The Effects of Accounting Knowledge and Context On The Omission of Opportunity Costs in

The Effects of Accounting Knowledge and Context on the Omission of Opportunity Costs in
Resource Allocation Decisions

Author(s): Sandra C. Vera-Muoz
Source: The Accounting Review, Vol. 73, No. 1 (Jan., 1998), pp. 47-72
Published by: American Accounting Association
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THE ACCOUNTING REVIEW

Vol. 73, No. 1
January 1998
pp. 47-72
The
Effects
Knowledge
Omission
Resource
of
of
Accounting
Context
and
on
Opportunity Costs
Allocation
the
in
Decisions
Sandra C. Vera-Mun-oz
University of Notre Dame
ABSTRACT: Economic theory stresses that opportunity costs are relevant to
resource allocation decisions, while prior empirical accounting research finds
that decision makers tend to ignore or underweight opportunity cost information. This study examines whether accounting knowledge is associated
with a decision maker's tendency to ignore opportunity costs in business decisions. The experiment's results indicate that the number of opportunity costs
ignored by subjects in a business resource allocation decision is greater for
subjects with high-accounting knowledge than for subjects with low-accounting knowledge. The experiment also indicates that subjects with highaccounting knowledge ignore a greater number of opportunity costs when the
decision is posed in a business context than when it is posed in a personal
context.
Key Words: Opportunity costs, Knowledge structures, Accounting knowledge,
Decision context.
Data Availability: Contact the author
This paper draws on my Ph.D. dissertation completed at the University of Texas at Austin. I wish to thank
the members of my dissertation committee, Urton Anderson, Susan Broniarczyk, Bryan Cloyd, Pat West and
especially William R. Kinney, Jr. (chairman) for their insightful comments and suggestions. This research also
benefited from the comments and suggestions of two anonymous reviewers, Carolyn Callahan, Anthony Catanach,
Lisa Koonce, Pam Losefsky, Rafael Mufioz, Gabriel Radvansky, Laura Radvansky, Shelley Rhoades, David Ricchiute and Brian Spilker. Workshop participants at the University of Arizona, University of Notre Dame and
University of Texas at Austin, Florida State University, Georgia Institute of Technology, Texas A&M University,
the Indiana-Notre Dame-Purdue Summer Workshop and the 1996 Management Accounting Research Conference
provided helpful comments on earlier versions of this paper. I am indebted to the students of the Graduate School
of Business at the University of Texas at Austin for their participation in the experiment, and to Amanda Collins
and Kristina Zvinakis for their able research assistance. Financial support from the Coopers & Lybrand Foundation,
Ernst & Young LLP, and the Eugene and Dora Bonham Memorial Fund is gratefully acknowledged.
Submitted June 1996.
Accepted August 1997.
47
The Accounting Review, January 1998
48
I. INTRODUCTION
CONOMIC theory stresses that opportunity costs are relevant to resource allocation
decisions (Solomons 1966; Coase 1981, 108; Zimmerman 1995, 24), while prior
empirical accounting research reports that decision makers tend to ignore or underweight opportunity cost information (Becker et al. 1974; Neumann and Friedman 1978;
Friedman and Neumann 1980; Hoskin 1983; Northcraft and Neale 1986). The reasons why
decision makers ignore or underweight opportunity costs are not well understood. The goals
of this study are to develop and test predictions about the tendency of decision makers to
leave opportunity costs out of their analysis of a particular problem, and, in the end, to
help decision makers improve the quality of their decisions. This study relies on Holland
et al.'s (1986) theoretical framework of cognitive processing to examine whether decision
context and the level of accounting knowledge affect a decision maker's consideration of
opportunity costs.
Holland et al. (1986) and others (Hayes-Roth et al. 1983; Anzai and Yokoyama 1984;
Glaser 1984) suggest that people have knowledge structures stored in memory that guide
their problem solving. One implication of the research in knowledge structures is that people
with high knowledge in one area will recall a familiar knowledge structure whenever it
appears appropriate for a given decision context. I maintain that accounting knowledge
structures do not ordinarily emphasize the relevance of opportunity costs. Consequently, I
hypothesize that decision makers with high-accounting knowledge will have a greater tendency to ignore opportunity costs in business contexts than decision makers with lowaccounting knowledge because the former group of decision makers will recall accounting
knowledge structures which do not place an emphasis on such costs. However, I predict
that decision makers with high-accounting knowledge will not have a tendency to ignore
opportunity costs in personal decision contexts because such contexts will not usually trigger the application of their accounting knowledge.
The joint influence of accounting knowledge and decision context on the consideration
of opportunity costs was examined in a between-subjects laboratory experiment. In the
reported experiment, accounting knowledge was measured in two ways: discretely and
continuously. The discrete measure classified subjects into high- and low-accounting knowledge categories based upon the program of graduate business study in which the subjects
were enrolled. The continuous measure was the number of accounting courses the subjects
had completed. Decision context was a manipulated variable. Subjects were presented with
a resource allocation decision in either a business or a personal context. Subjects assumed
the role of a financial consultant asked by a partner to recommend a resource allocation
for a new client. The business and personal resource allocation cases were structurally
equivalent. The experimental design randomized context treatments and controlled for the
potential effect of analytical ability on performance.
The experiment produced the counter-intuitive result that high-accounting knowledge
interferes with a decision maker's ability to incorporate opportunity costs into a business
decision, but such knowledge does not interfere with a decision maker's ability to factor
opportunity costs into a personal decision.1 In particular, the results indicate that the number
E
The word "interferes" as used in this study should not be confused with the psychological theory of interference,
which provides an explanation for why forgetting occurs. According to interference theory, new information
interferes with the recall of old knowledge structures from memory, and therefore, forgetting occurs as a result
of a weakening of a stimulus-response association by learning of another association (Massaro 1975, 542-543).
In contrast, the knowledge structures-guided explanation of why opportunity costs are ignored by subjects with
high-accounting knowledge posits that recall of existing knowledge structures from memory interferes with information processing of external cues (i.e., new information). For an application of interference theory in the
accounting context, see Moser (1989) and Frederick (1986).
Vera-Mufioz-The Effects of Accounting Knowledge and Context
49
of opportunity costs ignored by subjects increases significantly with increases in the subjects' accounting knowledge when the case is posed in a business context. In contrast, when
the case is posed in a personal context, there is no relation between the number of opportunity costs ignored and subjects' accounting knowledge. Validity tests rule out differential
knowledge about the opportunity cost concept by high- and low-accounting knowledge
subjects as an alternative explanation of their average tendencies to ignore opportunity costs.
Also, ex post analyses show that the experiment's findings are robust to differences in the
subjects' maximization objective for the resource allocation task.
This study extends prior research in several ways. First, except for Hoskin (1983), prior
accounting studies make no formal attempts to provide an explanation for why people tend
to ignore opportunity costs when making resource allocation decisions. In this study, however, knowledge structures research is applied to improve our understanding of the role of
accounting knowledge in resource allocation tasks that require incorporation of opportunity
costs. Second, prior studies use graduate business students and/or CPAs as subjects, but do
not measure the level of accounting knowledge of the graduate business students. Therefore,
no reliable conclusions can be drawn about the effects of accounting knowledge on decision
makers' tendencies to ignore opportunity costs. In contrast, the subjects used in the current
study are selected from groups likely to have distinctly different levels of accounting knowledge. Third, to rule out poor general performance by high-accounting knowledge decision
makers as an explanation of the observed results, the study controls for analytical ability
and manipulates decision context.
Finally, this study is one of few (Chase and Simon 1973; Marchant et al. 1991) to
address the dysfunctional effect of knowledge of a subject matter by examining specific
conditions under which high-accounting knowledge may hinder performance. Most of the
behavioral accounting studies that examine the effects of knowledge and/or experience on
performance (Libby 1985; Plumlee 1985; Frederick and Libby 1986; Libby and Frederick
1990; Frederick 1991; Bonner et al. 1992; Spilker 1995) address the benefits, but not the
costs, of high knowledge and/or experience. The findings of this study suggest that the
benefits usually associated with high knowledge and/or experience (e.g., increased processing speed, more complete problem representation, more accurate decisions, etc.) may
sometimes be overshadowed by a lack of fit between the knowledge structures recalled
from memory and the problem-solving situation at hand (Frensch and Sternberg 1989;
Libby and Luft 1993; Nelson et al. 1995).
The remainder of this paper contains four sections. Section II develops the motivation
and hypotheses. Sections III and IV, respectively, present the research design and results.
Section V discusses the results and possible implications for accounting theory, education
and practice.
II. MOTIVATION AND HYPOTHESES
Prior Accounting Research on the Use of Opportunity Costs in Decision Making
The essence of the economic principle of opportunity costs is that the cost of a resource
used in a particular application is determined by the value of the resource if used in the
best foregone alternative (Solomons 1966; Thompson 1973; Mansfield 1977; Coase 1981;
Heymann and Bloom 1990; Zimmerman 1995, 24). That is, opportunity costs are the estimated foregone receipts from actions that could, but will not, be undertaken (Zimmerman
1995, 26). When all uses of a resource cannot be accommodated, choices must be made
between or among alternative uses; thus, every act of choice also involves an act of sacrifice.
When resources are limited relative to demands, one must consider opportunity costs to
make the optimal decision.
50
Review,January1998
TheAccounting
The set of information potentially available in a resource allocation decision includes

