soned arguments against the allocation of overhead costs of products or operating divisions within an organization. Similarly, the practice of establishing transfer prices is convincingly questioned. In his view, attempts to alter divisional managerial behavior by distributing cost and impacting divisional profits will succeed in changing behavior. However, the change will almost certainly cause the firm to move away from a profit maximizing allocation. Overhead allocation formulas and arbitrary transfer prices based upon historical accounting data rather than current market prices do not motivate managers to behave in accordance with marginal principles. “The evaluation of the performance of managers should be based on those matters over which they have control.”
If the existing methods of cost allocation are not consistent with the marginalist view of the firm, what does Wells propose? An activity accounting model is set forth based upon Chambers’ system of Continuously Contemporary Accounting. The use of activity, rather than product costing, makes the accounting data more suitable for managerial evaluation against a given and agreed upon budget. By using current cash equivalent for all assets Wells claims that the information provided by the system is “unaffected by overhead allocations, fictitious revenues and transfer prices, depreciation provisions, and other fabricated figures.” His suggested system is thought-provoking but, in the opinion of the reviewer, creates new needs to fabricate new kinds of data. For example, it is especially difficult to envision a system which could accurately capture the current market value of assets without incurring exceptionally high costs or adopting rules of thumb.
Overall this collection of articles is well worth reading. It gives an overview of how the underlying theory of the firm clearly relates to the appropriateness of certain conventional accounting practices. This volume forces the reader who does not agree with Wells’ con-demnation of traditional internal costing models to consider whether the disagreement reflects a fundamentally different underlying theory of the firm or whether, and where, errors in his analysis have been made.
