Activity-based costing (ABC) employs numerous cost groups, organized by activity, in the allocation of overhead costs. The conception is that activities are necessitated to generate products, basically activities, such as procuring materials, setting up machinery, assembling products, and scrutinizing finished products. It is imperative to note that these activities can be expenses and therefore the cost of activities ought to be apportioned to products on the basis of how the products use the activities. The costs are placed on the products on the basis of the use of individual products for every activity (Hansen et al., 2007). In the traditional product costing system, to begin with, costs are not linked or mapped out to activities but they are rather traced to a unit within the organization, for instance a department or a division, and thereafter to products. This implies that in the traditional and ABC costing systems, the second as well as finishing stages are made up of linking costs to the product. Nonetheless, by laying emphasis on activities, the activity-based costing system attempts to determine the factors that cause every key activity, cost of these sorts of activities and the association between activities and the products produced (Lal, 2009). The purpose of this paper is to discuss the theoretic shortcomings of activity-based costing and the decision encompassed on the manner in which cost drivers are chosen for an activity.
Moreover the approach requires additional simplification. In particular, the aspect of ascertaining cost pools and cost drivers is not always an easy and direct undertaking. At times, it is essential to vindicate and give a good reason for the number of cost pools and cost drivers aimed at diminishing the intricacy and cost of the activity-based costing system. This may be considered to be a weakness to the ABC system. Moreover Bendrey et al. (2003) indicate that the ABC system has a weakness in the lack of conformity to SSAP 9. In particular, the ABC system reassures all costs, comprising selling and distribution costs. This aspect encompasses and spreads across the standard foundation for prizing stocks for financial accounting reasons. SSAP 9 necessitates stocks as well as work in progress to be valued at complete production costs up to the phase of finalizing the end-product, which would generally disregard retailing and distribution expenses (Bendrey et al., 2003).
Another theoretical demerit of the activity-based costing system is that the approach has dissimilar levels of utility for dissimilar entities, for instance major manufacturing companies can employ it more efficaciously in comparison to smaller companies. In addition, there is a likelihood that companies that rely on cost-plus pricing can make the most of ABC method, owing to the fact that it provides precise and correct product cost. However, the companies that employ market-based prices may not have a preference for ABC method. The level and magnitude of technology and manufacturing setting existing in various companies also have an influence on the application and administration of ABC systems (Lal, 2009). Another major weaknesses of the ABC method is that its execution is largely costly. To begin with, setting up the system can be costly and time-consuming. With the analysist of activities for an organization, such activities must be further itemized into the individual constituents of every activity. The process, as a whole, can come to an end and deplete valuable resources as data is gathered, measured, and keyed into the new system. In addition, organizations may also need the help of a consultant that is an expert in setting up an ABC system and can offer training on its application and administration. The utilization of software can bring into play an extra expense for the execution and computerization of the manual elements that encompass using the activity-based costing system (Lal, 2009).
The ABC system is also considered to have a flaw as it misconstrues data. The information reported by an activity-based system takes into account data, for instance, product margins, which are completely dissimilar from the information that is produced by a traditional costing approach. Moreover, it is conceivable that a number of costs entailed in the ABC system may be immaterial and unrelated in particular decision-making instances. A very fitting illustration encompasses the sense that ABC does not comply with standards and, for that reason, cannot be employed by companies for the purposes of external reporting. Taking into consideration that traditional cost amounts and figures have a tendency of being the standard figures, construing and understanding data from the ABC system together with common accounting information can be perplexing, giving rise to an organization making poor decisions (Weygandt et al., 2009).
Activity-Based Costing and AIS Activity-Based Costing (ABC) is an accounting method that identifies the activities a company carries out and then assigns indirect costs (overhead) to products. Activity-based costing shows the relationships between the activities, the costs, and the products, and correctly associates the lion's share of the resources used with the actual production or provision of services. The recognition of these relationships enables the indirect costs to be assigned to products in
(Questions that will assist in quantifying the relationship between resources and activities include: How much time is spent performing each activity? What equipment is used to perform activities? Do some activities have dedicated equipment? Do some activities require more space than others?) After the data on resources have been collected, establish cause-and-effect relationships between resources and activities or resources and cost objects. The third step in the process is
ABC can identify high overhead costs per unit and find ways to reduce the costs, avoid decreases in head counts due to inaccurate allocation of costs, and measure profitability with higher accuracy than traditional costing that uses direct-labor hours as the only cost driver (Activity-based costing, n.d.). Bibliography Activity-based costing (ABC). (n.d.). Retrieved Apr 2, 2009, from Managers-Net: http://www.managers-net.com/activityBC.html Activity-based costing (ABC): What is it and how can reengineering teams use it?
Activity-Based Costing in Service Industries Describe the company you researched in one to two (1-2) paragraphs. Since many traditional industries that deal with goods for sale also offer some service, it was somewhat difficult to settle on a company that dealt in services exclusively. Home Depot or another of that sort would have been easy because they offer both, but the company used for this examination was State Farm. Insurance companies will
But the customized product probably takes much more design and engineering time than the mass-produced product. Traditional costing systems would not, in most cases, pick up this difference. With traditional costing a company that makes both low and high volume products might spread all of its overhead to products it manufactures based solely on machine hours. This might misallocate overheads between products. And if one product demands a significant amount
Activity-Based Costing and Traditional Systems Activity-based costing (ABC) measures the cost of a product/service based on the activities performed to produce the product/service. Activities are processes, functions, or tasks that occur over time and have recognized results. Activities use up assigned resources to produce products and services. An ABC system first allocates indirect and support expenses to activities and processes and then to products, services and customers. Therefore, the ABC system