both historical accounting costs and opportunity costs. While opportunity cost is a forwardlooking, or ex ante concept, historical accounting costs measure the resources expended for
actions actually undertaken. Generally Accepted Accounting Principles (GAAP)-based rules
are concerned primarily with producing ex post reports of states or outcomes of business
decisions, and with matching historical expenses to revenues (Kaplan 1984, 99; Zimmerman
1995, 26). Alternative actions that might have been considered contemporaneously in decision making are neither measured nor recorded in the organization's accounting system
(Horngren and Foster 1991, 377). Thus, while optimal decision making incorporates opportunity costs, externally reported historical financial accounting measures do not generally
include them.
Existing empirical research suggests that decision makers tend to ignore or underweight
opportunity costs in resource allocation decisions when the costs are not explicitly provided
(Becker et al. 1974; Neumann and Friedman 1978; Friedman and Neumann 1980; Hoskin
1983). Becker et al. (1974) present graduate business students with a choice between two
mutually exclusive projects whose margins are equal if opportunity costs are considered.
The authors find that the subjects are not indifferent between the two projects because they
ignore opportunity costs. Neumann and Friedman (1978) replicate and extend the Becker
et al. (1974) study by asking graduate business students to evaluate mutually exclusive
investment projects with different margins. The authors find that the subjects consider opportunity costs only when they are explicitly provided. In an extension to their first study,
Friedman and Neumann (1980) find that graduate business students and CPAs tend to ignore
equally opportunity costs when only partial or no information is provided about the costs.2
Hoskin (1983) shows that even when graduate business students are exposed to explicit
opportunity cost information, they are not more likely to consider opportunity cost information that is provided implicitly in subsequent problems.
Although prior studies provide evidence that individuals tend to ignore opportunity
costs, they do not specify factors that influence the tendency to ignore these costs. The
current study extends prior research by examining whether differential knowledge of
GAAP-based rules and decision context are related to the failure to consider opportunity
costs. As discussed in the next section, knowledge structures research-coupled with the
expectation of constant knowledge of the opportunity-cost concept across accounting
knowledge levels-will
help provide a basis for understanding the role of accounting
knowledge in resource allocation decisions that incorporate opportunity costs.3
Cognitive Processes, Accounting Knowledge and Opportunity Cost Consideration
According to Holland et al. (1986), the process of cognition (or reasoning) occurs when
information from external sources is combined with knowledge structures recalled from
long-term memory. For example, Anderson et al. (1991) use Holland et al.'s (1986) theoretical framework to provide a detailed model of the cognitive processes by which auditors
form professional judgments.4 The Anderson et al. (1991) model illustrates that cognition
2 The CPAs used in the Friedman and Neumann (1980) study presumably had accounting-related experience.
However, the study provides no demographic information about the graduate business students.
I The expectation of constant knowledge of the opportunity-cost concept across accounting knowledge levels is
tested empirically. The description of the validity test and results are reported in section IV of the paper.
4 In a related study, Bonner and Pennington (1991) provide a review and synthesis of the audit judgment literature
using explanations based on the knowledge and types of cognitive processes needed for performing specific tasks.
The cognitive-psychology literature cited by Bonner and Pennington (1991) is encompassed by Holland et al.'s
(1986) theoretical framework.
Vera-Mufioz-The Effects of AccountingKnowledgeand Context
51
is guided by a system of rules developed through formal instruction and/or as a result of

