Estimating Activity Cost

BEHAVIORAL RESEARCH IN ACCOUNTING
Volume 19, 2007

pp. 133–159
Estimating Activity Costs:

How the Provision of Accurate
Historical Activity Data from a
Biased Cost System Can Improve
Individuals’ Cost Estimation Accuracy
Dan L. Heitger
Miami University
ABSTRACT: An integral component of effective cost control and performance evalu-
ation is the ability to accurately estimate relationships between activities and overhead
costs (i.e., activity costs). Individuals using a single cost pool system often have to rely
on memory of historical activity data when estimating activity costs. If individuals’ recall
of data is representative of the historical data, then reliance on memory should not be
detrimental to cost estimation accuracy. However, individuals often possess incorrect
initial beliefs about activity costs. These incorrect beliefs are expected to serve as an
anchor from which individuals make insufficient adjustments when estimating activity
costs based on memory of historical activity data. Multiple cost pool systems frequently
provide biased standard rates; however, such systems also provide accurate historical
activity data when individuals estimate costs. I extend prior accounting research by
experimentally examining whether a multiple cost pool system’s provision of accurate
historical activity data improves activity cost estimation for individuals with incorrect
cost beliefs even when the cost system also provides biased standard rates. The main
contribution of the study is its finding that the multiple cost pool system’s provision of
historical activity data improves individuals’ adjustments from their incorrect initial cost
beliefs when estimating activity costs, thereby increasing their estimation accuracy. The
results suggest that this improved adjustment from incorrect initial cost beliefs occurs
because the provision of historical activity data improves individuals’ recognition of
how wrong their initial cost beliefs were in reality. This result is achieved even though
the cost system provides biased standard rates. The ability of flawed cost systems to
improve individuals’ activity cost estimation in other such ways has received little re-
search attention and is important because of its potential for improving managerial
decision making.
Keywords: activity cost estimation; biased cost systems; multiple versus single cost
pool systems; activity-based costing; initial cost beliefs; anchoring and
adjustment.
This paper is based on my dissertation completed at Michigan State University. I express my appreciation to the
members of my dissertation committee, Susan Haka (Chair), Franklin Boster, Joan Luft, and Ronald Marshall for
their assistance and guidance. I also thank Brian Ballou, Jacob Birnberg, Harry Evans, Joe Fisher, Les Heitger,
Steven Kaplan, Marlys Lipe, Laureen Maines, Jamie Pratt, Michael Shields, Geoff Sprinkle, two anonymous re-
viewers, and participants at the 2003 Managerial Accounting Research Conference, Auburn University and at
Indiana University workshops for their valuable comments. In addition, I acknowledge Donna Booker, Elizabeth
Connors, and Andrea Drake for their many helpful suggestions. Financial support from Michigan State University
is gratefully acknowledged.
133
134 Heitger
Data Availability: Data gathered in this study are available from the author upon
request.
INTRODUCTION
A
n integral component of effective cost control and performance evaluation is ac-
curately estimating relationships between activities and overhead costs (Cooper and
Kaplan 1998; Bruns and McKinnon 1993; Cooper et al. 1992). This paper defines
activity cost as the amount by which total overhead costs increase for a one-unit increase
in the activity. Accurate activity cost estimates are important inputs into numerous strategic
and other managerial operational decisions (Ittner et al. 2002; Kaplan and Norton 2001;
Kaplan and Cooper 1998; Anderson 1995). For example, individuals estimate activity costs
at various times throughout the year to price and evaluate products, services, and projects
that require different levels of activities (Cooper et al. 1992, 4), improve efficiency by re-
engineering operating processes (Kaplan and Cooper 1998, 138), create budgets (Cooper
and Kaplan 1998), perform customer profitability analyses (Krumwiede 1998), enhance
quality improvement initiatives (Armitage and Russell 1993) or other routine (e.g., make-
or-buy) decisions (Hansen and Mowen 2003, 826). However, according to managers, ac-
curate activity cost estimation is a difficult task (Pemberton et al. 1996; Cooper et al. 1992).
Surprisingly, this task has received relatively little research attention. This study helps de-
velop an understanding of how specific features of cost systems are associated with the
accuracy of activity cost estimates.
Callahan and Gabriel (1998, 423) note that, ‘‘the impact of more accurate product
costing information on firm profitability is an unresolved and controversial issue’’ as the
costs and benefits of more refined costing systems are still being debated in the literature.
Ittner et al. (2002) echo this view, as do Foster and Young (1997), by observing that the
linkage between more accurate cost systems, various decisions, and overall firm profitability
is an important accounting research issue, but that there is limited agreement among re-
searchers about the basis for asserting that a new or more accurate costing system is better
than an existing system. One issue that remains unclear is whether cost systems that provide
inaccurate cost information can improve individuals’ judgments, in particular their judg-
ments outside the context of product cost estimates. Gupta and King (1997) encourage
research on how cost system accuracy affects other decisions, such as cost management
and control, strategy formulation, and strategic management in organizations. This paper
contributes to this literature by examining whether a flawed cost system that provides
accurate historical activity data improves activity cost estimates for individuals with incor-
rect cost beliefs.
Often individuals subjectively estimate activity costs for numerous reasons (Luft and
Shields 2001; Banker et al. 2000; Bruns and McKinnon 1993). Individuals’ cost estimates
are expected to be affected by several sources of information, three of which are examined
in this paper: historical activity and total cost data, initial cost beliefs, and standard rates.
First, individuals generally estimate costs based on historical activity and total overhead
cost data (i.e., data from all relevant previous periods). Under a single cost pool system,
individuals have access to historical activity data for only a single activity and historical
activity data often are unavailable from sources (e.g., information system, etc.) other than
Behavioral Research in Accounting, 2007

Estimating Activity Costs 135
the cost system when individuals estimate costs.1 Thus, individuals using a single cost pool
system often must recall historical activity data for other activities if they are to be used
in estimating costs.
Second, individuals across numerous organizations and industries often possess initial
beliefs or knowledge structures about how activities impact costs (Cooper et al. 1992).
Initial cost beliefs arise from previous experiences, outside consultants, or colleagues and
often are incorrect (Krumwiede 1998; Cooper et al. 1992). For example, individuals report
that well designed, newly implemented activity-based cost (ABC) systems informed them
of activities that were ‘‘surprisingly’’ or ‘‘unexpectedly’’ more or less costly than they had
formerly believed (Krumwiede 1998; Pemberton et al. 1996; Cooper et al. 1992, 57–59,
144, 171–174). In order for individuals with incorrect initial cost beliefs to accurately
estimate costs, they must realize that their beliefs are incorrect and make significant ad-
justments from those beliefs.
Third, the cost system provides approximations of expected activity costs in the form
of standard rates. Initial cost beliefs are exogenous to the cost system and as examined in
this paper refer to individuals’ beliefs about activity costs prior to observing the actual
activity and total cost data. Standard rate(s) (i.e., cost rate) refers to the cost system’s
approximation of activity cost(s). One of the major benefits of a successful ABC system is
that it can provide managers with better estimates (i.e., standard rates) of the cost of various
important activities (Krumwiede 1998; Pemberton et al. 1996). However, prior research
shows that multiple cost pool systems sometimes suffer from design flaws that lead to the
provision of biased rates (Datar and Gupta 1994; Noreen 1991) that have led some re-
searchers (Ittner et al. 2002, 713) to question the usefulness of such cost systems for
decision-making. However, flawed cost systems might improve individuals’ cost estimation
in other ways. For example, multiple cost pool systems that provide biased rates often
accurately measure total activity (i.e., cost allocation base) data for multiple activities, which
is important for activity cost estimation where individuals must estimate the increase in
total costs for a one-unit increase in the activity.
The purpose of this paper is to examine whether a multiple cost pool system’s provision
of accurate historical activity data for multiple activities increases cost estimation accuracy
for individuals who possess incorrect initial cost beliefs, even when the system provides
biased standard rates. It is unclear from prior research whether providing individuals with
accurate historical activity data improves their activity cost estimation. Datar and Gupta
(1994) show analytically (in Proposition 3) that more accurately measuring the units of
each activity used by individual products produces more accurate estimates of product cost
from the cost system.
However, this paper differs from Datar and Gupta (1994) in three ways. First, the task
of a cost system estimating product cost is fundamentally different from the task of an
individual estimating activity costs. Second, Datar and Gupta (1994) employ an analytical
setting to examine the cost system’s estimate of product cost, which requires that total
activity data be measured, as well as each individual product’s usage of each activity. This
1
A primary source for periodic activity data is informal communication, such as telephone or face-to-face con-
versations with shop floor personnel (Bruns and McKinnon 1993). As a result, when activity costs are estimated,
historical activity data often are unavailable from their primary source either because they are not recorded in
a formal manner (McCarthy 1998; Pemberton et al. 1996; Cooper et al. 1992, 191) or because they are recorded
but are difficult or even impossible to access (Fickes 2002; Ward 2002). Although enterprise resource planning
(ERP) systems are capable of recording activity data, a high failure rate (King and Wright 2002) and large
implementation costs (Cruz 2002; Worthen 2002) prevent the majority of companies from possessing such
systems.

