A Discussion on Activity-Based Costing

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A Discussion on Activity-Based Costing
ACC-532 Graduate Paper

A Discussion on Activity-Based Costing

When we think of cost of accounting it is easy to come up with numerous different cost accounting methods which is because over the year’s cost accounting has developed in numerous ways to accommodate different types of situations. While every type of cost accounting is important and has its own benefit and disadvantages this paper will focus on what I believe is one of the most important cost accounting methods. The method that this research paper will focus on is the activity-based costing method, more commonly known as the ABC method. “A costing method that first assigns costs to activities and then to goods and services based on how much each good or service uses the activities” (Hilton, 2014), this is the definition of the ABC method according to the textbook Advanced Cost Accounting. While I believe that this definition gives us a good idea of the general idea of what the ABC method is it does not even begin to crack the surface of how important this costing method is and how essential it is to the companies that utilize it. In order to get a broad understanding of the ABC method this research paper will focus on three focus points. The first focus point is the history of the method, the second focus of this paper is why a company would use the ABC method and how it is set up, and the last focus point of this paper will be the role of the ABC method in today’s business environment. The goal of this paper is to focus on these various aspects of the ABC method in order to come to a better understanding of the process and its importance.

The ABC method came about in the 1980s because companies felt that the current cost accounting methods were becoming less and less relevant due to technological advances that had occurred since cost accounting methods were developed. “The traditional cost accounting methods were designed around 1870 - 1920 and in those days industry was labor intensive, there was no automation, the product variety was small and the overhead costs in companies were generally very low compared to today” (Emblemsvag, 2010). As this excerpt explains cost accounting was created around labor intensive industries and as industries modernized accounting did not modernize with it. Companies begin to realize that the old cost accounting method was becoming more of a liability then it was helping them. The main problem these companies were having with traditional cost accounting was that it was hard to accurately track their production costs, since production was no longer made up of just labor and material it involve equipment and other machines. The ABC method was created out of a need to break down complicated processes into smaller activities that costs can be expensed to. The ABC method became hugely popular among production companies and by the early 1900s was widely used. It was widely considered at the time to be one of the greatest management techniques created in recent memory. The historical impact of the ABC method cannot be overstated it completely modernized cost accounting for the industrial age and gave management much more control over their costs.

When a company realizes that their current costing method may not be effective they may decide it is time to switch to a new method, one of their options could be the ABC method. Companies that benefit the most from the ABC method is companies that have overhead that is related to a number of different activities, companies that usually need the ABC method also normally have a wide range of consumer needs. A company that has limited overhead that is only related to a few expenses would probably not benefit from the ABC method, for example a small painting company would have no need of the ABC method. If a company does decide that their company would benefit from the ABC method they should not make the change lightly...
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