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International Journal of Industrial Engineering Research and Development (IJIERD), ISSN 0976 – INTERNATIONAL JOURNAL OF INDUSTRIAL ENGINEERING 6979

(Print), ISSN 0976 – 6987(Online) Volume 3, Issue 1, January - June (2012), © IAEME RESEARCH AND DEVELOPMENT (IJIERD)

ISSN 0976 – 6979 (Print) ISSN 0976 – 6987 (Online) Volume 3, Issue 1, January- June (2012), pp. 30-42 © IAEME: www.iaeme.com/ijierd.html
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IJIERD
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COMPATIBILITY BETWEEN THE MIXBC -MIX BASED COSTING METHOD – AND COSTING PHILOSOPHIES
LEANDRO TORRES DI GREGORIO M.D., Graduate Program - Civil Engineering –Fluminense Federal University, Ph. D. Student, leandrogregorio@ig.com.br.Address: Rua Primeiro de Janeiro, 43, Vila Madalena, Belford Roxo, RJ, Brazil, CEP 26130-320 CARLOS ALBERTO PEREIRA SOARES Ph.D., Graduate Program - Civil Engineering –Fluminense Federal University, Associate Professor ORLANDO CELSO LONGO Ph.D., Graduate Program - Civil Engineering –Fluminense Federal University, Associate Professor WAINER DA SILVEIRA E SILVA Ph.D., Graduate Program - Civil Engineering –Fluminense Federal University, Professor ABSTRACT After a bibliographic research on costing methods / philosophies, and an analytical deduction of MIXBC- Mix Based Costing method, we sought to verify the compatibility of this methodwith the "Traditional Cost Accounting”, "Variable" and "Full" costing philosophies.This was conducted through an analytical approach in which the results of MIXBC were applied to the income statements of each costing philosophy. Compatibility with all situations was demonstrated. The analyses of different production scenarios show that the MIXBC is a method that allows the distribution of costs and indirect costs to products without the subjectivity and uncertainty typical of traditional apportionment. Keywords Cost management. Cost accounting. MIXBC - Mix Based Costing. Apportionment-Free Costing.

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International Journal of Industrial Engineering Research and Development (IJIERD), ISSN 0976 – 6979(Print), ISSN 0976 – 6987(Online) Volume 3, Issue 1, January - June (2012), © IAEME

1 INTRODUCTION The aim of this paper is to demonstrate the compatibility of the Mix Based Costing (MIXCB) method with the “Traditional Cost Accounting ”, “Variable”, and “Full” costing philosophies. The major drawback of all costing methods is that they include subjective and arbitrary elements in the determination of production costs when dealing with the apportionment of indirect costs. These uncertainties may become more significant according to the costing philosophy adopted. Not only that, but also the only philosophy legally accepted in Brazil is Traditional Cost Accounting, which is not always the most adequate for managerial decision making. Hence the need for a method that may be coherently applied to all costing philosophies presented. It is our aim to demonstrate that the Mix Based Costing (MIXBC) method is compatible with all the costing philosophies mentioned above, thus making it possible to significantly reduce arbitrary and subjective elements caused by the apportionment of indirect costs not only in financial accounting, but also in managerial accounting. The methodology adopted was bibliographical research, followed by an analytical approach in which the results of the MIXBC were applied to the income statementtypicalof each costing philosophy. The advantages resulting from this work include the improved quality of accounting information in general, not only for financial but also managerial purposes, thus contributing to more consistent decision making. 2 COST ACCOUNTING AND PRODUCTION STRATEGIES MARTINS (2010) explains that costing means cost appropriation. To this it can be added that a costing system can be regarded as the whole structure necessary to accomplish the task, including the philosophy and the costing method. In this sense, the costing system can be considered as defining and applying a costing philosophy / method to a particular organizational reality. This encompassesthe structuring of the measurementsnecessary to the production process, the definition of responsibilities, data collection, data treatment, recording of data generated, the decision of whether or not to use computer systems, etc. In this context, Cost Accountingplays an important role, and whenused witha costing system that is both efficient and coherent with the characteristics of the organizationit provides an understanding of product profitability, and of possible ways to reduce costs.BEUREN et al (2003) state that cost information may be useful in cost structure reduction, expansion of production capacity, launching of new products or calculation of sales price. The basic outline for Cost Accounting is made up of the following steps, adapted from MARTINS (2010). The greatest variation among the methods is found in step 3 (or in its absence). STEP 1: Separation of costs and expenses; STEP 2: Appropriation of direct costs; STEP 3: Appropriation (apportionment) of indirect costs; STEP 4: Record keeping of costs. 3 DISTINCTION BETWEEN PHILOSOPHIES AND COSTING METHODS A distinction between philosophies and costing methods is proposed. This distinction is simple: the costing philosophies (or principles) are made up of ways of recording data in order to reach a certain result, whereas costing methods are made up of ways of generating and applying data according to a certain philosophy. For example, costing philosophy is responsible for
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International Journal of Industrial Engineering Research and Development (IJIERD), ISSN 0976 – 6979(Print), ISSN 0976 – 6987(Online) Volume 3, Issue 1, January - June (2012), © IAEME

