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ABSTRACT: The concepts of incremental cost, opportunity cost, sunk cost, and cost allocation are identified and discussed in the context of early U.S. foreign policy. The case is derived from an authentic exchange of views between Thomas Jefferson and John Adams about how the United States should protect its merchant shipping against the Barbary pirates. Both men compare the cost of waging war against the Barbary States with the cost of paying ransom for captured U.S. seamen and bribes to protect future shipping. Adams quantifies the opportunity cost associated with not taking any action. Jefferson articulates an incremental costing argument, on the assumption that the U.S. should build a navy regardless of U.S. policy toward the Barbary States. The case constitutes a brief introduction to management accounting by illustrating various cost concepts. The case lends itself to a discussion of how cost information can be chosen to support a particular course of action, and it can also prompt a discussion of the historical origins of management accounting.
The beginning of wisdom in using accounting for decision-making is a clear understanding that the relevant costs and revenues are those which as between the alternatives being considered are expected to be different in the future. It has taken accountants a long time to grasp this essential point.
-R.H.Parker (1969, 15)
BACKGROUND
The Barbary Pirates
Throughout the seventeenth and eighteenth centuries, the North African Barbary States of Morocco, Algiers, Tunis, and Tripoli engaged in piracy of European merchant shipping. The Barbary pirates routinely captured and confiscated ships and cargo, and enslaved or ransomed their crews and passengers. England, France, and Spain entered into treaties with the Barbary States, in effect, paying "protection money" for their merchant shipping. These powerful European nations preferred bribery to war, in part because they perceived an economic benefit from the threat the pirates posed to the merchant shipping of other European nations.
Until the Revolutionary War, merchant ships from the American Colonies were protected by the British Navy and by treaties between England and the Barbary States. American shipping lost this protection after the war. Within three years of the Treaty of Paris, which formally ended the war in 1783, three American ships were captured, one by Morocco and two by Algiers....