136 Heitger
study employs an experimental setting in which individuals estimate the cost of various
activities based on total activity (and total cost) data. Thus, this study extends prior research
by examining whether the cost system’s provision of historical activity data affects indi-
viduals’ estimates of activity costs.
Third, in demonstrating the finding described above, Datar and Gupta (1994) assume
no error in the cost allocation (i.e., standard) rates (i.e., zero error in measuring the costs
for each pool and the total units of each activity). Thus, this study also extends prior
research by examining whether the provision of accurate historical activity data improves
individuals’ activity cost estimation accuracy even when the cost system also provides
biased standard rates. Cost systems, like the one employed in the current study, that provide
biased standard rates (i.e., activity costs at individual cost pools) can result in noisy but
unbiased estimates of individual product costs, because the systematically overstated allo-
cation to a product from one pool is offset by a systematically understated allocation from
another pool (see Datar and Gupta [1994] and Foster and Gupta [1990] for further discus-
sion and examples). As a result, examining biased approximations of activity costs (i.e., in
the form of the cost system’s standard rates) is important in its own right, even if product
costs are unbiased, because activity costs are used in management decisions, such as the
optimal number and length of production runs or the optimal level of parts variety, etc.
I manipulate initial cost beliefs and cost systems to examine individuals’ cost estimation
accuracy and whether their recall of historical data anchors on initial beliefs. I manipulate
initial cost beliefs by varying whether the activity cost beliefs based on management ex-
perience presented to individuals at the beginning of the experiment are correct or incorrect.
Cost system is manipulated by varying whether the cost system provides individuals with
a biased standard rate and accurate historical activity data for only one activity or all
relevant activities.
The results support the prediction that the multiple cost pool system’s provision of
historical activity data for multiple activities increases cost estimation accuracy for individ-
uals with incorrect initial cost beliefs. This finding occurs even though the cost system
provides biased standard rates. Also, the results suggest that recall of historical data anchors
on initial beliefs and that this anchoring effect is negatively associated with individuals’
cost estimation accuracy. Finally, the results indicate that the provision of historical activity
data improves cost estimation accuracy by reducing the extent to which individuals’ recall
of historical data anchors on their incorrect initial beliefs. Thus, this paper demonstrates
that cost systems do not have to provide accurate standard rates, which can be expensive
and quite difficult to generate, in order to improve individuals’ activity cost estimation
accuracy. This study has several implications for practice and future accounting research
involving cost system design and performance evaluation that are discussed in detail in the
final section of the paper.
The next section of the paper develops the hypotheses. The third and fourth sections
describe the experimental method and present the results, respectively. The final section
provides a conclusion and directions for future research.
DEVELOPMENT OF HYPOTHESES
The Activity Cost Estimation Process
Based on field research (Bruns and McKinnon 1993; McKinnon and Bruns 1992), I
depict the general activity cost estimation process as consisting of several steps (Figure 1,
A–D). The process begins with the possession of initial beliefs, based on management
experience, about the cost of activities (Figure 1, A). Individuals frequently (e.g., daily)
observe activity data (Figure 1, B), albeit often from informal sources outside the cost

FIGURE 1
The Activity Cost Estimation Process
Individual possesses initial

beliefs about the relationship
A between each activity
and total costs
Individual observes
B periodic changes
in the levels of
activity data
Individual calculates expected

change in total costs based on
C initial cost beliefs and change
in observed activity data
Individual observes actual

D total costs and compares
calculated change in total costs
to actual change in total costs
F
Individual’s perception of how Individual

E close calculated changes in receives historical
total costs are to actual activity data for
G changes in total costs multiple activities
Individual receives
a standard rate
for multiple
activities
Individual adjusts from

H initial cost beliefs to
estimate activity costs
Dashed rectangles denote that F and G are provided by the multiple cost pool system.
system (Bruns and McKinnon 1993). Periodically (e.g., monthly), individuals calculate a
change in total costs for the current period based on their initial cost beliefs and the ob-
served changes in the levels of the activities (Figure 1, C). Individuals then refer to periodic
cost reports containing actual total costs (and activity data for either a single or multiple
activities depending on the cost system) to compare how close their initial beliefs’ calculated

138 Heitger
change in total costs is to the actual change in total costs, as a way to check the accuracy
of their initial beliefs (Bruns and McKinnon 1993; Figure 1, D).
Individuals might proceed through Figure 1, processes B through D for a few or many
periods, as depicted by the feedback loop, before estimating activity costs for a specific
purpose (e.g., budgeting at year-end). Prior research suggests that covariation estimates—
similar to parameter estimates (e.g., estimation of the cost of a given activity)—are affected
by initial beliefs that are irrelevant to an objective (i.e., statistical) measure of covariation
(Lipe 1998). However, except for general speculation (Broniarczyk and Alba 1994), the
process by which initial beliefs affect cost estimation has received little empirical research
attention.
Individuals with incorrect initial cost beliefs should realize that, on average, there are
activity costs that, when combined with the monthly change in the levels of the activity
data, produce a change in total cost that is more similar (or closer) to the actual monthly
change in total costs than the calculated monthly change in total cost computed using their
incorrect initial beliefs. However, this study proposes that, rather than relying solely on
historical data to estimate activity costs, individuals treat initial cost beliefs as an anchor
from which they make adjustments when they estimate activity costs. Initial cost beliefs
can be relevant to cost estimation in a static production environment that remains completely
unchanged from the time when beliefs were formed to the time period for which activity
costs are to be estimated.
However, a more common scenario is one in which the plant’s production environment
changes (due to technology advances, product mix changes, process re-engineering, etc.).
As a result of this dynamic environment or numerous other reasons, managers’ cost beliefs
are incorrect and, thus, their cost estimates should be based solely on the plant’s historical
activity and total cost data from the relevant time period (e.g., past 12 months). Therefore,
as examined in this study, incorrect initial cost belief anchors, although salient, are irrelevant
when individuals estimate costs. Individuals often focus their attention on salient, yet ir-
relevant, anchors that are present in the task setting at the start of the judgment process
and then make insufficient adjustments from these anchors when making a final judgment
(Chapman and Johnson 2002; Hastie and Dawes 2001; Switzer and Sniezek 1991; Tversky
and Kahneman 1974). An anchor also can affect the nature of other information that is
subsequently sought and retrieved at the time of final judgment (Chapman and Johnson
2002; Hastie and Dawes 2001; Mussweiler and Strack 1999), such as the type of historical
data recalled when estimating costs.
Based on prior nonbusiness-related research (Hastie et al. 1999; Wilson et al. 1996),
an anchoring effect is expected in an activity cost estimation setting even when individuals
are instructed prior to estimating costs to ignore their initial cost beliefs and base their cost
estimates solely on the data. Given that individuals are expected to anchor on their initial
cost beliefs, the accuracy of their cost estimates is expected to depend upon how well they
adjust from such beliefs (Figure 1, H). The presence of random error in actual total costs
is expected to strengthen individuals’ reliance, or anchoring, on their initial cost beliefs.
Specifically, individuals’ perception of the size of the monthly differences between their
initial cost beliefs’ calculated change in total costs (i.e., cost change based on initial beliefs)
and the actual change in total costs (Figure 1, E) is important in appropriately adjusting
from incorrect cost beliefs when costs are estimated. As individuals consider these monthly
cost differences, they must determine whether they are due to random error in actual total
costs or to the fact that their initial beliefs are incorrect. Attributing the difference to random
error suggests that adjustments from initial beliefs are unnecessary. Thus, random error

provides individuals with an easy way to partially ‘‘explain away’’ these differences without
abandoning their initial beliefs and, as such, is expected to strengthen the effect of anchoring
on initial cost beliefs.
Two Elements of Multiple Cost Pool Systems: Historical Activity Data and
Standard Rates
In contrast to single cost pool systems, multiple cost pool systems provide historical
activity data for multiple activities and provide a standard rate for each of the multiple
activities (Panel A of Figure 2). These two elements of multiple cost pool systems are
discussed separately. Hypothesis 1 examines the effect of providing historical multiple
activity data, and H2 examines the effect of providing multiple standard rates.
The Effect of Providing Historical Activity Data on Individuals’ Cost

Estimation Accuracy
As discussed in the first section, individuals using a single cost pool system often rely
on memory of historical activity data when used in estimating activity costs. Although
individuals with incorrect beliefs are expected to estimate costs less accurately than indi-
viduals with correct beliefs, the provision of historical data for multiple activities (Figure
1, F) is expected to mitigate this tendency. When individuals are provided with historical
data for multiple activities and total costs, they do not need to rely on memory of how
large or small the difference was each month between the calculated change in total costs
and the actual change in total costs. The provision of historical data for multiple activities
is expected to help individuals learn or determine that their beliefs are incorrect (Figure 1,
E). As individuals realize that their initial beliefs are incorrect, they are expected to update
their beliefs, thereby increasing their cost estimation accuracy.
However, anchoring on correct initial cost beliefs is expected to have no effect on
individuals’ cost estimation accuracy because individuals have no reason to update their
beliefs. Thus, the multiple cost pool system’s provision of historical data for multiple ac-
tivities is not expected to affect individuals’ cost estimation accuracy when their initial
beliefs are correct. The following ordinal interaction between initial cost beliefs and the
cost system’s provision of historical activity data is predicted (Panel B of Figure 2).
H1: Relative to the control system’s provision of historical activity data for only
a single activity, the multiple cost pool system’s provision of historical ac-
tivity data for multiple activities increases (has no effect on) activity cost
estimation accuracy for individuals with incorrect (correct) initial cost
beliefs.
Regardless of the prediction in H1, there are reasons why the provision of historical
data for multiple activities might have no effect on individuals’ cost estimation accuracy.
For example, Klayman (1988) speculates that individuals performing a parameter-estimation
task (e.g., estimation of the cost of a given activity) might pursue a strategy where initial
beliefs are completely abandoned in favor of new beliefs when the data (e.g., actual costs)
better ‘‘fit’’ the new beliefs. Individuals might apply this reasoning within a cost estimation
setting where random error exists such that it becomes clear to individuals early on that
their cost beliefs are inaccurate. Under this view, individuals would be quite effective
on their own at recognizing that their initial cost beliefs are incorrect.

