University of the People **We aren't endorsed by this school
BUS 3304
Nov 4, 2023
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According to Investopedia, Activity-based costing (ABC) is a costing method that assigns overhead and indirect costs to related products and services. Activity- based costing recognizes the relationship between costs, overhead activities, and manufactured products, assigning indirect costs to products less arbitrarily than traditional costing methods. Notwithstanding, some indirect costs, like management and office staff salaries, are difficult to assign to a product (Kenton, W. (n.d.). Implementing Activity-Based Costing (ABC) typically involves the following five steps: 1. Identify Activities: Identify all the activities and processes involved in your organization's operations. These activities should cover both direct and indirect costs. 2. Assign Costs: Allocate or assign costs to each activity. This includes direct costs, which are easily traceable to specific activities, and indirect costs, which may need allocation based on relevant drivers. 3. Identify Cost Drivers: Determine the cost drivers for each activity. Cost drivers are the factors that directly influence the cost of performing an activity. They can be volume-based (e.g., number of units produced) or transaction-based (e.g., number of customer orders). 4. Calculate Activity Rates: Calculate the cost rates for each activity by dividing the total cost of each activity by its associated cost driver. This step helps in assigning costs more accurately to products or services. 5. Allocate Costs: Finally, allocate the costs to products, services, or projects based on their usage of the activities and the associated cost rates. Advantages of ABC: 1. Improved Cost Accuracy: ABC provides a more accurate view of costs by attributing them to specific activities, making it easier to identify cost-saving opportunities. 2. Better Decision-Making: With a clearer understanding of where costs originate, organizations can make more informed decisions regarding pricing, product/service profitability, and resource allocation. 3. Enhanced Cost Control: ABC helps in identifying and managing cost drivers, allowing organizations to focus on activities that add value and eliminate or reduce non-value-added activities.
4. Product Profitability Insights: It provides insights into the profitability of individual products or services, helping organizations focus on high-margin offerings. 5. Process Improvement: By highlighting inefficient processes, ABC encourages process improvement efforts, ultimately leading to increased efficiency. Disadvantages of ABC: 1. Complex Implementation: ABC can be resource-intensive to implement, requiring significant time and effort to identify, allocate, and track activities and their costs. 2. Data Requirements: Accurate data collection and analysis are crucial, and organizations may struggle to gather the necessary data. 3. Maintenance Costs: Ongoing maintenance of the ABC system can be expensive, as it requires updates and adjustments to remain relevant. 4. Subjective Allocation: Assigning costs to activities can be subjective and open to interpretation, potentially leading to bias. 5. Resistance to Change: Employees may resist changes in how costs are allocated, and there can be resistance to the new system. Despite its disadvantages, ABC remains a valuable tool for organizations seeking a more precise understanding of their costs and seeking ways to enhance cost management and profitability. References: Kenton, W. (n.d.). Activity-based costing (ABC): Method and advantages defined with example. Retrieved from https://www.investopedia.com/terms/a/abc.asp
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