accumulated experiences with a given concept or procedure. This rule-based system can be
thought of as a network which evaluates competing knowledge structures, discarding some,
storing others, and modifying those that already exist. They also show that cognition is
highly knowledge- and context-dependent. A specific context will trigger recall of knowledge structures that are presumed relevant in that context (Chase and Simon 1973; Frensch
and Sternberg 1989; Marchant et al. 1991).
Prior accounting research provides evidence that different rule-based systems developed
through formal instruction and/or experience lead to different representations of knowledge
in long-term memory. For example, Frederick (1991) shows that the way in which the
auditor's knowledge of internal controls is organized in memory (i.e., taxonomic vs. schematic representation) differentially affects their recall. Similarly, Choo and Trotman (1991)
show that experienced and inexperienced auditors recall information from memory differently and, thus, their going-concern judgments differ.
Both knowledge structures research and prior empirical studies suggest that individuals
who have received formal accounting training are expected to have accounting knowledge
structures stored in long-term memory (Holland et al. 1986). I maintain that accounting
knowledge structures are dominated by GAAP. As previously discussed, GAAP does not
generally incorporate opportunity costs. Application of knowledge structures research to a
resource allocation decision process suggests that: (1) the decision context triggers recall
of accounting and normative knowledge structures from long-term memory; (2) the quality
and completeness of the cognitive problem representation (an internal, unobservable state)
is dependent on these knowledge structures; and (3) the cognitive problem representation
developed by the individual, along with his or her analytical ability, determines the individual's tendency to ignore opportunity costs (an observable state) in resource allocation
decisions.5
Prior research indicates that decision quality is eroded when there is a lack of fit
between the knowledge structures recalled from memory and the given problem-solving
situation (Chase and Simon 1973; Marchant et al. 1991). For example, Chase and Simon
(1973) give chess masters and novice chess players five-second exposures to a chessboard
set randomly with chess pieces. The subjects' task is to reconstruct the positions of the
chess pieces from memory. Chase and Simon (1973) find that chess masters perform worse
than beginners because the chess masters attempt to place the pieces according to the
strategies and rules in their knowledge structures. Because such rules are violated when
pieces are arranged randomly, the recalled knowledge structures inhibit the chess masters'
performance in the context of this particular task.
In a tax context, Marchant et al. (1991) examine analogical transfer and its relation to
expertise in legal reasoning. The authors conduct a series of experiments using introductory
tax students and experienced tax practitioners as subjects. They find that in solving novel
tax problems, the novice tax students outperform the experienced tax practitioners. The
results of their study suggest that novel tax problems cause experienced subjects to recall
inappropriate knowledge structures, and their reliance on these inappropriate structures inhibits their ability to solve the novel problem. The Chase and Simon (1973) and Marchant
et al. (1991) studies provide evidence of the dysfunctional effects resulting from the lack
5
The accounting literaturehas recognized that individual differences in abilities affect the acquisition of knowledge
(e.g., see Mock and Vasarhelyi 1984). Thus, consistent with prior research, this study controls for the potential
effects of analytical ability on performance (Frederick and Libby 1986; Butt 1988; Bonner 1990; Frederick 1991;
Nelson 1993).
52
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TheAccounting
of fit between the knowledge structures recalled from memory and the given problemsolving situation.
The studies cited above suggest a possible link between accounting knowledge and the
consideration of opportunity costs in decision making. In particular, when decision makers
with high-accounting knowledge are presented with an information set to assist in making
a business resource allocation decision, they construct a problem representation based on
their knowledge of GAAP-based rules. Thus, those with high-accounting knowledge may
fail to consider opportunity costs because their GAAP-based representation of the problem
does not indicate to them the need to consider these costs. To test these suggestions, the
following alternative-form hypothesis is proposed:
Hi: The number of opportunity costs ignored in a business resource allocation decision
will be greater for decision makers with high accounting knowledge than for decision makers with low accounting knowledge.
Decision Context
Prior research provides evidence that context triggers recall of domain-specific knowledge from long-term memory, which in turn affects performance (Butt 1988; Marchant
1989; Nelson 1993). Butt (1988) examines the effects of audit expertise in financial statement error frequency judgments. She finds that experienced auditors perform better than
inexperienced auditing students when the judgment task is posed in an audit context, but
not when the task is posed in a generic context. Marchant (1989) uses the same type of
subjects to examine the role of analogical reasoning and experience in hypothesis generation. He finds that experienced auditors outperform inexperienced auditing students, but
only in auditing tasks that trigger recall of domain-specific knowledge.
Nelson (1993) uses accounting and non-accounting students and experienced auditors
to examine the effects of error frequency and accounting knowledge on error diagnosis in
analytical review. He predicts that performance improves with knowledge of accounting
principles. To avoid confounding the effects of knowledge differences with differences in
ability across groups, the subjects are randomly assigned to one of two different contexts,
namely, analytical procedures or medical diagnosis. Nelson finds no significant differences
in performance between levels of accounting knowledge in the medical diagnosis context,
but significant differences between each level of accounting knowledge in the analytical
procedures context. This evidence suggests that accounting knowledge plays a role only in
contexts which trigger its application.6
The studies cited above suggest that there is a link between decision context and the
recall of knowledge structures. An implication of these studies is that when high-accounting
knowledge decision makers are presented with an information set to assist in making a
resource allocation decision, they will be more likely to access their GAAP-based knowledge from memory in business decisions than in personal decisions. Thus, they will have
a higher tendency to ignore opportunity costs in a business decision context than in a
personal decision context because the latter context will not usually trigger the application
of accounting knowledge. The following alternative-form hypothesis tests these suggestions:
H2: The number of opportunity costs ignored by high-accounting knowledge decision
makers will be greater in a resource allocation decision posed in a business context
than in a resource allocation decision posed in a personal context.
6
Further research on the effects of context and domain-specific knowledge on performance also comes from
medical studies on clinical diagnosis accuracy (Patel et al. 1989).
53
Analytical Ability
This study makes no a priori predictions about differences in analytical ability between
individuals with high-accounting knowledge and those with low-accounting knowledge.7
However, prior research suggests that analytical ability may affect subjects' decision behavior. For example, prior behavioral accounting studies have controlled for the potential
effects of analytical ability on performance (Frederick and Libby 1986; Butt 1988; Bonner
1990; Frederick 1991; Nelson 1993), and several auditing studies suggest a positive association between analytical ability and performance in audit tasks (Bonner and Lewis 1990;
Libby 1992; Libby and Tan 1992). Therefore, although analytical ability is assumed in this
study to be constant across groups, and above the minimum necessary for the experimental
task, its potential effect on performance is controlled for in the study by measuring and
statistically removing it.
III. RESEARCH DESIGN
A between-subjects experiment involving a resource allocation task was constructed to
focus on two factors: accounting knowledge and decision context. The level of accounting
knowledge possessed by the participants is operationalized as a dichotomous categorical
measure (high or low), based on graduate degree program membership, and as a continuous
measure, based on the number of accounting courses completed. The second factor is the
decision context, namely, business or personal.
A total of 80 students from graduate business administration and accounting programs
at the University of Texas at Austin participated in the experiment. The participantsreceived
monetary compensation consisting of a flat payment of $10.00, plus a performancecontingent bonus. The bonus had two purposes: (1) to encourage subjects to commit more
cognitive effort to the analysis; and (2) to encourage subjects to provide complete and clear
supporting computations.8
Case Materials and Procedures
The study was conducted in two parts: the experiment phase and the post-experiment
phase (hereafter denoted Parts One and Two, respectively). In Part One, the case materials
included the instructions, the assignment memorandum, supporting addenda, and a response
memorandum. In Part Two, the materials included a reaction questionnaire, a combined test
of analytical ability and opportunity costs knowledge, and a background questionnaire.9
Figure 1 summarizes the experimental procedures of Parts One and Two.
Analytical ability is composed of two constructs: analytical reasoning and logical reasoning. Analytical reasoning
is the ability to analyze a given structure of arbitrary relationships and to deduce new information from that
structure. Logical reasoning is the ability to analyze and critique argumentation by understanding and assessing
relationships among arguments or parts of an argument (Graduate Record Examinations Board 1990).
8 Three graduate accounting students who did not meet one of the two criteria for classification in the highaccounting knowledge group (discussed in the "Independent and Dependent Variables" section), and four students
who failed to provide supporting computations were excluded from the analyses. Thus, the analyses are based
on a sample of 73 subjects. The subjects received the flat payment immediately upon completing the experiment
and submitting the materials. The performance-contingent bonus, paid to the subjects one week after the experiment was conducted, was based on a composite score computed from the number of opportunity costs considered
by the subjects in their resource allocation recommendations, plus the subjects' scores on an analytical ability
test. Participants whose scores were in the top quartile received a bonus of $15.00, the next quartile received
$10.00, and the third quartile received $5.00; the bottom quartile did not receive a bonus.
9 The experiment was conducted in the University of Texas' Graduate School of Business Behavioral Laboratory
in 14 two-hour sessions over three consecutive days. Subjects were free to choose the day and time of their
voluntary participation. The experimenter was present in all of the sessions. The number of subjects in any
particular session ranged from three to 12. Both contexts, business and personal, were distributed in each session.
Measures were taken such that subjects sitting contiguously worked on different contexts. Subjects completed
the required tasks of Parts One and Two in 45 minutes each, on average.
54
FIGURE 1
Sequence of Experimental Procedures
Part One: Experiment Phase
Procedure
1. Read general instructions
2. Read assignment memorandum
3. Read supporting addenda
4. Complete response memorandum
Description
Information about the study, tasks and monetary
compensation scheme
Brief description of the client, the problem situation, and the resource allocation recommendation requested by the client
Client's letter and staff memorandum containing
detailed financial and non-financial information
about the client
Elicited recommendation, supporting calculations,
and a brief explanation of the rationale underlying the recommendation
Part Two: Post-Experiment Phase

Procedure
1. Complete reaction questionnaire
2. Complete reasoning exercise
3. Complete background questionnaire
4. Receive monetary compensation
Description
Debriefing questions
Analytical ability and opportunity cost knowledge
tests
Academic background and work experience
questions
Flat compensation paid upon completion of Parts
One and Two
In Part One, subjects assumed the role of a financial consultant asked by a partner to
recommend a resource allocation for a new client. Each participant was presented with one
of two structurally equivalent cases in a business or a personal context. In the business
case, a shopping mall has been scheduled for condemnation by the state government. The
president of one of the mall's retail branch stores asks whether she should vacate the retail
space at the end of the current year or at the end of the forthcoming year. In the personal
case, a civilian is employed in the data processing department at an Air Force Base scheduled for closure at the end of the forthcoming year. The civilian asks whether he should
leave his job at the Base at the end of the current year or at the end of the forthcoming
year. To reduce both task complexity and the potential for different interpretations of the
task, subjects were instructed to ignore income taxes. Appendices A and B show the instructions for Part One and the staff memorandum provided to the participants in the business and personal context conditions, respectively.'"
'0 The case materials were calibrated in a two-stage pilot test with the assistance of six persons at the University
of Texas at Austin. In the first stage, two management accounting professors and a graduate business student
who was also a 20-year veteran Air Force Lieutenant Colonel were asked to read the case narratives and to
"think aloud" as they evaluated the information. The case materials were revised in the first stage to enhance
the completeness and accuracy of the information set provided. In the second stage, the revised case materials
were pilot-tested with three graduate business students, and were further revised to enhance their clarity.
55
Independent and Dependent Variables