140 Heitger
FIGURE 2
Two Differences between Single and Multiple Cost Pool Systems: Providing a Standard Rate
and Historical Activity Data for a Single versus Multiple Activities
Panel A: Cost System Provision of Biased Standard Rates and Accurate Historical Activity
Data
SINGLE CONTROL a MULTIPLE

COST COST COST
POOL SYSTEM POOL
Biased Standard Rate for: Single Multiple Multiple
[each month] Activity Activities Activities
Accurate Historical Activity Data for: Single Single Multiple
[at year-end] Activity Activity Activities
Panel B: Hypotheses 1 and 2
H2 H1d
c
CO R
b
A
Estimation Accuracy
INC
C
Activity Cost
Single C ontrol M ultiple

C ost Pool C ost Pool
Cost System
a
The control cost system possesses one (standard rate for multiple activities) of the two elements of the multiple
cost pool system.
b
A through F correspond to the six experimental conditions.
c
COR (INC) ⫽ correct (incorrect) initial cost beliefs.
d
H1 compares the multiple cost pool condition to the control cost condition within each initial cost belief
condition (i.e., that F ⬎ E and C ⫽ B). H2 compares the control cost condition to the single cost pool
condition within each initial cost belief condition (i.e., that E ⬎ D and B ⬍ A).

The Effect of Providing Biased Standard Rates on Individuals’ Cost

Estimation Accuracy
Prior research finds that providing individuals with accurate feedback about the param-
eters they subsequently estimate (i.e., similar in nature to a standard rate) usually increases
estimation accuracy relative to when such feedback is not provided (Klayman 1988; Sniezek
1986). Also, Gupta and King (1997) find that individuals incorporate the cost system’s cost
forecasts into their cost estimates. Thus, standard rates are expected to affect individuals’
activity cost estimation to some degree.
However, standard rates often are biased (Datar and Gupta 1994). The effect of pro-
viding a biased rate for multiple activities on individuals’ cost estimation accuracy is ex-
pected to depend on the accuracy of the rates relative to initial cost beliefs. For example,
if the standard rate for a given activity is biased but still more accurate than the individual’s
incorrect initial cost belief for that activity (e.g., the standard rate of $1,500 is biased as
compared to the actual activity cost of $2,500 but is more accurate than the incorrect cost
belief of $500), then any weight placed on the rate is expected to increase cost estimation
accuracy. Alternately, if the standard rate for a given activity is biased (e.g., $1,500) and
less accurate than the individual’s correct initial cost belief for that activity (e.g., $2,500),
then any weight placed on the rate is expected to decrease cost estimation accuracy (i.e.,
towards the relatively less accurate rate of $1,500 and away from the relatively more ac-
curate correct cost belief of $2,500). Thus, the multiple cost pool system’s provision of a
biased standard rate for multiple activities (Figure 1, G) is expected to increase (decrease)
cost estimation accuracy when the rates are more (less) accurate than the initial cost beliefs.
Assuming that the biased rates are more (less) accurate than the incorrect (correct) initial
cost beliefs, the following ordinal interaction between cost beliefs and the cost system’s
provision of biased standard rates is predicted (Panel B of Figure 2).2,3
H2: Relative to the single cost pool system’s provision of a biased standard rate
for only a single activity, the control system’s provision of a biased standard
rate for multiple activities increases (decreases) activity cost estimation ac-
curacy for individuals with incorrect (correct) initial cost beliefs.
Thus, the prediction in H2 is dependent on the assumption that the biased rates are more
(less) accurate than the incorrect (correct) initial cost beliefs.
2
As discussed earlier, although initial cost beliefs and standard rates emanate from different sources, each can
be inaccurate to varying degrees. This paper examines the situation in which the magnitude of the bias in two
of the three standard rates is approximately half of the magnitude of the bias present in the incorrect initial cost
beliefs (e.g., the actual activity cost for PRuns [Parts] is $500 [$2,500], the biased cost rate for PRuns [Parts]
is $1,500 [$1,600] and the incorrect initial cost belief for PRuns [Parts] is $2,500 [$500]). I examine this setting,
where the bias in incorrect beliefs is greater than the bias in standard rates, because beliefs typically arise from
less formal, less quantitative sources (e.g., individuals’ experiences and conversations with other employees
[Krumwiede 1998]) than standard rates. Thus, the extent of bias in cost beliefs often is likely to be greater than
the extent of bias in standard rates. If the relative magnitude of the biases were switched, such that standard
rates were more biased than incorrect cost beliefs, then the predicted effect of biased standard rates on cost
estimation accuracy of individuals with incorrect cost beliefs would change.
3
Although individuals could anchor on standard rates, I believe that individuals are far more likely to anchor on
initial cost beliefs. It is relatively easy for individuals to realize when the cost system is flawed and producing
biased standard rates. In contrast, the only way to determine that one’s cost beliefs are incorrect is through
careful observation of historical data.

142 Heitger
EXPERIMENTAL DESIGN
Design, Participants, and Independent Variables
The experiment manipulated initial cost beliefs (correct and incorrect) and cost systems
(single cost pool, multiple cost pool, and control cost system) between subjects in a 2 ⫻ 3
design. Participants were 50 M.B.A. and 57 undergraduate cost-accounting students at a
large midwestern university. Participants were informed that their pay was based on (i.e.,
positively associated with) the accuracy of their activity cost estimates. Average pay was
$18 for the one-hour experiment and was adjusted across conditions so that the average
payment in each condition was approximately the same.
The experiment creates a setting in which three main activities are performed in the
production plant that are measured by the number of machine hours operated, the number
of product parts handled and used in production, and the number of production runs per-
formed for separate batches of products. Based on empirical studies documenting significant
positive linear associations between each activity and overhead costs (Banker et al. 1995;
Banker and Johnston 1993), I adopt the following linear model:
y ⫽ bo ⫹ b1x1 ⫹ b2x2 ⫹ b3x3 ⫹ ε, (1)
where y ⫽ total overhead costs, bo ⫽ fixed costs, x1, x2, and x3 ⫽ the number of machine
hours (MHs), parts in production (PARTS), and production runs (PRuns), respectively, for
all products during the period, and b1, b2, and b3 ⫽ the cost of a MH, Part, and PRun,
respectively, for all products during the period. ε represents random error. The three activ-
ities are independent and are the activities for which cost estimates are determined. Table
1 presents the cost function and monthly activity levels used in the production and cost
reports.
Initial cost beliefs are manipulated by varying the information given to participants on
an information sheet at the beginning of the experiment concerning the change in total
costs that should be expected from a one-unit change in each of three activities: MHs,
PARTS, and PRuns. (The information sheet is available from the author upon request.) Initial
cost beliefs has two conditions: correct and incorrect. Figure 3 displays the initial cost
beliefs for both conditions, along with the actual activity costs and standard rates. In the
correct condition, the initial cost belief is the same (i.e., correct) as the actual activity cost
for all three activities. In the incorrect condition, the initial cost belief is different (i.e.,
incorrect) from the actual activity cost for PARTS and PRuns and the same as the actual
activity cost for MHs. Thus, as in reality, some participants possess incorrect initial beliefs
about the activity costs they subsequently estimate.
The cost system variable has three conditions that vary whether participants are pro-
vided with (1) a standard rate for a single activity or all three activities each month, and
(2) historical activity data for a single activity or all three activities at year-end. The single
cost pool system each month provides a standard rate for a single activity (MHs) and at
year-end provides historical activity data for only a single activity (MHs). The multiple cost
pool system each month provides a standard rate for multiple activities (MHs, PARTS and
PRuns) and at year-end provides historical activity data for multiple activities (MHs, PARTS
and PRuns) [Panel A of Figure 2]. The third cost system condition, control, is a cross
between the other two conditions in that each month it provides a standard rate for multiple
activities (MHs, PARTS, and PRuns) and at year-end provides historical activity data for
only a single activity (MHs). Thus, this third condition controls for the effect of providing
a standard rate for multiple activities on cost estimation accuracy. As a result, a direct test
of the incremental effect of providing historical activity data for multiple activities on cost

