A comparative analysis of utilizing activity-based costing and the theory of constraints for making product-mix decisions

Abstract

Activity-based costing (ABC) and the theory of constraints (TOC) represent alternative paradigms for evaluating the economic consequences of production-related decisions. However, their application can lead to contradictory product-mix decisions. To resolve this conflict, it is frequently suggested that the TOC is appropriate for the short run, while ABC is appropriate for the longer term. This paper models the selection of a product mix with the TOC and an ABC model integrating activity-based cost with the capacity of production-related activities. The paper demonstrates that management's discretionary power over labor and overhead resources determines when the TOC and ABC lead to optimal product-mix decision. Equally important, it demonstrates that both the TOC and ABC may lead to a suboptimal product mix across a wide range of economic conditions. The paper develops a more general model of the product-mix decision and demonstrates that the TOC and ABC are special cases of this model. Finally, the paper discusses how the general model may be used to supplement information provided by the TOC and ABC.