determining whether indirect costs should be directly incorporated to the products (thus pertaining indirectly to stock and being registered when the income is obtained) or whether they should be treated as expenses (thus pertaining directly to the results, with no relation whatsoever to stock), or whether expenses and indirect costs should be totally aggregated to products, therefore not being treated globally. It is clear that the accounting treatment of the information is different in each case. On the other hand, costing methods are responsible for decisions on how to obtain indirect costs, such as, for example, those related to ways of performing cost tracking or apportionment. Costing methods, then, need to be set in a costing philosophy in order to reach a certain result. Examples of cost philosophies include Traditional Cost Accounting, direct or variable costing, and full costing. As regards costing methods, examples include standard cost, departmentalization costing, production effort unit method, RKW, process and job-order costing, target method, and Activity-Based Costing (ABC). 4 COSTING PHILOSOPHIES “Traditional Cost Accounting” philosophy This philosophy consists in the appropriation of all production costs to the productsproduced, and only those of production (MARTINS, 2010). Traditional Cost Accounting philosophy is not concerned about the distinction between fixed and variable costs. Its basic premise is the separation ofcosts from expenses. Costs are appropriated to products so that when these are sold, costs are comparedwith the sales generated, and expenses are recorded directly in the resultof the period (BEUREN et al, 2003). HORNGREN et al (2004) state that […]Traditional Cost Accounting is the stock costing method, in which all manufacturing costs, variable and fixed, are considered countable costs. That is, stock absorbs all manufacturing costs. It is the only method accepted for tax purposes in Brazil. AZEVEDO et al (2006) point out that Traditional Cost Accounting is useful in the evaluation of business stock and in aiding price decision taking for products and services, provided the part apportioned be small. For managerial decision taking, however, complementary information is necessary. SILVA (1998) mentions that Traditional Cost Accounting cannot be used indiscriminately, without taking into consideration problemsthat may be entailed, particularly its incentive to overproduction. The basic outline for DRE (Income Statement) for managerial or tax purposes is: Sales (-) Cost of Products Sold (direct and indirect distributed) (=) Gross Profit (-) Expenses (=) Result before Income Tax Table 1 Typical DRE for “Traditional Cost Accounting” Philosophy Source: MARTINS (2010) “Variable” or “Direct” costing philosophy ANDRADE et al (2004) suggest that the variable costing system tries to reduce the distortion present in the apportionment required by the Traditional Cost Accounting system: “[...] In the Traditional Cost Accounting system, fixed costs are apportioned to products and/or
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International Journal of Industrial Engineering Research and Development (IJIERD), ISSN 0976 – 6979(Print), ISSN 0976 – 6987(Online) Volume 3, Issue 1, January - June (2012), © IAEME