TABLE 1
Cost Function and Activity Levels Used in Creating the Production Reports
and Cost System Reports
Fixed MHs Parts PRuns Random TOTAL OH

Month Costs X1 X2 X3 Error COSTSa
Jan $15,000 480 30 30 ⫺$2,000 $163,000
Feb $15,000 360 30 30 $3,000 $153,000
Mar $15,000 300 42 12 $2,000 $165,500
Apr $15,000 480 30 30 ⫺$2,000 $163,000
May $15,000 300 48 48 ⫺$1,000 $195,500
Jun $15,000 360 30 30 $3,000 $153,000
Jul $15,000 300 24 18 ⫺$3,000 $118,500
Aug $15,000 300 12 42 $1,000 $104,500
Sep $15,000 300 30 36 $2,000 $147,500
Oct $15,000 240 30 30 ⫺$3,000 $132,000
Nov $15,000 300 24 24 $1,000 $125,500
Dec $15,000 120 30 30 ⫺$1,000 $119,000
a
The cost function used to generate TOTAL OVERHEAD (OH) COSTS ⫽ $15,000 ⫹ $125X1 ⫹ $2,500X2 ⫹
$500X3 ⫹ R, where R represents random error, which is uniformly distributed and varies independently of the
level of X1, X2, and X3.
The OLS estimate of the cost function ⫽ $15,000 ⫹ $125X1 ⫹ $2,500X2 ⫹ $500X3 ⫹ e, where e represents the
independent random error term.
R2 ⫽ .989.
FIGURE 3
Comparison of Actual Activity Cost, Initial Cost Belief, and Standard Rate for each Activity
Standard
Rates
Initial Cost Beliefs SINGLE CONTROL MULTIPLE

Actual COST POOL COST COST POOL
Activity Activity Cost CORa INC SYSTEMb SYSTEM SYSTEM
MHc $125/MH $125 $125 $453 $162 $162
Part $2,500/PART $2,500 $500 — $1,500 $1,500
PRun $500/PRun $500 $2,500 — $,1600 $1,600
a
b
The three cost system conditions.
c
MH ⫽ machine hour; PART ⫽ part; PRun ⫽ production run.

144 Heitger
estimation accuracy is achieved by comparing estimation accuracy between the multiple

cost pool and control systems.
Cost system manipulates these two cost system differences using two types of reports:
monthly cost system reports and the year-end cost report. First, the monthly cost reports in
the single cost pool condition provide activity data and a standard rate only for MHs. In
this condition, all costs are combined into a single cost pool, which causes the standard
rate to be biased. The monthly cost reports in the multiple cost pool and control conditions
provide activity data and a standard rate for all three activities. A common cost system
design flaw, error in measuring overhead costs, is incorporated into the multiple cost pool
and control conditions, which leads to an inaccurate allocation of costs into cost pools and,
thus, the generation of biased standard rates for MHs, PARTS, and PRuns (Datar and Gupta
1994). Figure 4 details the computation of the standard rates for each condition. The
monthly cost reports in all conditions provide actual total costs for the current month and
the previous month. All activity and total cost data are accurate.
Second, the year-end cost report in all conditions provides historical actual total cost
data. However, the year-end cost report in the single cost pool and control conditions
provides historical activity data only for MHs. Thus, in these two conditions, participants’
use of historical PARTS and PRuns activity data when they estimate costs at year-end is
FIGURE 4
Standard Rates for Each Cost System
Budgeted Total Budgeted Standard

SINGLE COST POOL SYSTEM: Activity Overhead Costsa Activity Level Rateb
MH $1,740,000 3,840 $453
Assigned portion
of Budgeted Total Budgeted Standard
MULTIPLE COST POOL SYSTEM Activity Overhead Costsc Activity Level Rated
& CONTROL SYSTEM: MH $623,784 3,840 $162
PART $540,168 360 $1,500
PRun $576,048 360 $1,600
$1,740,000
a
Budgeted total annual overhead costs, budgeted total annual fixed costs, and budgeted total annual machine
hours are assumed to equal actual total annual overhead costs, actual total annual fixed costs, and actual total
annual machine hours, respectively.
b
Standard rate(s) are determined at the beginning of the year based on budgeted total annual overhead costs and
budgeted total annual level of the activity(s). To arrive at the standard rate for the single activity (MH),
budgeted total annual overhead costs are divided by budgeted total annual machine hours.
c
Budgeted total annual overhead costs, budgeted total annual fixed costs, and budgeted total annual machine
hours, parts, and production runs are assumed to equal actual total annual overhead costs, actual total annual
fixed costs, and actual total annual machine hours, parts, and production runs, respectively.
d
To arrive at the standard rate for each activity, budgeted total annual overhead costs minus budgeted total
annual fixed costs are assigned to the three cost pools in the following erroneous manner: approximately 36
percent are assigned to the MH pool, 31 percent to the PARTS pool, and 33 percent to the PRuns pool. The
accurate assignment of costs would be 31 percent to MH, 58 percent to parts, and 11 percent to PRuns.
Finally, budgeted total annual fixed costs are assigned evenly to each of the three cost pools.
For example: [($1,740,000 ⫺ $180,000) ⫻ .3614] ⫹ [(1 / 3) ⫻ $180,000] equals the portion of budgeted total
overhead costs (variable ⫹ fixed) assigned to the MH cost pool under the multiple cost pool and control
systems.

restricted to their memory of such data. The year-end cost report in the multiple cost pool
condition provides historical activity data for all three activities. Thus, participants in the
multiple cost pool condition do not need to rely on memory of historical data when they
estimate costs at year-end.
Experimental Procedure
The experiment follows the same general order of events as the activity cost estimation
process depicted in Figure 1. Prior to the experiment, an introductory lecture explained
managers’ desire to estimate activity costs and the general cost estimation process. Partic-
ipants’ completion of two practice rounds familiarized them with this process, which then
was used in the experiment.
Participants were randomly assigned to experimental conditions. The experiment began
by providing participants with the information sheet that provides information concerning
initial cost beliefs and an explanation of their role as plant manager and the cost system’s
standard rates.4 The information sheet also explains that actual total costs contain an element
of randomness. Participants kept the information sheet until the exit questionnaire was
handed out. Participants were told that they were going to look at several monthly produc-
tion reports and cost reports, one month at a time. As in the practice rounds, they were
instructed to determine each month the calculated change in total costs, given the cost belief
information about each activity’s impact on total costs and the monthly change in the level
of each activity. Participants also were instructed to compare the calculated change in total
costs to the actual change in total costs shown on the monthly cost report to see how close
the two cost changes are to one another.5 Finally, they were told to pay careful attention
to the reports and their contents because they would later be asked several questions about
them.6
The first month’s (February) production report and cost report then were distributed.
The production reports represent the informal (and exogenous to the cost system) source
from which individuals often observe activity data. The production reports contain the actual
level of MHs, PARTS, and PRuns for the current month and the one month prior to the
current month (see Figure 5). The monthly change in each activity level also is shown.
Each production report instructs participants to compute and write down, on the line pro-
vided, the calculated change in total costs from the previous month to the current month
based on the initial cost beliefs and the monthly change in MHs, PARTS, and PRuns.
February’s reports were collected when participants finished examining them as instructed.
The following months’ reports were distributed and collected in the same manner through
December. Thus, participants in all conditions were given the same monthly production
reports, containing the same accurate activity data. Participants then completed a demo-
graphic data form to clear working memory.
Next, participants performed the cost differences recall task based on the eleven dif-
ferences between calculated and actual monthly changes in total costs. The year-end cost
report and activity cost estimation form then were handed out, and participants performed
the activity cost estimation task. Although all participants encountered the same monthly
activity data, the year-end cost report provided historical activity data either for all three
4
The information sheet explained to participants that, for various reasons, the cost system’s standard rates might
not be accurate. Participants also were informed that the activity data and total cost data are accurate.
5
Participants were provided with simple calculators for use in determining calculated cost changes and the
difference between the calculated and actual cost changes each month.
6
This statement was made to participants to be consistent with other studies examining memory recall (Libby
and Trotman 1993; Choo and Trotman 1991; Dellarosa and Bourne 1984; Srull 1981; Graesser et al. 1982).