Decision context was manipulated by using two resource allocation cases, one in a
business context and one in a personal context. Two knowledge groups were sampled and
formed the dichotomous categorical measure of accounting knowledge: the low-accounting
knowledge group and the high-accounting knowledge group. The low-accounting knowledge group consists of 33 subjects who: (1) were enrolled in the Master in Business Administration program, and (2) had completed no more than four accounting courses. These
subjects reported completing an average of two accounting courses, with a range of one to
four." The high-accounting knowledge group consisted of 40 subjects who: (1) were enrolled in the Master in Professional Accounting program, and (2) had completed at least
seven accounting courses (indicative of students who are in their last two years of their
professional accounting degree programs).'2 These subjects reported completing an average
of 12.23 accounting courses, with a range of seven to 22.13 Accounting knowledge is also
measured continuously, based on the number of accounting courses completed by subjects.
The dependent variable is measured as the number of opportunity costs omitted by the
subjects in their recommendations. There are a total of five possible opportunity costs in
each decision context (discussed below). The opportunity costs were selected for inclusion
in the case narratives after a review of both prior accounting research on opportunity costs
and behavior (Becker et al. 1974; Neumann and Friedman 1978; Friedman and Neumann
1980; Hoskin 1983), and current authoritative textbooks and monographs on opportunity
costs and resource allocation decisions (Atkinson 1987; Heymann and Bloom 1990;
Horngren and Foster 1991, 377).
As discussed earlier, opportunity costs are defined as the benefit foregone from a given
decision, or the receipts that could have been obtained if that particular decision had not
been made (Zimmerman 1995, 92). In both decision contexts, the subjects were required
to choose between recommending the client to take a given action at the end of the current
year, or at the end of the forthcoming year. These mutually exclusive options involve a
trade-off in receipts and expenditures over time, thus giving rise to opportunity costs. Specifically, in the business context, the following five opportunity costs would have to be
considered if the president decided to wait one year before relocating the store: (1) the
return on the disposal proceeds of the store's fixed assets; (2) the sublease revenue on the
store's current retail location; (3) the return on the differential compensation award offered
by the lessor; (4) the return on the differential advertising; and (5) the opportunity cost of
capital used to compute the discounted value of cash flows.
Similarly, in the personal context, the following five opportunity costs would have to
be considered if the civilian currently employed at an Air Force Base decided to wait one
year before leaving his job: (1) the return on the disposal proceeds of the civilian's fixed
assets; (2) the sublease revenue on the civilian's current condominium; (3) the return on
Seventy-three percent of the low-accounting knowledge subjects reported having undergraduateand/or graduate
degrees in nonbusiness-related disciplines (e.g., liberal arts, law, psychology, engineering, physics, political
economics). The remaining 27 percent reported having undergraduateand/or graduate non-accounting business
degrees (e.g., management, marketing, computer sciences, operations research). Also, the low-accounting knowledge subjects reported having no accounting-related experience.
12 Three students enrolled in the Master in Professional Accounting program had completed between five and six
accounting courses, and thus, were excluded from the analyses because they did not meet the second criterion
for classification in the high-accounting knowledge group.
3Seventy percent of the high-accounting knowledge subjects reported having accounting-related experience, ranging from one month to 50 months, for an average of 8.53 months. Also, two high-accounting knowledge subjects
were CPAs.
56
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TheAccounting
the differential compensation award offered by the government; (4) the return on the differential salary; and (5) the opportunity cost of capital used to compute the discounted
value of cash flows. The financial magnitude of the opportunity costs included in the business context case differed by a multiple of ten from the opportunity costs included in the
personal context case.
The key feature of the design was the presentation of the opportunity cost items in the
staff memorandum. Specifically, each of the opportunity cost items was implicitly presented
(i.e., without an explicit historical financial statement), and in juxtaposition to a parallel
historical (accounting) cost or revenue. This manipulation allowed me to distinguish which
subjects used in their analyses.
cost or historical cost-the
information cue-opportunity
For example, a paragraph in the staff memorandum contained information that could assist
subjects in computing the cost of borrowing rate (i.e., an accounting-related cue), while
information contained in another paragraph could assist subjects in computing the opportunity cost of capital. However, the staff memorandum was silent as to which (or whether
any) of the two rates was required for the analysis. This intentional omission allowed me
to test whether the subjects used the cost of borrowing rate, or the normatively correct
opportunity cost of capital.
Subjects in both contexts also were presented with information regarding the net book
value of fixed assets, as well as parallel information regarding the expected disposal value
of those assets within a two-year period. The key distinction, for purposes of measuring
the dependent variable, was whether subjects used in their analyses the accounting profit
on the fixed assets' disposal, or the foregone return on the fixed assets' disposal proceeds.
Subjects also were presented with information regarding the lease cost of a retail space or
condominium, as well as parallel information about the going rate of lease renewals. In this
case, the key distinction was whether subjects used in their analyses the accounting cost of
the lease, or the foregone sublease revenue on the retail space or condominium.'4
IV. RESULTS
Tests
of
Results
Validity
Knowledge of the opportunity cost concept, analytical ability and perceptions of task
difficulty were not expected to differ between high- and low-accounting knowledge subjects
in the business context, or between high-accounting knowledge subjects in the business
context and their counterparts in the personal context. To validate the assumption of constant
knowledge of the opportunity cost concept, subjects were given eight questions to measure
their knowledge of this concept.'5 In the business context, the mean scores for high- (6.28;
s.d. = 1.02) and low- (6.38; s.d. = 1.50) accounting knowledge subjects do not differ
Two coders (an experienced accounting instructor and an accounting doctoral student) independently coded the
dependent variable. The coders were compensated and received training with facsimile practice cases. A negligible number of differences had to be reconciled between the coders.
'5 The test was validated with 26 "economically naive" undergraduatebusiness students who were enrolled in an
introductory financial accounting course at the University of Texas at Austin. The number of economics courses
that these subjects reported completing ranged from zero to two. The Kuder Richardson 20 reliability coefficient
(Crocker and Algina 1986, 131-156) was calculated. This coefficient measures the degree of relationship between
the examinee's true and observed scores on a test. The reliability coefficient achieved with the undergraduate
students was 0.62. The average test score of the undergraduatestudents (3.0) was lower than the average score
of the experimental subjects (6.32). The overall distributions of scores of the undergraduate students and the
experimental subjects are significantly different (Mann-Whitney U = 164; p = .000, two-tailed). These results
suggest that the opportunity cost knowledge test reasonably measures knowledge (or lack thereof) of opportunity
costs. That is, the average scores are low when they are expected to be low, and high when they are expected
to be high.
4
Vera-Mui'oz-The Effects of AccountingKnowledgeand Context
57
significantly (F = 0.049; p = .825). Also, in the high-accounting knowledge level, the mean
score for subjects in the business context (6.28; s.d. = 1.02), and for subjects in the personal
context (6.73; s.d. = 1.28) do not differ significantly (F = 1.462; p = .234).16
To validate the assumption of constant analytical ability, subjects were given eight
questions indicative of analytical ability selected from prior Graduate Record Examinations.
In the business context, the mean scores for high- (6.89; s.d. = 1.18) and low- (7.06; s.d.
= 1.12) accounting knowledge subjects do not differ significantly (F = 0.191; p = .665).
Also, in the high-accounting knowledge level, the mean score for subjects in the business
context (6.89; s.d. 1.18), and for subjects in the personal context (7.23; s.d. = .685) do not
differ significantly (F = 1.281; p = .265).7
To validate the assumption of similar perceptions of task difficulty, subjects were asked
to evaluate the task on a ten-point scale anchored on one end by "Not difficult" (1) and
on the other end by "Very difficult" (10). In the business context, the mean scores for high(4.32; s.d. = 2.21) and low- (4.61; s.d. = 2.52) accounting knowledge subjects do not differ
significantly (F = 0.128; p = .723). Also, in the high-accounting knowledge level, the mean
scores for subjects in the business context (4.32; s.d. = 2.21), and for subjects in the
personal context (4.43; s.d. = 1.94) do not differ significantly (F = 0.028; p = .868). In
conclusion, taken together, the results of the validity tests suggest that cell-level differences
in the subjects' knowledge of the opportunity cost concept, analytical ability and perceptions
of task difficulty did not drive their tendencies to ignore opportunity costs in resource
allocation tasks.'8
Descriptive Statistics
Panel A of table 1 presents descriptive statistics for the average number of opportunity
cost items omitted by the subjects. Panel A shows that the overall mean number of opportunity cost items omitted by the subjects was 2.04. Averaged across contexts, the mean
number of omissions was higher for subjects with high accounting knowledge than for
subjects with low accounting knowledge (2.42 vs. 1.67, respectively). Also, averaged across
accounting knowledge categories, the mean number of omissions was higher in the business
context than in the personal context (2.43 vs. 1.66, respectively). These differences in the
row and column means are due largely to the high-accounting knowledge/business
context
subjects who averaged 3.11 omissions (cell 1), while means of the other three groups (cells
2 through 4) ranged from 1.59 to 1.75.
Panel B of table 1 presents the total number and percentage of subjects who omitted
each opportunity cost item, by accounting knowledge/context
combination.'9 Panel B shows
that for all the opportunity cost items, the highest percentages of omissions are in the
16
The cell-level comparisons addressed by the validity tests are consistent with the comparisons addressed by Hi
(i.e., in the business context, highvs. low-accounting knowledge subjects) and H2 (i.e., in the high-accounting
knowledge level, business vs. personal context conditions). Additional validity tests were conducted to compare
the mean scores between high- and low-accounting knowledge subjects (i.e., across contexts), and the mean
scores between the business and the personal context conditions (i.e., across accounting knowledge levels). The
results of parametric and non-parametric tests are qualitatively similar to the results of validity tests conducted
at the cell level; that is, the mean scores are not significantly different.
7 The mean analytical ability scores for the high- and low-accounting knowledge subjects (i.e., across contexts)
were 7.06 and 7.03, respectively. These high scores may indicate the presence of ceiling effects in the test of
analytical ability.
18 Non-parametric tests were also conducted. The results are qualitatively similar to the results of the F-tests.
'9 For each cross-classification condition, the sum across the five opportunity cost items of the frequencies of
omissions divided by the total number of subjects in each cross-classification equals the cell means reported in
panel A.
58
TABLE 1
Descriptive Statistics and Planned-Comparisons Tests for the Average Number of Opportunity
Costs Omitted, by Accounting Knowledge/Context Combination
(n = 73)
Panel A: Descriptive Statistics (standard deviations in parenthesis; the maximum possible number of
opportunity cost omissions was five, and the minimum was zero)a
Decision Context
Overall
Personal
Business
Accounting Knowledge
1.73
(1.39)
n = 22
2.42
(1.42)
n = 40
1.75
(1.39)
n= 16
1.59
(1.54)
n= 17
1.67
(1.47)
n= 33
2.43
(1.42)
n = 34
1.66
(1.47)
n = 39
2.04
(1.44)
n = 73
3.11
(1.45)
n = 18
High
3
Low
Overall
Resultsof the statisticalanalysesthat controlfor analyticalabilityare qualitativelysimilarto those that do not

