Understanding Activity-Based Costing

Activity-based costing (ABC) involves the assigning of overhead and subsidiary costs to link goods and services. This type of accounting technique acknowledges the correlation between price and overhead actions, and industrial goods, conveying rent and indirect costs to goods and services less subjectively than old-style costing approaches. Even so, some indirect expenses like administration and workplace staff salaries are challenging to allocate to a product. The process of activity-based accounting offers a more precise methodology of merchandise and service costing, which results to a more accurate decision while pricing a commodity. Activity-based costing improves the comprehension of expenditures and cost determinants, and ensure inflated and non-value addition events more perceptible, which permits supervisors to reduce or do away with them (Ringelstein 2018). It permits efficacy when challenging operational costs to find better and enhanced approaches of distributing and doing away with expenses. At the same time, it also allows enhanced products and the analysis of client productivity.

Activity-based costing is frequently applied in the manufacturing business because it improves the consistency of cost data, therefore establishing approximately true charges and improved classification of the prices sustained by the corporation during the process of invention. The formula for deriving activity-based costing is dividing the cost pool with the cost driver, which leads to the cost driver rate (Diavastis, Anagnostopoulou, Drogalas, and Karagiorgos 2016, p. 757). The same cost driver rate is applied in activity-based costing to calculate the sum of overhead and subsidiary expenses that are connected to a certain movement.

Practically, activity-based costing assists in assigning overhead expenses to services and products based on the prices of the activities needed to manufacture a merchandise rather than the simple estimation of how much each service cost. Giving the correct value of indirect costs is essentially important for management, particularly when outsourcing or downsizing. In most cases, profitable departments can be assigned too more indirect costs than they can handle which makes them look unprofitable in real life. Based on the assessment, managers can choose if they want to continue the operations or close a profitable department because the costs were adequately distributed. To compound the challenges, once a profitable branch is closed, the only remaining one is unprofitable. By closing the down a profitable unit, the company might not be able to cover its fixed costs (Huang 2018). The same scenario is also relevant when outsourcing. Managers might estimate outsourcing to be a cheaper option due to the fact that costs might not have been allocated justifiably. Outsourcing can prove to be more costly.

In addition, Activity-based costing changes the landscape of several indirect costs, which makes the costs previously measured to be indirect like devaluation, utilities or salaries, which can be traced to various activities. On the other hand, Activity-based accounting transforms costs from high-volume merchandises to truncated volume ones who raise the unit cost od low-volume products.

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References

Diavastis, I., Anagnostopoulou, E., Drogalas, G. and Karagiorgos, T., 2016. The interaction effect of accounting information systems user satisfaction and Activity-Based Costing use on hotel financial performance: Evidence from Greece. Accounting and Management Information Systems, 15(4), p.757.

Huang, Q., 2018. Skylar, Inc.: Traditional Cost System vs Activity-Based Cost System–A Managerial Accounting Case Study. Applied Finance and Accounting, 4(2), pp.55-66.

Ringelstein, D., 2018. Time-Driven Activity-Based Cost Accounting: A Critical Review. The Journal of New Business Ideas & Trends, 16(3), pp.20-27.