services, whereas in variable costing these costs are treated as expenses and as such are recorded directly in the result. MARTINS (2010) stresses that, although all variable costs are by nature always direct, it does not always compensate to track and measure them individually according to product; this is the reason why some are treated as indirect. MARTINS(2010) also presents the concept of Unit Contribution Margin, “[...] which is the difference between sales price and Variable Cost for each product; it is the value that each unit effectively brings to the business, the difference between its sales and the cost it actually represented and what is unmistakably imputable to it [...]”, and which “[...] multiplied by the amount sold and added to the remaining (products), makes up the a Total Contribution Margin”. A little further MARTINS (2010) points out that “[...] the concept of Contribution Margin is somewhatwider than the concept previously mentioned, since it is the difference between the Sales Revenue and the sum of Costs and Variable Expenses [...]” (among which the main are sales expenses, such as commissions), and not only between revenue and variable costs. MARTINS (2010) also reminds us that the revenue to be considered must be netrevenue, that is, after the deduction of taxes leviedon it, and that despite the fact that Variable Expenses are used to calculate the Contribution Margin; they are not aggregated to the product for stock purposes. The best solution is to treat them as a reduction in the sales price, which does not alter in the least the calculation of the Margin, but it makes it easier to solve the problem of what to quantify as product cost. Variable Cost goes against accounting principles, particularly that of Sales Earning, which determines accounting recognition of the result (profit or loss), only when sales are actually earned (in Variable costing, fixed costs of the products are recorded in that period and not when they are sold). This philosophy, then, can only be used for managerial purposes. The basic outline for DRE (Income Statement) for managerial purposes is: Sales (-) Taxes levied on Sales Revenue and Variable Expenses (=) Net Sales (-) Cost of Products Sold (variable direct and variable indirect costs) (=) Contribution Margin (-) Fixed Expenses and Fixed Costs (=) Result Table 2 Typical DRE for “Variable” or “Direct” Costing Philosophy Source: MARTINS (2010) In case there are fixed costs that may be identified with a product or a group of products, these are called Identified Fixed Costs, and the remaining, Non-Identified Fixed Costs. When these concepts are inserted in the DRE, the Contribution Margin may be presented in a sequence, as follows:

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International Journal of Industrial Engineering Research and Development (IJIERD), ISSN 0976 – 6979(Print), ISSN 0976 – 6987(Online) Volume 3, Issue 1, January - June (2012), © IAEME

Sales (-) Taxes levied on Sales Revenue and Variable Expenses (=) Net Sales Revenue (-) Cost of Products Sold (variable direct and variable indirect costs) (=) 1st Contribution Margin (-) Identified Fixed Costs (=) 2nd Contribution Margin (-) Non-Identified Fixed Costs (=) Result Table 3 Typical DRE for “Variable” Costing using Contribution Margin in a sequence Source: MARTINS (2010) “Full” Costing philosophy Santos (apud BEUREN et al, 2003) describes full costing philosophy as “characterized by the appropriation of all costs and expenses to manufactured products. These costs and expenses are direct and indirect costs, fixed and variable costs, as well as those related to commercialization, distribution, general administration, etc. Because this philosophy goes against accounting principles, it can only be used for managerial purposes”. The basic outline for DRE (Income Statement) for managerial purposes is: Sales (-) Cost of Products Sold (direct, indirect and expenses) (=) Result (numerically equal to gross profit) Table 4 Typical DRE for “Full” Costing Philosophy Source: authors 5 MIX BASED COSTING METHOD What it is MIX Based Costing is a costing method that allows the reduction of uncertainties caused by arbitrary apportionment of indirect costs and expenses in product cost. The MIX-Based Costing method was built on the analyses of the product mix (rather than on that of products individually), and also on the hypothesis that the absence of a certain product in the mix provides clues as to the degree of utilization of shared costs (costs shared by one or more products, usually indirect) by that particular absent product. MIXBC allows costs and indirect shared expenses -- which cannot be actually separated for each product -- to be treated in a mathematical and coherent way. This contrasts with the other methods, which usually apportion or track expenses. In this sense, it is an apportionmentfree costing system, since the uncertainties are calculated by a process of cost inference, based on the exclusive production (only the product analyzed is produced) and excludent production (only the product analyzed is not produced) scenarios.

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International Journal of Industrial Engineering Research and Development (IJIERD), ISSN 0976 – 6979(Print), ISSN 0976 – 6987(Online) Volume 3 Issue 1, January - June (2012), © IAEME 3, ),

The distribution of fixed indirect costs Let us examine the hypothetical case of a business that produces three products (exemplified as Alpha, Beta, Gamma), which have total fixed costs (CF) and fixed expenses (DF).

