Allocating costs on the basis of the amount of resources for the consumption of a product or service is the nature of activity-based costing (ABC). This is important for businesses offering customized services or products. It is required in a customized production environment to allocate actual indirect costs for a product. Thus, it can help in the identification of problems in production. However, the implementation of activity based costing can be challenging for any type of business. In fact, the process of implementing this concept may have several advantages and disadvantages.
Basically, ABC offers a big help to every company or organization aiming to have activities for business or team building purposes. For this reason, many entrepreneurs utilize this costing methodology so that the allocated cost of a particular activity should be enough and that there will be no shortcomings. Accordingly, this is arguably the best method in order to gain accurate estimates to the cost that should be incurred.
Likewise, ABC is helpful for institutions and companies in order to identify activities and assign each cost for every activity. This is a method to estimate the cost successfully. This method is concerned about the tracing of the consumption that should be spent which has made entrepreneurs interested. Hence, this is not only a way to save money but it is also a way utilizing resources in a productive way.
Entrepreneurs should be able to acquire many advantages through this costing method including the opportunity to be able to become competitive and successful globally in their choice of venture. In order to better understand this methodology, here are a few pros and cons of activity based costing.
List of Pros of Activity Based Costing
1. Improvement of Business Processes
Since activity-based costing will allocate indirect costs for each product, the business processes become clear. Thus, it determines which processes are doing well and which ones need improvement. This is because the process of activity-based costing will be able to identify the non-value added activities. This will help in the proper allocation of resources for profitable activities. At the same time, activity-based costing should be able to provide more value to the continuous improvement of a particular business process.
2. Identification of Wasteful Products
The method used for activity-based costing will account for the costs in a similar way that production work is done. Thus, it will allow the business to understand where the overhead costs are heading. The data will allow the management to identify unnecessary costs and wasteful products in order to use the resources in a productive manner. This method also helps in fixing the price of services or products that are incorrect or excessive. As a result, the overall service and product quality will improve if a business will rely on activity-based costing.
3. Accurate Costing Process
This method will allow business institutions to gain an accurate costing of services and products. As it will focus on costing of services and products, it should be done with accuracy as the whole process has been monitored. Therefore, it will allow a company to know the cost which should be friendly for both the consumer and manufacturer.
4. Easy to Understand
The activity-based costing method doesn’t require much understanding to be implemented. This is because it focuses only on the reality on how to undertake the process. For this reason, it will only depend on the type of business aiming to consider activity-based costing.
5. Generally Good for Business
The utilization of this method will allow many advantages for business. One is the proper utilization of unit cost compared to its total cost. Likewise, it is helpful in the company’s programs for continuous improvement. Benchmarking is also being facilitated. Moreover, it supports scorecards and performance management.
List of Cons of Activity Based Costing
1. Implementation is Expensive
Those who are not in favor of activity based costing has spoken and thought that this can be a time-consuming process not to mention expensive. Well, the analysis of business activities will require the breaking down of individual components in each activity. However, the entire process should be able to utilize valuable resources in the collection, measurement, and entering of data into a new system. Likewise, this can require the assistance of consultants specializing in the setting up of activity based costing and can also provide training regarding its use. Sometimes, another added expense may include the use of software for its implementation. But this can be essential in the automation of many aspects that use manual operation in implementing activity based costing.
2. Data Misinterpretation
ABC system reports contain information, including product margins that could differ from the reported information for a method focusing on traditional cost. On some cases, activity-based costs could be irrelevant in some decision making scenarios. For instance, the process of activity based costing doesn’t conform to standards of accounting and this shouldn’t be utilized for external reporting. In a norm of traditional cost figures, the interpretation of ABC data together with regular information on accounting could only be confusing and could lead to decision making error. For this reason, the utility of software will be able to streamline the maintenance process for the ABC system and will simplify its integration with information from regular cost accounting.
3. Odd Product Margins
Some people thought that the implementation of this method will produce product margins that are unusual in nature. This means that the data is far off compared to traditional costing systems.
The pros and cons regarding this method have been measured and every entrepreneur should be knowledgeable with this one. This is intended so that he or she will be able to make the right decisions in the event of crisis. Not only will the pros matter but the cons as well will be an essential factor when considering activity-based costing for any business. If you are having a dilemma in relation to production and service costs in your company, perhaps you need to consider activity based costing methodology and determine which process needs to be improved or maintained.
Crystal Ayres is a proud veteran, wife and mother. Our goal at Green Garage is to publish the most in depth content on the internet for every topic we write about. If you would like to reach out to contact Crystal, then go here to send her a message.