146 Heitger
FIGURE 5
Monthly Production Report
Production Department Report

March 1998
Totals Changes in
Activity Feb98 Mar98 Activity Levels
Number of machine hours 360 300 –60
Number of parts in production 30 42 12
Number of production runs 30 12 –18
Given the change in the level of each of the three activities and the beliefs provided on the Information
Sheet about each of the activities’ impact on total overhead costs, what should be the predicted change
in total overhead costs? $___________
activities or for only a single activity. The year-end cost report, activity cost estimation
form, and information sheet then were collected. The order of the cost differences recall
task and the cost estimation task is counterbalanced. Participants who performed the cost
differences recall task before the cost estimation task then performed the same cost differ-
ences recall task a second time after completing and turning in the activity cost estimation
form and year-end cost report. The experiment concluded with the exit questionnaire.
Description of the Three Tasks and Dependent Variables

Participants perform two main tasks: a cost differences recall task and an activity cost
estimation task. The cost differences recall task measures participants’ recall of how close
their initial cost belief’s calculated change in total costs was to the actual change in total
costs each month. Column 4 (6) of Figure 6 displays these eleven cost differences for
participants with incorrect (correct) initial cost beliefs. For example, March’s change in
MHs, PARTS, and PRuns is a decrease of 60, an increase of 12, and a decrease of 18,
respectively (Table 1). The calculated cost change is a decrease of $46,500 [(⫺60)($125)
⫹ (12)($500) ⫹ (⫺18)($2,500)] for incorrect initial cost beliefs and an increase of $13,500
[(⫺60)($125) ⫹ (12)($2,500) ⫹ (⫺18)($500)] for correct initial cost beliefs (columns 3
and 5 of Figure 6, respectively). Thus, the cost difference between the incorrect (correct)
initial cost belief’s calculated cost change and the actual cost change—a $12,500 increase—
is $59,000 ($1,000).
Variability in the cost differences for individuals with incorrect initial cost beliefs was
intentionally chosen so that some cost differences are small (e.g., seven differences are
between only $1,000 and $7,000) and some are large (e.g., four differences are between
$49,000 and $68,000, with each being more than an order of magnitude greater than the

FIGURE 6
Differences between Calculated and Actual Monthly Changes in Total Costs for Incorrect and
Correct Initial Cost Beliefs
1 2 3 4 5 6
CALCULATED COST DIFFERENCE CALCULATED COST DIFFERENCE
ACTUAL COST CHANGE [For Incorrect COST CHANGE [For Correct
MONTH COST [For Incorrect Initial Cost Beliefs]c,d [For Correct Initial Cost Beliefs]c,d
CHANGEa Initial Cost Beliefs]b (Column 3—Column 2) Initial Cost Beliefs]b (Column 5—Column 2)
Feb –$10,000 –$15,000 –$5,000 –$15,000 –$5,000

Mar $12,500 –$46,500 –$59,000 $13,500 $1,000
Apr –$2,500 $61,500 $64,000 $1,500 $4,000
May $32,000 $31,500 –$1,000 $31,500 –$1,000
Jun –$42,500 –$46,500 –$4,000 –$46,500 –$4,000
Jul –$34,500 –$40,500 –$6,000 –$28,500 $6,000
Aug –$14,000 $54,000 $68,000 –$18,000 –$4,000
Sep $43,000 –$6,000 –$49,000 $42,000 –$1,000
Oct –$15,500 –$22,500 –$7,000 –$10,500 $5,000
Nov –$6,500 –$10,500 –$4,000 –$10,500 –$4,000
Dec –$6,500 –$4,500 $2,000 –$4,500 $2,000
a
ACTUAL COST CHANGE ⫽ the actual monthly change in total costs.
b
CALCULATED COST CHANGE ⫽ the calculated monthly change in total costs given incorrect (column 3) or
correct (column 5) initial cost beliefs and the change in the levels of the three activities—MHs, PARTS, and
PRuns.
c
COST DIFFERENCE ⫽ the difference between the incorrect (column 4) or correct (column 6) initial cost
belief’s calculated monthly change in total costs and the actual monthly change in total costs.
d
The average absolute value of the cost differences between the calculated and actual monthly cost changes
across all eleven monthly cost differences for participants with incorrect (correct) initial cost beliefs is $24,455
($3,364). The greatest absolute value of the cost differences between the calculated and actual monthly cost
changes across all eleven monthly differences for participants with incorrect (correct) initial cost beliefs is
$68,000 ($6,000).
mean [$4,143] of the seven small differences). By having both relatively large and small
cost differences, it is possible to examine whether participants’ recall focuses more on the
smaller differences where the calculated cost changes were relatively close to the actual
cost changes. Such a focus, as evidenced by recalling the differences between calculated
and actual cost changes as being smaller than they were in reality, would indicate a tendency
to overemphasize those months in which their initial cost beliefs’ calculated cost change
was closer (i.e., more similar) to, rather than further (i.e., more dissimilar) from, the actual
cost change.
The cost differences recall task asks participants at year-end to recall the average and
greatest of the eleven monthly differences between the calculated change in total costs and
the actual change in total costs. Participants were told to disregard the sign of the differences
and consider the absolute value. RECAVGD (RECGRTD) is defined for each participant as
the actual average (greatest) absolute value of the cost differences minus the participant’s
recalled average (greatest) absolute value of the cost differences. A positive RECAVGD
(RECGRTD) indicates that the participant recalls the average (greatest) cost difference to
be smaller than it is in reality. Thus, RECAVGD (RECGRTD) provides a measure of the
extent to which participants anchor on their initial cost beliefs when recalling the average

148 Heitger
(greatest) cost difference between calculated and actual changes in total costs and is used
in supplementary analyses in the Results section.7
The activity cost estimation task asks participants at year-end to estimate the activity
cost for MHs, PARTS, and PRuns for use in the following January’s budget. Participants
were instructed to base their estimates solely on the twelve months of activity and total
cost data and to ignore the initial cost beliefs provided on the information sheet. They also
were told that fixed costs were projected not to change. Only the information sheet and the
year-end cost report were available to participants for this task.
For each of the three activity cost estimates, the estimated activity cost was subtracted
from the actual activity cost, which produced an error for each estimate. The absolute value
of the estimation error was then taken so that errors in either direction were treated in the
same way and did not offset each other. Finally, the absolute value of the estimation error
was subtracted from 3,000 in order to convert the measure from one of error to one of
accuracy. Discussing the results in terms of accuracy, rather than error, is more straight-
forward and is consistent with the second section. A perfect cost estimate would be equal
to the actual activity cost, thereby yielding no error and an accuracy measure of 3,000.
Total estimation accuracy for each participant is the sum of the three accuracy scores. Given
that there are three activity cost estimates, the maximum activity cost estimation accuracy
score for any individual is 9,000. Table 2 shows the procedure for determining the accuracy
of each cost estimate. Total estimation accuracy serves as the dependent variable in tests
of the hypotheses.
RESULTS
Manipulation Checks
To examine the initial cost beliefs manipulation, the exit questionnaire asked partici-
pants to identify from a list of four alternatives ($125, $500, $2,500, and unsure) the cost
belief for each activity that was provided on the information sheet. Ninety-nine percent of
participants selected the appropriate initial cost belief for all three activities. Also, they
were asked to recall the experiment’s first month and report, on a scale from $0 to $2,500,
the amount they expected total costs to change for each one-unit change in each activity.
Table 3 reports the results of t-tests that were employed to examine participants’ responses
to the manipulations. Participants responded as expected for each activity (questions 1–3,
Table 3). For example, the t-test results for questions 1–3 illustrate that between the correct
and incorrect initial cost beliefs conditions, participants’ beliefs did not differ regarding
MHs, but did differ regarding PARTS and PRuns. Thus, the initial cost beliefs manipulation
was successful.
To examine the cost system manipulation, participants were asked about the standard
rates on their monthly cost reports and the historical activity data on their year-end cost
report. First, they were asked about the likelihood on a scale from 0 (strongly disagree) to
100 (strongly agree) that their monthly cost reports provided a standard rate for MHs,
PARTS, and PRuns and whether the cost system’s standard rate(s) was accurate. Participants
7
After the cost differences recall task, participants were presented with actual total costs and MHs for all months
and were asked to recall PARTS and PRuns for each month. The purpose of this brief exercise was to determine
whether participants in the single cost pool and control conditions, where historical activity data was provided
only for MHs, were able to recall significant quantities of historical data for the other two activities. As would
be expected, participants were unable to recall significant quantities of historical data for either PARTS or PRuns.
Thus, as anticipated, historical activity data were available to participants at year-end when they estimated costs
only if they were provided by the multiple cost pool system.

TABLE 2
Total Activity Cost Estimation Accuracy:a Descriptive Statistics
COST SYSTEM
SINGLE MULTIPLE
COST POOL CONTROL COST POOL
INITIAL CORb A B C
COST 8,641c 8,323 8,201 8,388
BELIEFS (287) (661) (613) (568)
[18] [18] [18]
D E F
5,498 6,105 7,192 6,248
INC
(717) (824) (1,058) (1,108)
[18] [18] [17]
7,070 7,214 7,697 7,328
(502) (742) (829) (1,385)
a
Total activity cost estimation accuracy ⫽ the sum of the accuracy of each of the three individual activity cost
estimates, with each being calculated as follows:
3,000 ⫺ 兩actual activity cost ⫺ estimated activity cost兩.
Thus, the maximum total accuracy score is 9,000, which results if there is no difference between the actual
activity cost and the estimated activity cost for any of the three activity cost estimates.
b
c
Cells contain means, (standard deviations), and the [number of observations].
responded as expected for each rate (questions 4–10, Table 3). Also, participants appro-
priately reported that they understood the rate(s) might have been inaccurate (mean response
of 75.82). Thus, participants generally understood which activities did and did not have a
standard rate provided on their monthly cost reports.
Second, participants were asked about the likelihood on the same 0 to 100 scale that
their year-end cost report provided the actual number of MHs, PARTS, and PRuns for all
months. Participants responded as expected for each activity (questions 11–16, Table 3).
Thus, participants understood which activity data were and were not provided on their year-
end cost report. Participants also reported on the same scale that they generally understood
the activity data provided on the production reports and cost reports were accurate (mean
response of 72.05). Finally, participants reported on the same scale that they understood
that actual total costs contained an element of random variation (mean response of 86.88).
Thus, the cost system manipulation was successful.
Two Elements of Multiple Cost Pool Systems: Historical Activity Data and
Standard Rates
Table 2 presents descriptive statistics for cost estimation accuracy.8 Panel A of Table 4
reports the ANOVA results. The ANOVA results show a significant main effect for initial
cost beliefs. The ANOVA results also show a significant main effect for cost system. Most
8
No order effects were detected; therefore, all data are combined and analyzed collectively regardless of task
order. Similar tests indicated that order has no effect on recall of the average or greatest cost differences.