Figure 1 Graphic representation of the universe of fixed costs for a business which produces products Alpha, Beta, and Gamma Source: authors Thus, the total fixed cost (CF) of the Product Mix (Alpha, Beta, and Gamma) can be written as: (Eq. v) Considering the situation in which product Alpha is discontinued by the business and its production is not substituted by any other product, the new distribution of fixed costs would be:

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International Journal of Industrial Engineering Research and Development (IJIERD), ISSN 0976 – 6979(Print), ISSN 0976 – 6987(Online) Volume 3 Issue 1, January - June (2012), © IAEME 3, ),

Figure 2 Graphic representation of the universe of fixed costs for a business which produces products Beta, and Gamma Source: authors The total fixed cost for the new p e product mix (only Beta and Gamma, without the ix participation of Alpha) can be written as:
-

(Eq. vi)

Substituting Eq. vi in Eq. v, we find:
-

(Eq. vii)

Alpha

This can also be considered as the Minimum Fixed Cost that can be ascribed to product ): (Eq. ix)

On the other hand, if there were only product Alpha (without the other mix products), the fixed costs related to it would be maximum and would be calculated by: (Eq. x) Substituting Eq. ix in Eq. x, we find: (Eq. xi)

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International Journal of Industrial Engineering Research and Development (IJIERD), ISSN 0976 – 6979(Print), ISSN 0976 – 6987(Online) Volume 3, Issue 1, January - June (2012), © IAEME

In which the term could be considered as the range of variation of fixed costs for product Alpha and it represents the extent of use of the mix structure by product Alpha, or the extent to which product Alpha depends on the mix structure. The fixed cost of the structure shared by the product mix can be defined by:
O

(Eq. xviii)

Applying the same reasoning and substituting in Eq. v, we find:
O

(Eq. xix)

That is, the fixed cost of the structure shared by the mix can be determined by subtracting from the present situation the minimum fixed costs for each product (determined by the scenarios of absence of each one, sequentially).
O

Thus,
O

-

-

)-

-

-

)-

-

-

)

(Eq. xx)

-

-

-

-2

(Eq. xx-a)

Generalizing for a mix of “N” products, we find:
O -1 -2

-

-

-1)

(Eq. xxi)

As previously seen, the ranges of fixed costs for each product ( i ) show the utilization of the mix for each product, respectively. Thus, to define the degree of use of the Mix for product I, based on costs (UC%), we find: U %i
O i

x100

(Eq. xxii)

Thus, in order to define the participation of each product in the Fixed Cost of the Mix (the amount each of them absorbs from the mix, when compared with the remaining products), it is necessary to normalize the UC% parameter, obtaining what was called FACTORS OF COST PARTICIPATION (FPCs), that is:
i U %i 1 U %j
i 1 j

(Eq. xxvi)

Thus, the total fixed cost for a particular product in terms of its shared structure in the mix can be written as:
i i i* O

(Eq. xxx)

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International Journal of Industrial Engineering Research and Development (IJIERD), ISSN 0976 – 6979(Print), ISSN 0976 – 6987(Online) Volume 3, Issue 1, January - June (2012), © IAEME

Checking coherence The situations in which the model loses its coherence may be due to misevaluation by the cost analyst, or due to a degree of coherence that is not easily perceived by the analyst, thus inducing to error. • Individual conditions o In the exclusive production scenario for product “i”, resources should notexceed amounts available in the mix; o In the excludent production scenarios for product “i”, resources should not exceed the amount available in the mix; o In the exclusive and excludent scenarios for product “i”, resources should not be lesser than the amount available in the mix; o For a certain product, the maximum resources shouldbe greater than the minimum resources defined from the mix; • Collective condition: Resources shared in the production mix should not be negative. THE MIXBC METHOD TO COSTING PHILOSOPHIES MIXBC applied to Traditional Cost Accounting philosophy MIXBC also allows the Traditional Cost Accounting philosophy – the only one to be legally accepted in Brazil -- to be used more consistently. Thus, we believe we have found a way of improving managerial decisions within the philosophy acknowledged by the legislation, aligning purposes and optimizing resources. Returning to the DRE model typical of the ‘Traditional Cost Accounting philosophy: DRE / PRODUCTS Net Sales Revenue (-)Cost of Products Sold (variable direct costs and variable indirect costs part) (-) Cost of Products Sold (fixed cost part) = Gross Profit (-) FixedExpenses (=) Profit beforeIncomeTax ALPHA Q * Q BETA * Q GAMMA * TOTAL Qi *

i

−Q

*

-Q

*

-Q

*

-

Qi *

i

-

-

-

-

i i

()Fixedexpenses (=) LAIR

Table 5 Typical DRE model for Traditional Cost AccountingPhilosophy, applying the MIXBC method Source: authors
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International Journal of Industrial Engineering Research and Development (IJIERD), ISSN 0976 – 6979(Print), ISSN 0976 – 6987(Online) Volume 3, Issue 1, January - June (2012), © IAEME

