Accounting for provisions: an economic analysis of intertemporal cost allocations and their incentive properties

Abstract The use of accounting information and related performance measures for (delegated) investment decision-making has been extensively analyzed in the context of investment projects with upfront investments. In many cases, however, a project may also require large payments at the end of its life. In accounting statements, companies anticipate such payments by setting up provisions during a project’s useful life. To date, very few studies have explored provision schemes with regard to the decision-facilitating and the decision-influencing roles of management accounting. In this paper, we analyze three different provision schemes of practical relevance. We benchmark the cost allocations that result from each such scheme against cost allocations resulting from two provision schemes that are derived from the analysis of investment projects with upfront investments. The first comparison concerns the decision-facilitating role and builds on the principles of investment-based cost accounting according to Kupper (1985, 2009). The second comparison concerns the decision-influencing role and is based on the theory of goal-congruent performance measures as developed by Rogerson (1997) and Reichelstein (1997). These comparisons demonstrate to which extent the cost allocations associated with the provision schemes that are commonly used in practice deviate from the benchmark solutions we present. We also examine the potential distortions that may arise when accounting performance measures based on the practically relevant provision schemes are used for investment decision-making.