controlfor analyticalability.Thus, for presentationpurposes,the means reportedhere are the raw (observed)
means(i.e., not adjustedfor analyticalability).
Panel B: Total Number (Percentage) of Opportunity Costs Omitted, by Accounting Knowledge/Context
Combination' -
Opportunity Cost
Foregone return on fixed assets' disposal proceeds
Foregone sublease revenue
Foregone return on advertising (business)/salary
(personal)
Opportunity cost of capital
Differential compensation award
Accounting
Knowledge
High
Low
High
Low
High
Low
High
Low
High
Low
Decision
Business
Context
Personal
13
5
13
10
12
5
9
6
9
2
8 (36.4)
8 (47.1)
6 (27.3)
1 (5.9)
8 (36.36)
4 (23.53)
6 (27.3)
7 (41.2)
10 (45.5)
7 (41.2)
(72.2)
(31.3)
(72.2)
(62.5)
(66.67)
(31.25)
(50.0)
(37.5)
(50.0)
(12.5)
condition.
Entriesarenumberand(percentage)of subjectsomittingthe opportunitycosts in the cross-classification
The percentagesare the ratio of the numberof subjectsomittingthe opportunitycost to the total numberof
condition.
subjectsin each cross-classification
c Numberof subjectsin each cross-classification
condition:High-Business(n = 18); High-Personal(n = 22); Low-
Business (n = 16); Low-Personal (n = 17).
Panel C: Planned Comparisons (dependent variable is the number of opportunity costs omitted)
Mean
Probability
t-statistic
(one-tailed)
Square
Planned Comparisons
.000
2.70
13.31
Business context: (cell 1 vs. cell 3, panel A) highvs. low-accounting knowledge (HI)
.000
2.70
13.30
High-accounting knowledge: (cell 1 vs. cell 2, panel
A) business vs. personal context (H2)
59
context combination (ranging from 50 percent to 72.2

high-accounting knowledge/business
percent).20 Panel B also shows that the opportunity cost items that appear to have contributed the most to the mean differences reported in panel A were the foregone return on the
fixed assets' disposal proceeds, the foregone sublease revenue, and the return on the differential advertising/salary costs; all costs were omitted by at least 67 percent of the subcontext combination. The opportunity cost
jects in the high-accounting knowledge/business
of capital and the discounted value of the differential compensation award made a moderate
contribution to the mean differences reported in panel A; both costs were omitted by 50
context combination.2'
percent of the subjects in the high-accounting knowledge/business
Tests of Accounting Knowledge (Hi) and Decision Context (H2)
Panel C of table 1 reports the results of the planned comparisons for purposes of testing
Hi and H2, after controlling for analytical ability.22 Hi predicts that in the business context,
high-accounting knowledge decision makers are more likely to ignore opportunity costs in
a resource allocation decision than are low-accounting knowledge decision makers (cell 1
vs. cell 3, panel A). The planned comparison for testing Hi shows that, as predicted, the
effect of accounting knowledge in the business context, after controlling for analytical
ability, is positive and significant (t = 2.70; p = .000, one-tailed). This result indicates that,
on average, the number of opportunity costs omitted in the business context is higher
for subjects with high-accounting
knowledge than for subjects with low-accounting
knowledge.23
Hypothesis two predicts that high-accounting knowledge individuals will ignore more
opportunity costs in the business context than in the personal context (cell 1 vs. cell 2,
table 1). The planned comparison for testing H2 is presented in table 1, panel C. As
predicted, the effect of context in the high-accounting knowledge level, after controlling
for analytical ability, is positive and significant (t = 2.70; p = .000, one-tailed), thus
20
Each of the five opportunity cost items was analyzed separately using tests of homogeneity of distributions
(Hildebrand and Ott 1991, 460-462). These tests are appropriatehere since the subjects were sampled from two
different accounting knowledge groups (as denoted by the rows in panel B of table 1). Thus, the null hypothesis
tested is that the row distributions (or proportions) are homogeneous. Results of the tests of homogeneity allow
rejection of the null hypothesis for four of the five opportunity cost items (p-values range from .000 to .032,
one-tailed), thus suggesting that the distribution (or proportion) of subjects' omissions was significantly higher
in the high-accounting knowledge/business context combination than in the other three knowledge/context
combinations. The foregone revenue on advertising (business)/salary (personal) was not significant (Chi-square
21
The normatively correct rate to discount the cash flows to their present value is the opportunity cost of capital
of 18 percent. As shown on panel B of table 1, 28 subjects made errors in cost of capital calculations. Of these,
21 subjects (75 percent) used the 12 percent cost of borrowing rate, and seven subjects (25 percent) ignored the
cost of capital altogether.
Analytical ability, the covariate in the overall ANCOVA model, is negative and significant, as expected
(t = -3.175, p = .002), thus suggesting that the number of opportunity costs omitted increases as analytical
ability decreases. The homogeneity of slope assumption for the analytical ability covariate was tested using the
general linear model procedure (Ott 1988, 818-821). The results do not allow rejection of the null hypothesis
that the slopes for the covariate are homogeneous (F = 0.327, p > .50). Also, the results of the Levene test
(SPSS 1993, 187-188) conducted to test for the assumption of homogeneity of variance, were not significant
= 0.892, p = .345, one-tailed).
22
(Levene statistic = 0.048, p = .827).