Note that the “Gross Profit” parameter characteristic of each product makes it possible to determine more safely the product that shows best result, which is extremely useful for managerial decisions. It is important to point out that the gross profit of a certain product is determined by the unit contribution margin ( i - i ), by the amount produced (Qi ) by the fixed costs exclusive of the product ) and by the participation factor of the product in the mix i structure ( i * O ). It is therefore a characteristic the product shares with others in the mix (by means of the parameter O ) rather than a characteristic of the product itself. This is reasonable in a shared structure. MIXBC applied to the “Variable” costing philosophy The DRE typical of the “Variable Costing” philosophy would be: DRE / PRODUCTS Net Sales Revenue Q (-) Cost of Products Sold (variable direct costs and -Q variable indirect costs) (=) 1st ContributionMargin (-) FixedCosts (=) 2nd ContributionMargin (-) FixedExpenses (=) Result 2 ALPHA * * Q -Q BETA * * Q -Q GAMMA * * TOTAL Qi * Qi *
i

i

1 -

1 2

1 2

1i
i

2i ()FixedExpenses (=) Result

Table 6 Typical DRE model for “Variable Costing” Philosophy, applying the MIXBC method Source: authors MIXBC applied to the “Full” costing philosophy Apportionment of fixed expenses Fixed expenses can also be analyzed in the light of MIXCB, that is, by applying the same sequence of reasoning used to solve the problem of fixed costs. In managerial terms, applying MIXBC to fixed expenses is extremely reasonable, since in a business, every expenditure (cost or expense) exists (or should exist) to somehow make possible the production and commercialization of one or more products. From this point of view, it is reasonable to associate expenses to products, which is possible with the MIXCB method.

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International Journal of Industrial Engineering Research and Development (IJIERD), ISSN 0976 – 6979(Print), ISSN 0976 – 6987(Online) Volume 3, Issue 1, January - June (2012), © IAEME

Applying the MIXCB to fixed expenses (DFs), the following equations for product “i” of a Mix of “N” products areto be found: D
i

D D
i

-D D
i

MIX-"i" i i -

(Eq. xxxiv) (Eq. xxxv) (Eq. xxxvi) -1)D (Eq. xxxvii)

D D
O

i

D

-D

D

-1

D

-2

… D

Likewise, the degree of use of the structure (U%) and the participation factor (FP) must be calculated using the parameter “Fixed Expenses”, expressed as: UD%i Di
D D i
O

x100
1

(Eq. xxxviii) (Eq. xxxix)

UD%i
1

UD%j

D i D j

Di *D O (Eq. xl) D i D i It must be pointed out that the MIXBC could have been applied to the fixed costs + fixed expenses set (and in that case participation factors corresponding to the whole set would be obtained, FPCDs) or it could have been applied separately to the fixed costs (with cost-specific FPs, FPCs) and then to the fixed expenses (with expense-specific FPs, FPDs). Thus, the DRE typical of the “Full Costing” philosophy would be: DRE / PRODUCTS Net Sales Revenue (-) Cost of Product Sold (variable direct costs and variable indirect costs) (-) FixedCosts (-) FixedExpenses (=) Result ALPHA Q * Q BETA * Q GAMMA * TOTAL Qi *
i

-Q

*

-Q

*

-Q

*

-

Qi *

i

-D R

-D R

-D R

D

i i

Ri

Table 7 Typical DRE model for “Full Costing” Philosophy, applying the MIXBC method Source: authors

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International Journal of Industrial Engineering Research and Development (IJIERD), ISSN 0976 – 6979(Print), ISSN 0976 – 6987(Online) Volume 3, Issue 1, January - June (2012), © IAEME

