Matching Revenues and Costs: The Counter-Intuitive Rationality of Direct Costing

Abstract

This study investigates the consequences of adopting two simple sets of rules the manager can consider as perfectly rational and follow in his decisions regarding price, volume and mix of the various products. The first set follows the full (absorption) costing method logic, while the second is based on the direct (variable, marginal) costing method logic. It shows that costing systems adopting the full-costing method can lead management to make non-rational decisions regarding the setting of prices, acceptance of orders, make or buy choices and, above all, determination of the optimal production mix through programming and budgeting. On the other hand, using the direct costing method allows the manager to achieve rational results during the decision-making and planning phases, even if these often appear counter-intuitive when compared with the results achieved using the full costing method, which seem to conform to naïve intuition. The risk in the latter case is even more serious when we are dealing with multi-production firms operating under conditions of limited production capacity regarding one or more factors, as occurs most of the time. The demonstration of the thesis of the superiority of direct costing method rules in management decisions related to the problem of the matching costs and revenues is carried out with numerical evidence, formulating a set of decision problems that are solved by comparing the results obtained both with the full costing method rules and with the direct costing method rules.