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Simpsons Reversal Paradox and Cost Allocation

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  • Sunder Shyam

Abstract

Allocation of indirect costs among products sometimes yields a paradoxical result that unit cost for each product may increase under one method of allocation and may decrease for each product under another method. The Stalcup Paper Company case illustrate such behaviour of costs at the same, time, provides an accounting example of Simpon’s Reversal Paradox Simpson (1951), which Blyth (1972) discussed in the statistics literature. As with other paradoxes, this cost allocation paradox disappears upon closer scrutiny. This paper examines the properties of allocated costs in order to arrive at an intuitive understanding of the results. The relationship of the cost allocation problem to Simpson’s Paradox and the implications of the analysis for cost control are briefly discussed. Necessary and sufficient condition for occurrence of the Paradox is also given.

Suggested Citation

  • Sunder Shyam, 1982. "Simpsons Reversal Paradox and Cost Allocation," IIMA Working Papers WP1982-02-01_00486, Indian Institute of Management Ahmedabad, Research and Publication Department.
    • Handle: RePEc:iim:iimawp:wp00486
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    Cited by:

    1. Nahum D. Melumad & Amir Ziv, 2004. "Reduced Quality and an Unlevel Playing Field Could Make Consumers Happier," Management Science, INFORMS, vol. 50(12), pages 1646-1659, December.
    2. Mingcherng Deng & Nahum Melumad & Toshi Shibano, 2012. "Auditors’ Liability, Investments, and Capital Markets: A Potential Unintended Consequence of the Sarbanes‐Oxley Act," Journal of Accounting Research, Wiley Blackwell, vol. 50(5), pages 1179-1215, December.
    3. Abraham Mehrez & J. Randall Brown & Moutaz Khouja, 1992. "Aggregate efficiency measures and Simpson's Paradox," Contemporary Accounting Research, John Wiley & Sons, vol. 9(1), pages 329-342, September.

    More about this item

    JEL classification:

    • M41 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - Accounting
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • L22 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Firm Organization and Market Structure

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