150 Heitger
TABLE 3
Results of Manipulation Checks
1 2a 3 4
Mean Comparison
Questionb Between: t-stat.c p-value
d
1. At the beginning of the first COR INC
month, by what amount did you $192 $170
expect total overhead costs would (116) (139) .88 .380
change for each one-unit change [54] [53]
in Machine Hours?
(scaled from $0 to $2,500)
month, by what amount did you $2,296 $585
expect total overhead costs would (556) (263) 20.28 ⬍ .001
in Parts?
month, by what amount did you $607 $2,283
expect total overhead costs would (406) (588) ⫺17.19 ⬍ .001
in Production Runs?
4. My Monthly Cost Reports SINGLE
contained a Standard Cost Rate 92.92 50 15.22 ⬍ .001
for MHs. (16.92)
(scaled from 0 to 100) [36]
5. My Monthly Cost Reports CONTROL
for MHs. (27.11)
6. My Monthly Cost Reports MULTIPLE
for MHs. (29.08)
7. My Monthly Cost Reports SINGLE MULTIPLE
contained a Standard Cost Rate 28.47 78.86 ⫺6.21 ⬍ .001
for Parts. (38.49) (29.08)
(scaled from 0 to 100) [36] [35]
8. My Monthly Cost Reports SINGLE CONTROL
for Parts. (38.49) (26.58)
(scaled from 0 to 100) [36] [36]
9. My Monthly Cost Reports SINGLEc MULTIPLE
for PRuns. (39.09) (29.08)
(scaled from 0 to 100) [36] [35]
10. My Monthly Cost Reports SINGLE CONTROL
for PRuns. (39.09) (26.58)
(scaled from 0 to 100) [36] [36]
(continued on next page)

TABLE 3 (Continued)
1 2a 3 4
Mean Comparison
Question Between: t-stat.b p-value
11. My Year-end Cost Report MULTIPLE SINGLE
contained the actual number of 74.57 81.94 .97 .340
MHs for each month. (34.59) (29.45)
(scaled from 0 to 100) [35] [36]
12. My Year-end Cost Report MULTIPLE CONTROL
contained the actual number of 74.57 84.94 ⫺1.44 .160
MHs for each month. (34.59) (25.63)
(scaled from 0 to 100) [35] [36]
13. My Year-end Cost Report MULTIPLE SINGLE
contained the actual number of 69.43 21.94 5.62 ⬍ .001
Parts for each month. (38.80) (32.14)
(scaled from 0 to 100) [35] [36]
14. My Year-end Cost Report MULTIPLE CONTROL ⬍ .001
contained the actual number of 69.43 24.39 4.94
Parts for each month. (38.80) (38.00)
(scaled from 0 to 100) [35] [36]
15. My Year-end Cost Report MULTIPLE SINGLE ⬍ .001
contained the actual number of 69.71 25.56 5.06
Production Runs for each month. (38.46) (35.01)
(scaled from 0 to 100) [35] [36]
16. My Year-end Cost Report MULTIPLE CONTROL
contained the actual number of 69.71 24.39 5.00 ⬍ .001
Production Runs for each month. (38.46) (38.00)
(scaled from 0 to 100) [35] [36]
a
Column 2 contains means, (standard deviations), and [number of observations].
b
For questions 4–16, participants indicated whether they agreed (100) or disagreed (0).
c
All t-tests are two-sample, two-tailed in nature except for those pertaining to questions 4–6, which are one-
sample, one-tailed.
d
COR (INC) ⫽ correct (incorrect) initial cost beliefs; SINGLE ⫽ single cost pool condition; CONTROL
⫽ control cost condition; MULTIPLE ⫽ multiple cost pool condition.
importantly, as predicted in H1 and H2, the results show a significant interaction between
initial cost beliefs and cost system. Preplanned comparisons were employed to analyze
whether the nature of the interaction is consistent with that predicted in H1 and H2. Spe-
cifically, four two-sample, one-tailed t-tests were conducted to examine the four individual
two-cell comparisons involved in H1 and H2. Panel B of Figure 2 graphically shows the
six cells (A–F) involved in these four comparisons. The results of these preplanned com-
parisons are reported in Panel B of Table 4.
Consistent with H1, for individuals with incorrect beliefs, the multiple cost pool sys-
tem’s provision of historical activity data for multiple activities increases cost estimation
accuracy relative to the provision of historical activity data for only a single activity [mean
accuracy in cell F is greater than in cell E (t ⫽ 3.40, p ⬍ .01)]. Also consistent with H1,
for individuals with correct beliefs, the multiple cost pool system’s provision of historical
activity data for multiple activities has no effect on cost estimation accuracy relative to the

152 Heitger
TABLE 4
Total Activity Cost Estimation Accuracy: Results of ANOVA and Preplanned Comparisons
Panel A: 2 ⴛ 3 (ICB ⴛ CSYS) ANOVA

Sum of
Factor Squares df Mean Square F-stat p-value
ICBa 120,529,294 1 120,529,294 228.01 ⬍ .001
CSYS 7,618,373 2 3,809,187 7.21 .001
ICB ⫻ CSYS 20,309,406 2 10,154,703 19.21 ⬍ .001
Explained 148,457,073 5 29,691,415 56.17 ⬍ .001
Residual 53,390,134 101 528,615
Total 201,847,207 106 1,904,219
Panel B: Preplanned Comparisons to Test H1 and H2

1b 2 3 4 5 6c
Mean Comparison Between: Hyp. t-stat.d p-value df r
F (INC, MULTIPLE)e E (INC, CONTROL)
7,192 6,105 H1 3.40 ⬍ .01 33 .510
(1,058) (824)
[17] [18]
C (COR, MULTIPLE) B (COR, CONTROL)
8,201 8,323 H1 ⫺.57 .29 34 ⫺.098
(613) (661)
[18] [18]
E (INC, CONTROL) D (INC, SINGLE)
6,105 5,498 H2 2.36 ⬍ .01 34 .375
(824) (717)
[18] [18]
B (COR, CONTROL) A (COR, SINGLE)
8,323 8,641 H2 ⫺1.88 .03 34 ⫺.307
(661) (287)
[18] [18]
a
ICB ⫽ initial cost beliefs; CSYS ⫽ cost system.
b
Column 1 contains means, (standard deviations), and [number of observations].
c
Column 5 presents r as a measure of effect size (Rosenthal and Rosnow 1985).
d
All t-tests are one-tailed.
e
A through F refer to the six experimental conditions shown in Table 2 and Panel B of Figure 2. COR (INC)
⫽ participants with correct (incorrect) initial cost beliefs. SINGLE, CONTROL, and MULTIPLE ⫽ the cost
system conditions.
provision of historical activity data for only a single activity [mean accuracy in cell C is
not different from that in cell B (t ⫽ ⫺.57, p ⫽ .29)].9
Consistent with H2, for individuals with incorrect beliefs, the multiple cost pool sys-
tem’s provision of a biased standard rate for multiple activities increases cost estimation
9
It is possible that some participants made informal adjustments to their initial cost beliefs during one or more
months, such that their year-end cost estimates were a result not only of their year-end adjustments from their
initial cost beliefs but also their monthly adjustments from their initial cost beliefs. Measuring and testing this
distinction would be of interest for future research.

