Activity-Based Costing for Economic Value Added

Abstract

Economic value added (EVA), which is the currently popular term for the traditional accounting concept of residual income, subtracts from operating income an interest charge for invested capital. This paper provides both a normative justification for EVA and an activity-based cost system that supports EVA maximization. We construct a model of participatory budgeting for a multi-activity firm in which we show that, if investment decisions are made myopically each period to maximize EVA, the resulting path of plant and equipment vectors asymptotically approximates the path that maximizes discounted cash flows. The cost system allocates plant and equipment cost to products using a formula that includes the interest charge.