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The real option approach to adoption or discontinuation of a management accounting innovation: the case of activity-based costing

Shu Feng () and Chun-Yu Ho ()
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Shu Feng: Clark University

Review of Quantitative Finance and Accounting, 2016, vol. 47, issue 3, No 14, 835-856

Abstract: Abstract This paper employs the real option approach (ROA) to study the investment decision of a management accounting innovation—the case of activity-based costing (ABC)—adoption or discontinuation under uncertainty. We argue that investing in ABC is analogous to having the option rights in a financial (American) call option. We propose a model taking the firm’s total annual production as primary decision variable and using the added annual net profits after establishing ABC to identify the optimal threshold for adoption or discontinuation. We find that the optimal adoption (resp., discontinuation) threshold is higher (resp., lower) when obtained by the ROA than by the net present value (NPV) method; thus, the ROA is more conservative than the NPV approach. Their difference stems mainly from the ROA’s option value of delay before implementing the adoption/discontinuation decision. Further, recent empirical researches based on survey found inconclusive results about the adoption of ABC. For instance, there are studies found that manufacturing sector having a higher adoption rate of ABC than non-manufacturing sector, but the other studies find the opposite. Our theoretical model explains the inconclusive results from the empirical researches can be driven by the variations in mean and volatility of sectoral output growth, which are omitted in those studies.

Keywords: Activity-based costing; Management accounting innovations; Real option theory; Investment under uncertainty (search for similar items in EconPapers)
JEL-codes: D81 G13 G32 M41 (search for similar items in EconPapers)
Date: 2016
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DOI: 10.1007/s11156-015-0522-4

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