accuracy relative to the provision of a biased standard rate for only a single activity [mean
accuracy in cell E is greater than in cell D (t ⫽ 2.36, p ⬍ .01)]. Also consistent with H2,
for individuals with correct beliefs, the multiple cost pool system’s provision of a biased
standard rate for multiple activities decreases cost estimation accuracy relative to the pro-
vision of a biased standard rate for only a single activity [mean accuracy in cell B is less
than in cell A (t ⫽ ⫺1.88, p ⫽ .03)].10 Thus, the results support both H1 and H2.11
Supplementary Analysis
Anchoring on Initial Cost Beliefs
As discussed in the Hypothesis Development section, I expected individuals to anchor
on their initial cost beliefs when estimating costs. Individuals anchoring on their initial
beliefs are expected to perceive the monthly differences between their initial cost belief’s
calculated change in total costs and the actual change in total costs as being smaller than
they were in reality. Thus, individuals’ recall of the average (and greatest) of these eleven
monthly cost differences is examined. Table 5 displays the descriptive statistics for mean
RECAVGD and RECGRTD. Mean RECAVGD for participants with incorrect beliefs is
$12,463, indicating that they recalled the average cost difference to be significantly less
(i.e., almost 50 percent smaller) than the actual average cost difference of $24,455 (t
⫽ ⫺12.660, p ⬍ .001). Also, mean RECGRTD for participants with incorrect beliefs is
$48,163, indicating that they recalled the greatest cost difference to be significantly less
(i.e., 29 percent smaller) than the actual greatest cost difference of $68,000 (t ⫽ ⫺8.406,
p ⬍ .001). Further, 94 percent and 92 percent of participants recalled the average and
greatest cost differences, respectively, as being smaller than they were in reality. Thus, as
expected, participants with incorrect beliefs appear to anchor on their beliefs as evidenced
by their misperception of the size of the monthly differences between their calculated costs
changes and actual costs changes.
The Relationship between Anchoring on Initial Cost Beliefs and Cost

Estimation Accuracy
The extent to which participants adjust from their initial cost beliefs when estimating
costs likely is based on the extent to which they believe that such beliefs are incorrect.
Thus, the smaller the recalled monthly cost differences, the more that individuals are likely
to anchor on their initial beliefs and make fewer adjustments from such beliefs when es-
timating costs. Reduced adjustment from initial beliefs is detrimental to cost estimation
accuracy when individuals’ beliefs are incorrect. Therefore, the relationship between par-
ticipants’ anchoring on initial beliefs, as measured by their year-end recall of the average
monthly cost differences, and their cost estimation accuracy is examined. For participants
with incorrect beliefs, RECAVGD is negatively correlated with cost estimation accuracy [r
⫽ ⫺.203, p ⫽ .074 (one-tailed)].12 Thus, as expected, the smaller the recalled average cost
10
Participants in the experiment correctly reported that they understood that the standard rates might be inaccurate
and were provided with twelve months of data over which to observe the degree of inaccuracy in the rates.
However, it is possible that participants might have been better in recognizing the degree of inaccuracy in the
rates had they been given additional monthly data.
11
ANCOVA analyses indicate that SAT scores, ACT scores, GMAT scores, and GPA are not associated with cost
estimation accuracy and do not alter the relationship between cost estimation accuracy and either initial cost
beliefs or cost system. Also, ANOVA analyses indicate that the number of completed statistics courses, years
of business experience (the 50 MBA participants possessed a mean [maximum] of four [ten] years of professional
business experience), academic degree, and gender are not associated with cost estimation accuracy. Thus, the
results do not appear to be driven by these potential covariates.
12
Individuals’ recalled greatest difference between calculated and actual changes in total costs (RECGRTD) is not
associated with activity cost estimation accuracy (r ⫽ .165, p ⫽ .121).

154 Heitger
TABLE 5
RECAVGDa and RECGRTDb: Descriptive Statistics
COST SYSTEM
SINGLE MULTIPLE
INITIAL A B C
COST c RECAVGDd RECAVGD RECAVGD
COR
BELIEFS 2,992 3,085 3,206 3,090
(1,669) (1,538) (2,101) (1,739)
RECGRTD RECGRTD RECGRTD
8,139 7,444 10,156
(5,067) (4,728) (9,387) 8,519
[18] [18] [16] (6,575)
D E F
RECAVGD RECAVGD RECAVGD
INC
11,859 14,306 11,118 12,463
(6,240) (8,568) (5,064) (6,830)
RECGRTD RECGRTD RECGRTD
50,000 44,778 49,912 48,163
(15,379) (18,448) (17,472) (17,017)
[17] [18] [17]
7,299 8,695 7,282 7,777
(6,319) (8,318) (5,569) (6,839)
28,471 26,111 30,636 28,341
(23,974) (23,121) (24,516) (23,697)
a
The average absolute value of the cost difference between the calculated monthly change in total costs and the
actual monthly change in total costs across all months is $3,364 (COR—see Figure 7, column 6) and $24,455
(INC—see Figure 7, column 4). The mean recalled average cost difference (RECAVGD) is $3,090 (COR) and
$12,463 (INC).
b
The greatest absolute value of the cost difference between the calculated monthly change in total costs and the
actual monthly change in total costs across all months is $6,000 (COR—see Figure 7, column 6) and $68,000
(INC—see Figure 7, column 4). The mean recalled greatest cost difference (RECGRTD) is $8,519 (COR) and
$48,163 (INC).
c
d
Cells contain means, (standard deviations), and [number of observations].
difference between calculated and actual changes in total costs, the less accurate the activity
cost estimates. This finding suggests that participants’ cost estimation accuracy decreases
as the extent to which they anchor on their incorrect initial beliefs increases, which is
important in establishing that recall of historical data plays a significant role in cost
estimation.
Reducing Anchoring on Initial Cost Beliefs by Providing Historical Activity Data

The multiple cost pool system’s provision of historical data for multiple activities (Fig-
ure 1, F), together with historical total cost data, allows individuals to observe once again
the monthly differences between calculated changes in total costs (based on their initial
cost beliefs) and actual changes in total costs. For individuals with incorrect initial beliefs,
this observation is expected to lead them to realize that these differences are greater than
they had recalled, thereby increasing the extent to which they make adjustments from their

incorrect beliefs in estimating activity costs.13 Contrary to expectations, for participants

with incorrect beliefs, a 1 ⫻ 3 (incorrect initial beliefs x cost system) ANOVA shows that
mean RECAVGD does not vary across cost system conditions (F ⫽ 1.05, p ⫽ .357). How-
ever, recall might be affected by additional factors other than whether or not historical
activity data are provided at year-end.
To more directly test the notion that providing historical activity data improves indi-
viduals’ recall of the monthly cost differences, each participant’s RECAVGD after having
seen their year-end cost report (i.e., post year-end cost report RECAVGD) was compared
to their RECAVGD before having seen their year-end cost report (i.e., pre year-end cost
report RECAVGD).14 ⌬RECAVGD is defined as the post-year-end cost report RECAVGD
minus the pre-year-end cost report RECAVGD. Only the multiple cost pool system’s year-
end cost report provides historical data for multiple activities. Thus, only participants with
incorrect initial beliefs in the multiple cost pool system are expected to increase (i.e.,
improve) their recall of the average cost difference after having seen their year-end cost
report. This within-subjects measure is a more direct test of whether the provision of his-
torical data for multiple activities improves participants’ recall of the average cost difference
than is comparing aggregate cell means of RECAVGD.
A 1 ⫻ 3 (incorrect initial beliefs x cost system) ANOVA with ⌬RECAVGD as the
dependent variable reveals a significant main effect for cost system (F ⫽ 4.66; p ⫽ .019).
Comparisons involving participants with incorrect beliefs show that the change in the re-
called average difference between calculated and actual cost changes (⌬RECAVGD) is
greater in the multiple cost pool system than in either the control cost system [t ⫽ 2.52, p
⫽ .012 (one-tailed)] or the single cost pool system [t ⫽ 2.70, p ⫽ .009 (one-tailed)]. Also,
Table 6 reports ⌬RECAVGD for each condition. A positive ⌬RECAVGD indicates that
RECAVGD is larger after seeing the year-end cost report than before seeing the year-end
cost report. As expected, only participants with incorrect initial beliefs in the multiple cost
pool system, demonstrate a significantly positive ⌬RECAVGD (t ⫽ 2.966, p ⫽ .009). There-
fore, the multiple cost pool system’s year-end provision of historical data for multiple
activities increases participants’ recall of the average monthly cost differences between their
initial cost beliefs’ calculated cost changes and actual cost changes.15 Taken together, the
results of the supplementary analyses are consistent with the notion that the multiple cost
pool system’s provision of historical activity data increases cost estimation accuracy by
reducing the extent to which individuals’ recall of historical data anchors on their incorrect
initial cost beliefs.
DISCUSSION AND DIRECTIONS FOR FUTURE RESEARCH

Accurately estimating activity costs is important for numerous managerial decisions,
such as cost control, performance evaluation, budgeting, process re-engineering, pricing,
13
Only individuals in the multiple cost pool condition can make this observation because they are the only
individuals who are provided with historical data for all three activities at year-end. Individuals in the single
and control cost system conditions are not provided with historical data for PARTS and PRuns and thus, cannot
make this observation. As a result, improved recall of the average differences after seeing the year-end cost
report is expected only for participants in the multiple cost pool condition.
14
As explained in the third section, half of the participants performed the cost differences recall task before the
activity cost estimation task. These participants then performed the same cost differences recall task a second
time after completing and turning in the cost estimation form. Thus, only these participants have a pre and post
year-end cost report RECAVGD measure.
15
Performing the same analysis using the change in the recalled greatest difference between calculated and actual
changes in total costs reveals that the provision of historical activity data does not significantly increase indi-
viduals’ recalled greatest cost difference (RECGRTD).

