Economic value added, which is the currently popular term for the traditional accounting concept of residual income (RI), subtracts from operating income an interest charge for invested capital. This paper provides an activity-based cost system that supports RI maximization. We construct a model of participative budgeting for a multi-activity firm in which the cost system allocates plant and equipment cost to products using a formula that includes the interest charge. The budget system we design enables decision makers to identify RI-improving opportunities for outsourcing and dropping unprofitable products. The budget system also has the “open-architecture” property that additional informal communication among activity managers can only serve to increase RI.
Review of Accounting Studies – Springer Journals
Published: Jan 13, 2005
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