6 CONCLUSIONS The MIX based costing is a method that allows product cost to be obtained from a sequence of analyses performed on the production mix. Its application is particularly useful for the treatment of indirect costs, in the hypothesis that the absence of a particular product in the MIX provides clues as to the degree of utilization of shared costs (costs that are common to one or more products, and that are usually indirect) for the absent product. The major advantage of the method may lie in allowing costs and indirect shared expenses -- which cannot be actually separated for each product -- to be treated in a mathematical and coherent way. This contrasts with the other methods, which usually apportion or track expenses. In this sense, it is an apportionment-free costing system, since the uncertainties are calculated by a process of cost inference, based on the exclusive production (only the product analyzed is produced) and excludent production (only the product analyzed is not produced) scenarios. It should be pointed out that MIXBC is a method strongly dependent on the experience and on the systemic vision of cost analysts, who should have an in-depth knowledge of the reality of the business operations. The good foresight of these professionals shall be responsible for building coherent scenarios of resource consumption, and the application of the method shall lead to the safe completion of the cost distribution task and to results free of arbitrary apportionments. It is recommended that the scenario analyses be performed by a multidisciplinary team, comprising professionals from human resources, production and administrative managerial level. It was noticed that MIXBCis perfectly compatible with the Traditional Cost Accounting philosophy. The method may be applied together with this philosophy in order to obtain the typical income statements,in which the “gross profit” parameter is the most adequate to evaluate the results of each product. It was also observed that MIXBC is perfectly compatible with the “Variable” costing philosophy and it may be applied together with this philosophy in order to obtain the typical income statements, in which the “contribution margin” parameter is the most adequate to evaluate the results of each product. It is important to notice that MIXBCcan also be applied to expenses, being perfectly compatible with the “Full” costing philosophy and it may be applied together with this philosophy so as toobtain the typical income statements, in which the results for each product can be directly obtained. The “Full” costing philosophy is believed to be the most informative in terms of managerial decisions. In general terms, it was observed that MIXBC is compatible with the three costing philosophies mentioned above. It is therefore a valuable tool in the distribution of costs to the products. This method reduces the arbitrariness caused by apportionment, contributing to improve informationnot only in financial accounting but also in managerial accounting, allowing the elaboration of more consistent and more profitable production strategies.

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International Journal of Industrial Engineering Research and Development (IJIERD), ISSN 0976 – 6979(Print), ISSN 0976 – 6987(Online) Volume 3, Issue 1, January - June (2012), © IAEME

REFERENCES 1. ANDRADE, Nilton de Aquino, BATISTA, Daniel Gerhard, SOUSA, Cleber Batista de, “Vantagens e Desvantagens da Utilização do Sistema de Custeio ABC”, in: Seminário de Gestão de Negócios da FAE, n. 1, Curitiba, PR, Publicações, 2004. Available at <http://www.fae.edu/publicacoes/pdf/art_cie/art_37.pdf>. Accessedon May 20 2011. 2. AZEVEDO, Ana P. F., GOUVÊA, Josiane B., OLIVEIRA, Ualison R., “Custeio por Absorção X Custeio ABC”, in: Simpósio de Excelência em Gestão e Tecnologia – SEGET, n. 3,Rezende, RJ, Anais, 2006. Availableat<http://www.aedb.br/seget/artigos06/ 871_CUSTEIO%20POR%20ABSORCAO%20X%20CUSTEIO%20ABC.pdf>. Accessedon May 20 2011. 3. BEUREN, Ilse Maria, SOUZA, Marco A. B. De, RAUPP, Fabiano M., “Um Estudo Sobre a Utilização de Sistemas de Custeio em Empresas Brasileiras”, in: Congresodel Instituto Internacional de Costos, n. 8, Puntadel Este, Uruguay. Anales, 2003. Available at <http://eco.unne.edu.ar/contabilidad/ costos/VIIIcongreso /110.doc>. Accessed on May 20 2011. 4. HORNGREN, Charles T., FOSTER, George, DATAR, Srikant M., “Contabilidade de Custos”, Rio de Janeiro, RJ: Ed. Pearson / Prentice Hall, 2004. 5. MARTINS, Eliseu, “Contabilidade de Custos”,São Paulo, SP: Ed. Atlas, 2010. 6. SILVA, César A. T., “Utilização do Custeio por Absorção para Fins Gerenciais”, Revista UnB Contábil, 1, 1, 1998. Available at <http://www.cgg-amg.unb.br/index.php/contabil/ article/view/98/pdf_6>. Accessed on May 20 2011.

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