23
Consistent with the theoretical development, there is no a priori reason to expect a significant simple main effect
of accounting knowledge in the personal context. The results of the planned comparison in the personal context
confirm this assumption (t = 0.48; p > .63, two-tailed).
60
Review,January1998
TheAccounting
indicating that, on average, the number of opportunity costs omitted by high-accounting

knowledge subjects is higher in the business context than in the personal context.24
Regression analysis was also conducted to test for the effects of accounting knowledge
on tendencies to ignore opportunity costs, when accounting knowledge is measured as a
continuous variable, based on the number of accounting courses that subjects reported
completing. Hypothesis one was tested by estimating the following regression equation:
Yi = Po + O3AK, + P2(AK, * BCi) + P3AAi + si
(1)
where Yi is the number of opportunity cost items omitted by subject i; AKi is accounting
knowledge, as measured by the number of accounting courses completed by subject i; BCi
is 1 if subject i is in the business context, and 0 otherwise; and AAi is the analytical ability
covariate, measured by subject i's score on the analytical ability test. Specifically, the regression equation allows for different slopes for the effects of accounting knowledge in the
business and personal contexts, and controls for the potential effects of analytical ability
on tendencies to ignore opportunity costs.
Table 2 shows that the regression equation is significant overall (F-statistic = 9.709;
=
p
.000), and explains 29.68 percent of the variation in the number of opportunity costs
omitted. As expected, the coefficient for the effects of accounting knowledge in the personal
context (IBM)
is not significant (t = 1.104; p = .137, one-tailed). The finding of most interest
in this analysis is the significant and positive coefficient for I2 that reflects the effects of
accounting knowledge in the business context (t = 3.172; p = .001, one-tailed). This result
supports Hi, indicating that more opportunity costs are ignored in the business context by
those subjects with greater accounting knowledge (as measured by the number of accounting courses completed). The coefficient for the effects of analytical ability (fP3) is negative
and significant, as expected (t = -3.059; p = .002, one-tailed), indicating increases in
opportunity cost omissions as analytical ability decreases.
Refining the Observed Associations: Investigation of Maximization Objective as an
Intervening Factor
Intuition suggests that the method of analysis used by the subjects to support their
recommendations should be consistent with their maximization objectives. That is, subjects
whose objective was to maximize net income presumably would be more likely to use
income statement analysis to support their recommendations, while subjects whose objective
was to maximize the present value of cash flows (hereafter PVCFs) would be presumably
more likely to use cash flow analysis to support their recommendations. The experimental
design purposely did not control for the maximization objective ex ante, thus allowing the
subjects to self-select the method of analysis. This is an important design feature, because
as the theoretical development suggests, different maximization objectives are likely to
24
Consistent with the theoretical development, there is no a priori reason to expect a significant simple main effect
of context in the low-accounting knowledge level. The results of the planned comparison in the low-accounting
knowledge level confirm this assumption (t = 0.39; p > .7 10, two-tailed). Finally, it is not clear whether subjects
in the business context who ignored the sublease revenue might have incorrectly assumed that the retail store
would be paying a higher market rental rate in its new location across town (thus offsetting the sublease revenue).
This is less likely in the personal context case, which indicated that the civilian would be moving to another
state (i.e., market rental rates vary by states). Thus, the sublease revenue might seem less relevant in the business
context than in the personal context. To address this potential concern, additional planned comparisons were
conducted to test for Hi and H2, excluding foregone sublease revenue from the list of opportunity costs. The
results are qualitatively similar to the results reported in table 1 (HI: t = 2.78, p = .000, one-tailed;
H2: t = 1.83, p < .05, one-tailed), thus suggesting that the results are robust to exclusion of the foregone
sublease revenue from the list of opportunity costs.
61
TABLE 2
Regression Results for Effects of Accounting Knowledge in the Business Context (Hi)
Accounting Knowledge Factor Measured as a Continuous Variable (n = 73)
Y, = f30 + f3AAK,+ J32(AK,* BCE)+ f33AAi + Si
Variable
Intercept
AK
AK*BC
AA
F-statistic
R2
Std. Error
Expected
Sign
(0)
(+)
(-)
Coefficient
4.819
0.034
0.109
-0.480
t-statistic
4.171
1.104
3.172
-3.059
Probability
(one-tailed)
.000
.137
.001
.002
9.709 (p = .000)
0.2968 (adjusted = 0.2663)
1.320
Variable definitions:
Yi = the number of opportunity costs omitted by subject i;
AKi = accounting knowledge, measured by the number of accounting courses completed by subject i;
BCi = 1 if subject i is in the business context condition, and 0 otherwise;
AAi = analytical ability, measured by subject i's score on an analytical ability test;
Ed= error term for subject i.
differentially influence the subjects' perceptions of salience of the external cues. Specifically, accounting-related information may be perceived as more salient than opportunity
cost information when the objective is to maximize net income, while the reverse may be
true when the objective is to maximize the PVCFs. Additional ex post analyses were conducted to investigate the role of the subjects' maximization objectives on their tendencies
to ignore opportunity costs.
Analyses and Results
An analysis of the explanations and supporting calculations provided by the subjects
in the response memorandum shows that they used one of two distinctly different and
mutually exclusive methods of analysis and report formats to support their recommendations. Specifically, all subjects prepared either comparative income statements (where
the bottom line is net income or net loss), or comparative cash flows statements (where the
bottom line is the PVCFs). Furthermore, subjects who prepared income statements recommended the option which, based on their calculations, maximized net income. Accordingly, this group was assumed to have a net income maximization objective. Similarly,
subjects who prepared cash flows statements recommended the option which, based on their
calculations, maximized cash flows. Accordingly, this group was assumed to have a PVCFs
maximization objective. The data show that eight of the 18 high-accounting knowledge
subjects in the business context (44 percent) had a net income maximization objective,
while ten (56 percent) had a cash-flow maximization objective. Also, eight of the 22 highaccounting knowledge subjects in the personal context (36 percent) had a net income maximization objective, while 14 (64 percent) had a cash-flow maximization objective.25 The
results of a Chi-square test of homogeneity do not allow rejection of the null hypothesis
25
The data was coded independently by three senior accounting students at a private Midwestern university. The
coders were compensated and received training with facsimile practice cases.
62
that the distributions (or proportions) of high-accounting knowledge subjects' maximization

objectives in the business and personal contexts are homogeneous (Chi-square = 0.269;
p = .604, one-tailed). These results suggest that high-accounting knowledge does not seem
to cause subjects in the business context to behave differently from their counterparts in
the personal context with respect to their maximization objectives.
If the knowledge structures-based findings reported in this study are generally descriptive of the tendency for high-accounting knowledge subjects to ignore opportunity costs in
business decisions, then the findings should remain unchanged (i.e., significant), after controlling ex post for the subjects' maximization objectives. This expectation is investigated
with an "augmented" version of regression equation (1) which adds a coefficient controlling
for the maximization objective by statistically removing the effects of this factor on the
dependent variable. Specifically, regression equation (2) takes the following form:
Yj = P + SIAKi +
2(AKi * BC) +
33AAi +
340BJi + ei
(2)
where Yi, AKi, BCi and AAi are as defined for regression equation (1), and OBJi is 1 if
subject i's objective was to maximize cash flows, and 0 if subject i's objective was to
maximize net income.
Table 3 shows the results of regression equation (2). As expected, the coefficients for
the effects of accounting knowledge in the personal context (1,) and for analytical ability
(133)are consistent with the results for the same coefficients on regression equation (1). The
findings most important to this analysis are threefold. First, consistent with the main findings of the study, the coefficient for the effects of accounting knowledge in the business
context (132) remains positive and significant (t = 3.395; p = .000, one-tailed), even after
controlling for the effects of maximization objective. Second, regression equation (2) explains 48 percent of the variation in the number of opportunity costs omitted, compared to
the R-squared of 29.68 percent for regression equation (1). Third, and related to the second
TABLE 3
Regression Results for Effects of Accounting Knowledge in the Business Context
After Controlling for Analytical Ability and Maximization Objective (n = 73)
Y, = go + J3AK, + f32(AK,* BCi) + 13AAi +
Variable
Expected
Sign
Intercept
AK
AK * BC
AA
OBJ
(0)
(+)
(-)
(-)
F-statistic
R2
Std. Error
15.683 (p = .000)
0.4800 (adjusted
1.143
Coefficient
4.973
0.020
0.101
-0.343
-1.458
=
340BJi
+ si
t-statistic
4.966
0.761
3.395
-2.466
-4.891
Probability
(one-tailed)
.000
.225
.000
.008
.000
0.4493)
Variable definitions:
OBJi= 1 if subject i had a cash flows maximization objective, and 0 if subject i had a net income maximization
objective.
All other variables are defined in table 2.
63
finding, this improvement in the explanatory power of the regression equation is caused
by the addition of the fourth coefficient, (I4), to control for the effects of maximization
objective. As shown in table 3, the coefficient is negative and significant (t = -4.891;
p = .000, one-tailed), indicating that the net income (PVCFs) maximization objective is
associated with a higher (lower) number of opportunity costs omitted.
In conclusion, the higher explanatory power of regression equation (2) suggests that
subjects who developed a problem representation guided by a net income maximization
objective were more likely to ignore opportunity costs than subjects who developed a
problem representation guided by a PVCFs maximization objective. At the same time, the
results of regression equation (2) lend support to the robustness of the main findings of
this study, namely, high-accounting knowledge interferes with a decision maker's ability to
incorporate opportunity costs in business resource allocation decisions, even after controlling for maximization objective.
V. DISCUSSION AND IMPLICATIONS