156 Heitger
TABLE 6
Change in RECAVGD: ⌬RECAVGDa
COST SYSTEM
SINGLE MULTIPLE
INITIAL A B C
COST 3,000c 2,955 40 1,964
BELIEFS (5,963) (6,753) (1,970) (5,300)
CORb
[t ⫽ 1.509] [t ⫽ 1.384] [t ⫽ .064]
{p ⫽ .170} {p ⫽ .200} {p ⫽ .950}
⬍8⬎ ⬍9⬎ ⬍9⬎
D E F
⫺250 ⫺5,389 4,722 ⫺304
(2,937) (11,033) (4,777) (7,921)
INC
[t ⫽ ⫺.269] [t ⫽ ⫺1.465] [t ⫽ 2.966]d
{p ⫽ .794} {p ⫽ .181} {p ⫽ .009}
⬍9⬎ ⬍8⬎ ⬍8⬎
1,289 ⫺997 2,258 850
(4,785) (9,759) (4,225) (6,753)
a
⌬RECAVGD is the change in participants’ recall of the average difference, measured both before (Pre) the
activity cost estimation task and after (Post) the activity cost estimation task. Specifically, ⌬RECAVGD ⫽ Post
Year-end Cost Report RECAVGD ⫺ Pre Year-end Cost Report RECAVGD. ⌬RECAVGD is a within-subjects
measure and pertains only to participants who perform the cost differences recall task before the activity cost
estimation task. A positive ⌬RECAVGD indicates that RECAVGD is larger after seeing the year-end cost report
than before seeing the year-end cost report.
b
c
Cells contain means, (standard deviations), [t-statistics], {p-values}, and ⬍degrees of freedom⬎.
d
A directional expectation about ⌬RECAVGD is present only for cell F. Thus, a one-tailed test is used in cell F
while a two-tailed test is used in the other five cells.
and outsourcing. This study examines the effects of initial cost beliefs and type of cost
system on individuals’ activity cost estimation accuracy. Understanding how these two
factors affect individuals’ cost estimation accuracy is important because individuals often
possess incorrect initial beliefs about the costs they subsequently estimate and operate under
a multiple cost pool system that provide biased standard rates. However, such biased cost
systems often provide accurate historical activity data that is predicted to improve individ-
uals’ adjustments from their incorrect initial cost beliefs when they estimate costs, thereby
increasing their cost estimation accuracy.
As expected, the results show that the multiple cost pool system’s provision of accurate
historical data for multiple activities improves activity cost estimation accuracy, relative to
a single cost pool system that does not provide such data, for individuals with incorrect
cost beliefs. This benefit to cost estimation accuracy occurs even though the multiple cost
pool system provides biased standard rates for each activity. The provision of historical
activity data has no effect on cost estimation accuracy for individuals with correct cost
beliefs. Also, the multiple cost pool system’s provision of biased standard rates for multiple
activities increases cost estimation accuracy for individuals with incorrect cost beliefs, and
decreases cost estimation accuracy for individuals with correct cost beliefs. This result
occurs because the biased rates are more accurate than individuals’ incorrect beliefs but
less accurate than individuals’ correct beliefs. Thus, combining the effects of these two cost
system elements (historical activity data and biased standard rates), the biased multiple cost

pool system increases cost estimation accuracy for individuals with incorrect beliefs but
decreases cost estimation accuracy for individuals with correct beliefs.16
In addition, the results of supplementary analyses provide some evidence as to why
the multiple cost pool system’s provision of historical activity data improves cost estimation
accuracy for individuals with incorrect initial cost beliefs. The results indicate that when
estimating activity costs, individuals’ recall of historical activity data anchors on their in-
correct initial cost beliefs. Further, for individuals with incorrect cost beliefs, the extent to
which recall is anchored on initial beliefs is negatively associated with cost estimation
accuracy. Finally, the analyses suggest that the multiple cost pool system’s provision of
historical activity data improves cost estimation accuracy by reducing the extent to which
individuals’ recall of historical data anchors on their incorrect initial beliefs when estimating
activity costs.
This study extends prior research on the judgment effects of cost system design by
showing that multiple cost pool systems can improve individuals’ cost estimation accuracy
by mechanisms other than the provision of accurate standard rates. Specifically, the paper’s
main finding that the provision of accurate historical activity data improves cost estimation
accuracy for individuals with incorrect cost beliefs has implications for the tradeoff that
firms face in designing alternate cost systems. For example, when designing a multiple cost
pool system, firms may need to decide how to allocate limited resources between a system
that provides accurate historical activity data versus one that provides accurate standard
rates. Given the results of this study, greater emphasis might be placed on designing a
system that provides individuals with accurate historical activity data when they estimate
costs, especially when they are likely to possess incorrect cost beliefs. Future research might
examine other mechanisms by which multiple cost pool systems, and their specific features,
affect cost estimation accuracy. In so doing, future research should consider this paper’s
finding that the judgment effects of flawed cost systems might depend on the cost beliefs
held by managers, as well as other environmental factors not examined in this study.
Finally, it is interesting to note that the most accurate cost estimates are produced by
individuals with correct initial beliefs in the single cost pool system. Future research might
examine why individuals with correct initial beliefs use biased standard rates (that are
relatively less accurate than their beliefs) from a multiple cost pool system to make
accuracy-decreasing adjustments to their initial cost beliefs even when they understand that
the rates might not be accurate. Such research could help individuals better understand the
conditions under which to use the cost system’s standard rates in estimating costs and when
to ignore such rates.
Like all research, this study is subject to limitations. The cost of storing, accessing,
and providing individuals with historical activity data might be considerable but is ignored
in this study. Also, this study assumes that the activity data provided to individuals are
accurate, which is not always true in reality. Future research might examine how accurately
firms measure activity data, as well as the costs and technology necessary to measure such
data accurately.
16
Thus, the examination of correct cost beliefs is important because it helps demonstrate empirically that a biased
cost system can have a beneficial or detrimental effect on individuals’ cost estimation accuracy depending upon
whether their cost beliefs are incorrect or correct. As such, future research should consider that the judgment
effects of flawed cost systems might depend on the cost beliefs held by managers, as well as other environmental
factors not examined in this study.

158 Heitger
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Estimating Activity Cost

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BEHAVIORAL RESEARCH IN ACCOUNTING

Volume 19, 2007

Estimating Activity Costs:

Behavioral Research in Accounting, 2007

Behavioral Research in Accounting, 2007

Behavioral Research in Accounting, 2007

Individual possesses initial

Individual calculates expected

Individual observes actual

Individual’s perception of how Individual

Individual adjusts from

Behavioral Research in Accounting, 2007

Behavioral Research in Accounting, 2007

The Effect of Providing Historical Activity Data on Individuals’ Cost

Behavioral Research in Accounting, 2007

SINGLE CONTROL a MULTIPLE

Panel B: Hypotheses 1 and 2

Single C ontrol M ultiple

Behavioral Research in Accounting, 2007

The Effect of Providing Biased Standard Rates on Individuals’ Cost

Behavioral Research in Accounting, 2007

y ⫽ bo ⫹ b1x1 ⫹ b2x2 ⫹ b3x3 ⫹ ε, (1)

Behavioral Research in Accounting, 2007

Fixed MHs Parts PRuns Random TOTAL OH

Initial Cost Beliefs SINGLE CONTROL MULTIPLE

MHc $125/MH $125 $125 $453 $162 $162

Part $2,500/PART $2,500 $500 — $1,500 $1,500

PRun $500/PRun $500 $2,500 — $,1600 $1,600

Behavioral Research in Accounting, 2007

estimation accuracy is achieved by comparing estimation accuracy between the multiple

Budgeted Total Budgeted Standard

Behavioral Research in Accounting, 2007

Behavioral Research in Accounting, 2007

Production Department Report

Number of machine hours 360 300 –60

Number of parts in production 30 42 12

Number of production runs 30 12 –18

Description of the Three Tasks and Dependent Variables

Behavioral Research in Accounting, 2007

Feb –$10,000 –$15,000 –$5,000 –$15,000 –$5,000

Behavioral Research in Accounting, 2007

Behavioral Research in Accounting, 2007

3,000 ⫺ 兩actual activity cost ⫺ estimated activity cost兩.

Behavioral Research in Accounting, 2007

Behavioral Research in Accounting, 2007

Behavioral Research in Accounting, 2007

Panel A: 2 ⴛ 3 (ICB ⴛ CSYS) ANOVA

Panel B: Preplanned Comparisons to Test H1 and H2

Behavioral Research in Accounting, 2007

The Relationship between Anchoring on Initial Cost Beliefs and Cost

Behavioral Research in Accounting, 2007

Reducing Anchoring on Initial Cost Beliefs by Providing Historical Activity Data

Behavioral Research in Accounting, 2007

incorrect beliefs in estimating activity costs.13 Contrary to expectations, for participants

DISCUSSION AND DIRECTIONS FOR FUTURE RESEARCH

Behavioral Research in Accounting, 2007

Behavioral Research in Accounting, 2007

Behavioral Research in Accounting, 2007

Behavioral Research in Accounting, 2007

Behavioral Research in Accounting, 2007

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