The key to gaining and keeping a competitive advantage or just staying in business is knowing how and where to effectively set prices without sacrificing the quantity and quality of the products. Companies that use the ABC methods of costing find it easier to set a competitive price.
Activity Based Costing assigns resource costs based on activities performed for the production of products or services. To phrase it simply a company’s products or services are the results of activities which use resources and incur costs. These costs are assigned to a specific task or action based on the activities that use or consume resources. ABC assigns costs by identifying the resources and activities as well as and the quantities needed to produce a profitable output.
There are three steps that need to be completed in order to implement an ABC costing system effectively. The first step is to conduct an activity analysis to identify the resource costs and activities of the company. Next, a company should choose activities that use or consume resources based on causal relationships. Finally, the company needs to assign the costs of activities to cost objects based on the appropriate activities performed for the cost objects.
The ABC method focuses on processes rather than the structure of a company. In other words, a company should increase or keep activities that add value to the product and eliminate activities that do not add any value to the product.
There are many benefits to using Activity Based Costing as it can provide a crucial in depth analysis of manufacturing processes. For instance, ABC costing provides more accurate and informative product costs, allowing the company to attain more accurate product and consumer profitability measurements and to gather an abundance of relevant information that can be used to make strategic decisions about pricing and product lines.
The ABC system provides the information to identify the areas where process improvement is needed. Also, improved product costs lead to better estimates of job costs for pricing decisions, budgeting and planning. Another major benefit that the use of ABC costing creates is the ability for management to identify the cost of unused capacity. Many companies may have seasonal or cyclical variances in sales and production, there may be times when the business may have excess capacity or space that is not being used. The company is still incurring costs associated with this unused space, and ABC costing provides a way for companies to separate these costs from their regular product costs. The main goal is to manage capacity levels to reduce the cost of underutilisation of capacity and to price products and services accurately.
In conclusion, Activity Based Costing is an excellent method that allows businesses to better identify the costs and activities that are incurred while producing their products and services. The ABC method gives a company the opportunity to reduce costs without sacrificing quality. As a result, a companies will be able to stay competitive with lower prices that will in turn increase sales.
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