This study provides empirical evidence that high-accounting knowledge interferes with
a decision maker's ability to incorporate opportunity costs into the analysis of a business
resource allocation decision. However, such knowledge does not interfere with a decision
maker's ability to incorporate opportunity costs into the analysis of a personal resource
allocation decision. This study contributes to our understanding of how accounting knowledge affects behavior in several ways. First, consistent with knowledge-structures research,
the study provides evidence that high-accounting knowledge subjects who make business
resource allocation decisions behave as if they access from memory GAAP-based rules
which do not incorporate opportunity costs. Second, this study contributes to our understanding of the effects of accounting knowledge by providing evidence that the tendency
for high-accounting knowledge individuals to ignore opportunity costs is limited to decisions in a business context. This evidence tends to rule out the idea that high-accounting
knowledge individuals, in general, ignore more opportunity costs across contexts than do
low-accounting knowledge individuals.
Third, this study contributes to understanding the effects of accounting knowledge by
providing evidence that the tendency of high-accounting knowledge individuals to ignore
opportunity costs is observed even after controlling for the effects of the subjects' maximization objective. This evidence lends support to the robustness of the main findings of
this study. Finally, most of the behavioral accounting studies that examine the effects of
knowledge and/or experience address the benefits, but not the costs, of high knowledge
and/or experience on performance. In contrast, this study addresses the dysfunctional effect
of knowledge of a subject matter by examining specific conditions under which highaccounting knowledge may actually hinder performance. The findings of this study suggest
that decision quality can be eroded due to the lack of fit between the accounting knowledge
structures recalled from memory and the resource allocation problem, which requires consideration of opportunity costs.
The results of this study, on their face, may be discouraging to accounting educators.
Modem managerial accounting courses include the topic of relevant costing, which emphasizes the importance of incremental and opportunity costs. However, the topic of relevant
costing represents a small portion of the total accounting curriculum at most universities.
The results of this study indicate that other aspects of the accounting curriculum, including
an emphasis on GAAP-based rules, appear to overwhelm this particular aspect of the managerial accounting courses. The implications of the evidence presented in this paper for the
64
TheAccounting
Review,January1998
design of an accounting curriculum await further research addressing the limitations of the
study and the robustness of its results.
Certain features of this study point to potential areas for future research. First, there is
no clear explanation for why there is no causal association between the subjects' accounting
knowledge and their maximization objectives. On one hand, this study argues that the
phenomenon underlying the data is knowledge structures-driven, which therefore would
suggest that subjects with high-accounting knowledge would be more likely than those with
low-accounting knowledge to have a net income maximization objective in the business
context. On the other hand, the nature of the subjects' formal accounting training, which
presumably emphasizes the concept of present value of cash flows as well as the income
statement, might have moderated any existing differences in the maximization objectives
of high- and low-accounting knowledge subjects. More research is needed to better understand why, while high-accounting knowledge does not seem to cause subjects to use a net
income maximization objective any more frequently than low-accounting knowledge, highaccounting knowledge does interfere with the subjects' ability to incorporate opportunity
costs in their business decisions.
Second, this study obtains experimental control by eliciting resource allocation decisions absent other important characteristics of the managerial setting. While I believe this
is a reasonable approach for the first knowledge structures-guided work in this area, future
research could examine the generality of the results in more realistic settings. For example,
future studies could examine the extent to which other factors (e.g., principal-agent opportunity cost information asymmetry), and other tasks (e.g., project continuation decisions)
cause decision makers to leave opportunity costs out of their analyses. Future research may
also address the extent to which different types of accounting training (e.g., predominantly
financial vs. predominantly managerial vs. predominantly tax) and/or different types of
domain-specific experience (e.g., financial accounting and valuation of long-term liabilities
vs. inventory accounting) lead to differential exclusions of opportunity costs in business
resource allocation decisions.
APPENDIX A
Resource Allocation Case in the Business Context
Andrew, Henderson & Company

Financial Planning Consultants
MEMORANDUM
DATE:
TO:
FROM:
SUBJECT:
December 26, 1993

Engagement Associate
Steve James, Partner
Closure of the retail location of the Harper & Baker's Sacramento store
I have just received the attached letter from Ms. Geraldine Evans, president and CEO of
Harper & Baker, Inc. (H&B), a privately held corporation that owns a chain of women's clothing
stores. Evans is seeking advice regarding a resource allocation problem related to the H&B's
Sacramento store.
Evans has informed me, via telephone conversation, that the H&B's Sacramento store was
opened in the 84-store Hancock Shopping Mall in suburban Sacramento, California about seven
years ago. The Mall's retail locations are owned and managed by Retail Property Managers,
Inc. (RPM). The Mall has been scheduled for condemnation by the State of California two
years from now (12-31-95); thus, the H&B's Sacramento store cannot continue at its present
location beyond the next two years.
I have enclosed additional client information compiled by our staff members to assist you
in making your recommendation as to whether the retail space of the Sacramento store should
be vacated on 12-31-93 (now), or on 12-31-94 (one year from now). I would like to have your
recommendation and supporting calculations.
Attachments:
Client's letter
Staff memorandum on operating characteristics
65
66

12-23-93
Attachment 2
STAFF MEMORANDUM
SUBJECT:
Operations of the Harper & Baker's Sacramento

Store for the Year Ended December of 1993
Current Business Operations

Net retail sales were $1,920,000 in 1993. The cost of goods sold represents approximately
30% of net sales. Operating expenses in 1993 amounted to $1,020,000 (which includes advertising of $120,000, depreciation of $36,000, and general and administrative expenses of
$864,000).
The Sacramento store's fixed assets, which include display fixtures and equipment, were
acquired 7 years ago at $360,000. The average useful life of the fixed assets is 10 years, and
are depreciated using straight line with zero salvage.
In 1993 all the H&B retail stores initiated a company policy of investing their excess cash
in a common fund managed by the parent company. Each retail store, in turn, received a return
equivalent to a pro-rata share of its investment in the common fund. The Sacramento store
earned $5,400 this year on an annual investment of $30,000. This return is expected to remain
constant over the next two years.
Lease Contract and Compensation Award
Four years ago Harper & Baker signed a 10-year transferable, noncancelable operating
lease for the 4,000 square-foot retail location of the Sacramento store, at $96,000 per year. Due
to a recent earthquake, there is shortage of retail space in the area; thus, lease renewals are
currently running at about $144,000 per year for a 4,000 square-foot location.
Since RPM will be unable to fulfill its lease contract with H&B, it has offered to pay H&B
a compensation award of $300,000 if Evans chooses to vacate the retail space now. If, on the
other hand, Evans chooses to vacate the retail space one year from now, the compensation
award that H&B will receive one year from now will be $320,000.
If Evans chooses to vacate the retail space now, she would sublease it to a third party for
the next two years at the market rate. If, on the other hand, Evans chooses to vacate the retail
space one year from now, she would sublease it to a third party for just 1995.
67
Financing
To help with financing and to establish a business presence in the community, H&B obtained from Sacramento Central Bank a loan of $200,000. The loan is guaranteed with the H&B
parent company assets. The annual interest ($24,000), is due annually and is charged to the
Sacramento store. The principal is due three years from now.
Prospects for the Next Two Years (1994 and 1995)
Projected annual operations:
According to Evans, average net retail sales, as well as the ratio of cost of goods sold to
net retail sales are expected to remain unchanged in real terms for the next two years. On the
other hand, due to a new advertising campaign scheduled for the year of the relocation, average
operating expenses are expected to increase during the relocation year. The following table
summarizes projected annual net retail sales and operating expenses for the Sacramento store
for 1994 and 1995 for the two options under consideration:
Projected Annual Net Retail Sales and Operating Expenses for 1994 and 1995
1994
1995
$1,920,000
$1,200,000
$1,920,000
$1,020,000
Vacates retail space 12-31-93 (now):

