Cost accounting systems provide accurate costs only under stringent conditions. However, we know little about the nature, level, and bias of costing errors. This paper reports the results of a simulation study of two‐stage cost allocation systems that provide the following main insights: (1) partial improvement in the costing system usually increases the overall accuracy of reported product costs except in specific cases identified in this paper where errors have an offsetting effect, most notably when there is aggregation error in the activity cost pools and measurement error in the resource drivers; (2) the impact of Stage II costing errors on overall accuracy is stronger than that of Stage I errors, so system refinements should focus on Stage II; and (3) the presence of aggregation and measurement errors usually results in relatively more products being under‐ than over‐costed, with large amounts of over‐costing for a few “big‐ticket” (in dollar terms) products, and small amounts of under‐costing for a larger number of less expensive products.
