Activity-based costing is a method that assigns costs to products or services depending on the amount of wherewithal that they consume. Managers can use this costing method for internal reporting on costs and decision-making (Freedman 2012). Even though the ABC system is only suitable for internal financial reporting, organisations can use it in analysing cost data. Apart from excelling at assigning costs to goods and services that are manufactured, activity-based costing is also excelling in assigning costs to products that support different categories of actions (Kaplan & Norton 2009). In comparison to the traditional system, activity-based costing is different in the way it assigns costs to goods and services. Activity-based costing assigns non-manufacturing costs to goods and services, as well as places manufacturing cost tags on goods and services. The multiple approaches that the ABC system poses enable it to provide accurate cost of production to organisations. For instance, ABC system considers warranty repair costs as a cost of production to take care of the company’s production process. The exclusion of the costs of cooling and heating industrial units is a major weakness of the activity-based costing as compared to traditional system given that plants have to meet such expenses even if they manufacture a small or large quantity of goods.
In allocating costs, heating computes rates for each act differently and allocates costs to groups dealing in such activities. Companies that use ABC system in developing new products or devices are able to predetermine the accurate outputs of such developments easily than when using the traditional costing system. The traditional system mostly approximates overhead costs at the beginning of each year. Even though the ABC system is far much better than the traditional costing system, it is time-consuming to set up, thus can be expensive in itself compared to the traditional system (Averkamp 2008). At the same time, the system requires a specialist to oversee its set up. In addition, there are high possibilities of data misinterpretation, thus making some activity-based costs irrelevant in making external decisions to the company.
According to Freedman (2012), the ability of ABC costing system to generate management reports helps in making internal decisions. The accounting system can use ABC system to improve business processes, as the system can help in identifying non-valued added pools, thus helping to allocate funds to efficient and profitable programmes. Moreover, in accounting for the costs of production’s work performance, the system allows businesses to account for the overhead costs expenses (Averkamp 2008). In this dimension, ABC system helps businesses to make apt decisions in identifying wasteful products, thus preventing unnecessary expenses for effective and productive use of the available resources. Companies can also be able to fix prices of products that may go to waste. From this perspective, ABC system helps organisations to improve quality of their products or services. In the early 1990s, Chrysler, an American car manufacturer, used the ABC system to manufacture cars that met the needs of their customers. The company reported high customer satisfaction, as the system made the Chrysler to outsource many car spare parts given that the system indicated that using local resources was 30 times more expensive than using outsourced products. Evidently, ABC system enables organisations to make decisions that increase their competitive edge over their competitors in the market, by offering quality products to their clients. Notably, the system makes it possible for companies to reduce their costs of production by giving different alternatives.
Averkamp, H 2008, Activity Based Costing (Explanation), Activity Based Costing, Web.
Freedman, J 2012, Activity-Based Costing Method in Accounting, Small Business, Web.
Kaplan, R., & Norton, D 2009, Activity-based costing, The Economist, Web.