Net retail sales
Operating expenses
Vacates retail space 12-31-94 (one year from now):

Net retail sales
Operating expenses
$1,920,000
$1,020,000
$1,920,000
$1,200,000
Disposition of fixed assets:

Evans has decided to sell some of the fixed assets at the time that the store's current retail
space is vacated. The net book value of those fixed assets now is $100,000, and will be $80,000
one year from now. Evans estimates that the fixed assets can be sold either now or one year
from now for about $130,000.
68
APPENDIX B
Resource Allocation Case in the Personal Context

MEMORANDUM
DATE:
TO:
FROM:
SUBJECT:
December 26, 1993

Engagement Associate
Steve James, Partner
Early job separation of Neil Spencer due to closure of Air Force Base
I have just received the attached letter from Mr. Neil Spencer, a civilian who works at
Mather Air Force Base (MAFB), located in Sacramento County, California. Spencer is seeking
advice regarding a resource allocation problem related to his future career plans.
Spencer has informed me, via telephone conversation, that he has been working in data
processing at the Base since graduating from High School seven years ago. MAFB has been
scheduled for closure by the Defense Base Closure and Realignment Commission one year from
now (12-31-94); thus, the personnel at MAFB cannot remain in their jobs at the Base beyond
the next year.
I have enclosed additional client information compiled by our staff members to assist you
in making your recommendation as to whether Neil Spencer should leave his job at MAFB on
12-31-93 (now), or on 12-31-94 (one year from now). I would like to have your recommendation
and supporting calculations.
Attachments:
Client's letter
Staff memorandum on Spencer's uses and sources of income

12-23-93
69
Attachment 2
STAFF MEMORANDUM
SUBJECT:
Sources and Uses of Income of Neil Spencer

for the Year Ended December 1993
Current Income
Neil Spencer, who has a full-time data processing job at the MAFB, earned a gross salary
of $18,000 this year. According to government officials, no changes of the salary scales, in real
terms, are expected for next year.
Although Spencer has never received a formal computer repair training, he also repairs
computers at home during his spare time. Spencer uses electronic tools that he acquired 2 years
ago at $48,000. The average useful life of the tools is 5 years using straight line with zero
salvage. The cost of the tools was financed in part with a bank loan. Spencer's self-employment
income, net of depreciation, averages $8,400 per year.
Spencer believes in the practice of "saving for rainy days." Therefore, in 1993 he started
the practice of investing his excess cash in stocks of the computer corporation owned by his
uncle Steve. Spencer earned $540 this year on an annual average investment of $3,000. This
return is expected to remain constant over the next two years.
Lease Contract and Compensation Award
Four years ago Spencer signed a 10-year transferable, noncancelable lease for his 800
square-foot condominium at $800 per month. Due to a recent earthquake, there is shortage of
apartments in the area; thus, lease renewals are currently running at about $1,200 per month
for an 800 square-foot condominium.
Since the government will be unable to fulfill its job contract with Spencer, it has offered
to pay him an early-separation compensation award of $30,000 if Spencer chooses to leave his
job now. If, on the other hand, Spencer chooses to leave his job one year from now, the
compensation award that he will receive one year from now will amount to $32,000.
If Spencer chooses to leave his job now and enroll in the one-year computer repairprogram,
he would sublease his condominium to a third party for the next two years at the market rate.
If, on the other hand, Spencer chooses to leave his job one year from now, he would sublease
his condominium to a third party for just 1995.
70
Financing
To help with financing for the purchase of some of his electronic tools, Spencer obtained
from Sacramento Central Bank a loan of $20,000. The loan is guaranteed by Spencer's uncle.
The annual interest ($2,400) is due annually; the principal is due three years from now.
Prospects for the Next Two Years (1994 and 1995)
Projected annual sources of funds:
Given the imminent closure of MAFB, Spencer has accepted work in Uncle Steve's computer company on a part-time basis immediately upon getting a computer repair training certificate. Uncle Steve has offered Spencer a starting annual salary of $18,000. The cost of the
one-year computer repair program in which Spencer has decided to enroll is estimated at $4,500,
and will be paid in full, in advance, by the government regardless of the early-separation date
chosen by Spencer. According to Spencer, all of his cost-of-living expenses are expected to
remain unchanged in real terms for the next two years. Spencer plans to continue repairing
computers at home while at school and thereafter. He expects to earn about the same annual
average self-employment income net of depreciation that he is currently earning. The following
table summarizes Spencer's projected annual sources of funds for 1994 and 1995 for the two
options under consideration:
Projected Annual Salary and Net Self-Employment Income for 1994 and 1995
1994
1995
$0
$8,400
$18,000
$8,400
$18,000
$8,400
$0
$8,400
Leaves job 12-31-93 (now):

Gross salary
Net Self-employment income
Leaves job 12-31-94 (one year from now):
Gross Air Force salary
Net Self-employment income
Disposition of electronic tools:
Spencer has decided to sell some of his tools at the time he enrolls in school. The net book
value of those tools now is $10,000, and will be $8,000 one year from now. Spencer estimates
that the tools can be sold either now or one year from now for about $13,000.
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The Effects of Accounting Knowledge and Context on the Omission of Opportunity Costs in

Resource Allocation Decisions

THE ACCOUNTING REVIEW

The Accounting Review, January 1998

Vera-Mufioz-The Effects of Accounting Knowledge and Context

The set of information potentially available in a resource allocation decision includes

Vera-Mufioz-The Effects of AccountingKnowledgeand Context

is guided by a system of rules developed through formal instruction and/or as a result of

Vera-Mufioz-The Effects of Accounting Knowledge and Context

The Accounting Review, January 1998

3. Read supporting addenda

4. Complete response memorandum

Part Two: Post-Experiment Phase

Vera-Mufioz-The Effects of AccountingKnowledgeand Context

Independent and Dependent Variables

Vera-Mui'oz-The Effects of AccountingKnowledgeand Context

The Accounting Review, January 1998

Resultsof the statisticalanalysesthat controlfor analyticalabilityare qualitativelysimilarto those that do not

Business (n = 16); Low-Personal (n = 17).

Vera-Mufioz-The Effects of AccountingKnowledgeand Context

context combination (ranging from 50 percent to 72.2

= 0.892, p = .345, one-tailed).

(Levene statistic = 0.048, p = .827).

indicating that, on average, the number of opportunity costs omitted by high-accounting

Vera-Mufioz-The Effects of Accounting Knowledge and Context

The Accounting Review, January 1998

that the distributions (or proportions) of high-accounting knowledge subjects' maximization

Vera-Mufioz-The Effects of Accounting Knowledge and Context

V. DISCUSSION AND IMPLICATIONS

Vera-Mufioz-The Effects of Accounting Knowledge and Context

Andrew, Henderson & Company

December 26, 1993

The Accounting Review, January 1998

Andrew, Henderson & Company

Operations of the Harper & Baker's Sacramento

Current Business Operations

Vera-Mufioz-The Effects of Accounting Knowledge and Context

Vacates retail space 12-31-93 (now):

Vacates retail space 12-31-94 (one year from now):

Disposition of fixed assets:

The Accounting Review, January 1998

Andrew, Henderson & Company

December 26, 1993

Vera-Mufioz-The Effects of Accounting Knowledge and Context

Andrew, Henderson & Company

Sources and Uses of Income of Neil Spencer

The Accounting Review, January 1998

Leaves job 12-31-93 (now):

Vera-Mufioz-The Effects of Accounting Knowledge and Context

The Accounting Review, January 1998

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