Weygandt, Kimmel, and kieso (2010;2) view Activity-Based Costing as a beneficial tool since it results in more accurate product costing and in a more careful scrutiny of all activities in the value chain which leads to better management decisions and control over ahead costs. Most people focus too much on the manufacturing side and forget about inputs like raw materials that come into the factory. Therefore, this may confirm that Activity-Based Costing does provide sustainability information for decision making.
What could lead a company to implement an Activity-Based Costing system are: first, businesses should have a strategic accounting method to make a profit, because there is a lot of competitors in the market. Second, the Activity-Based Costing method enables companies to decide which product, services and resources are increasing their profitability and which are contributing to a loss. Then, it enables managers to generate data, determine a better budget, and understand that there are expenses that are required to keep the company on track. Next, process environment will be affected because a new sophisticated system is needed in order to allocate costs directly to the goods and services produced by the business. After that, the markets are very competitive, so you need to determine how much your costs are exactly, which is necessary to correctly price the products and to beat the competition. Additionally, many managers believe that overhead costs and traditional costing are no longer correlated and that other factor drive overhead costs. Finally, Activity-Based Costing method is improving the budgeting practices of the organization (Sheu, Chen, and Kovar, 2003). They are aware of their production requirements and accordingly they are formulating a budget for them on a quarterly basis. Its effectiveness is not only important for the manufacturing units but also for the customers as it reduces the prices and cost of the product (Helberg, Galletly and Bicheno, 1994). Its applications help in obtaining the sufficient information related to the decision-making process and it helps in avoiding the confusion which can be arises in the production process. It facilitates in setting the benchmark in the field of accounting. Overall the calculation of production cost is the main advantage of Activity-Based Costing but this one feature has led to the generation of other improved solutions (GunaseKaran, Marri and Yusuf, 1999).
The Activity-Based Costing system can result in more reliable products costs than conventional labor-based product costing system. For instance: the traditional costing system which is based on labor, focuses on when manufacturing activity of production. Not to mention, Activity-Based Costing improves the reliability of cost data, hence producing nearly realistic costs. Obviously, Costing systems are nothing but the arrangements which provides data and information. A specific data is required by them like units produced and direct labor hours to be of value. The cost of products and other information are determined from the input data as per the particular costing system defined methodology. The final outcomes derived will be based upon the costing system employed, as there are numerous techniques in which the same input data can be used (Hoggett and Merlin, 2006). These days, fierce worldwide competition is compelling manufacturing organizations and services to become more flexible, highly automated and integrated for increasing their productivity at condensed cost. However, it is not possible to sustain this competitiveness in absence of an accurate mechanism for cost calculation. Therefore, Activity-Based Costing is an alternate approach to traditional costing system, which allocates costs to individual actions making use of more than one cost driver and then assigns costs to product units on the basis of every unit’s usage of these actions. When several actions are used as cost driver then the risk related to distortion is reduced plus more precise cost information is obtained (Özbayrak, Akgün, and Türker, 2004).
The Activity-Based Costing system changes because when the Activity-Based Costing method focuses on the activity that caused costs to occur, then this will result in a better choice of products, pricing decisions to reduce costs. To be more efficient, maintaining activities that add value, and eliminating others that do not add value. Moreover, by using Activity-Based Costing method we can eliminate low value-added without reducing quality. On the other hand, better pricing decisions will be taken into consideration because of the accurate product cost data. As well as, by having more detailed and better estimation of costs, a company will be in a position to decide which products to make and which ones to eliminate. In addition, Activity-Based Costing method leads managers to choose products that are more profitable.
Activity-Based Costing affects Cost – Volume – Profit analysis in many different ways. First, traditional costing can be misleading for managerial purposes and let management make wrong decisions. Second, Cost – Volume – Profit is based on one or more volume, based on cost drivers. There are some activities that their cost change in proportion to some cost drivers other than sales volume. For instance, the setup costs. Third, costs that are fixed with respect to sales volume, may not be fixed with respect to other important cost drivers. In fact, Activity-Based Costing system acknowledges these non-volume cost drivers, unlike the traditional costing system which does not acknowledge them.
The implementation of an ABC Costing system offers you greater control of your organization’s costs. This methodology develops tracing and allocation models that identify the costs related to each activity with precision as well as how they affect your company’s profitability.
In this way, it’s possible to construct an efficient management system based on activities, making it possible to reallocate resources and make a structural reduction of costs, promoting greater profitability, even within scenarios that are more and more competitive.
In addition to this, this system makes it possible to make assertive decisions with assurance in terms of pricing and the analysis and control of products, markets, channels, clients, etc.
Thus, your implementation will culminate in greater profitability in the middle and long-term through a detailed vision of organizational processes and will also result in an increase in your company’s competitiveness.
With these tips, you can implement an Activity-Based Costing methodology in a way that will make this process more efficient and help your company grow more and more.