Activity Based Costing

Topics: Balanced scorecard, Cost accounting, Cost Pages: 7 (2757 words) Published: June 23, 2013
When it comes to a company, there are many factors that must be taken into consideration. For instance: location, products/services, branding, advertising, marketing etc. But even with all that taken care of how will the managers, auditors and even employee’s know if they are being successful or not? This is where strategies of accounting come to play. A very successful method is Activity Based Costing. This method has continued to help companies by keeping track of their spending and figuring out ways to improve their flaws. The purpose of this essay is to give a three hundred sixty degree knowledge of ABC. Starting from an in depth description of the method, how it has evolved from the past and how it has provoked other alternatives to assist it. Activity based costing is a strategy used by managers to determine where to spend money. This contrasts the traditional costing system (Marx, 2009). Activity based costing provides a lot more benefits for the company and displays a more clear look at how the company is doing economically (Cooper, 1991). It allows managers to see where to spend money, and on which resources to focus their spending (Cooper, 1991). Managers should cut back spending on resources, and at the same time increase the output of their products (Cooper, 1991). There are several benefits to using the activity based costing method, and that is why it is growing in popularity. Though, in order for managers to optimize the benefits that activity based costing can provide, they will need to fully understand how it works. Activity based costing in most basic terms is spending money on specific recourses depending on the activity they serve the company economically (Cooper, 1991). This is in contrast to the standard per-unit costs. A per-unit cost is not a beneficial to know, appose to knowing how much money a specific production line would bring in per year (Cooper, 1991). Knowing how much each section brings in will allow the managers to know how much to allocate to each resource based on how much it brings in. this will be useful in situations where the units bring in a large amount of money each but either cost a lot to make, or do not sell a high quantity, whereas if a unit may bring in a fraction of the amount each, but sell many times more and are, in the long run, making a lot more money. This allows activity based costing to be a more precise way to calculate the unit costs, as well as the profit the company is going to make on the units. Knowing where to spend money will allow managers to focus on improving what will have the largest effect on the profit made.

Along with activity based costing, managers see that different products will require greatly different uses on the companies specific resources (Cooper, 1991). So with this, they can realize a more accurate cost of each product per-unit, and figure out how much profit each product could potentially bring in. to do this they need to view the relationship between the costs and the activities (Cooper, 1991). The company will then balance most of their costs in the more profitable areas of production and activity (Cooper, 1991). It gives managers the understanding of where to base the costs so that more profit is produced. Managers who use activity based costing also assume that activities cause costs, appose to just products causing the cost (Marx, 2009). The amount each activity would cost depends on the amount of resources that are used doing the specific activity (Marx, 2009). How to use activity based costing is not standard, but it has many similarities across all organizations that use it. There is a hierarchy of factory operating expenses for use with activity based costing (Cooper, 1991). These can also be referred to as cost pools (Marx, 2009). The first, and lowest, tier in the hierarchy of factory operation is unit-level activities (Cooper, 1991). Examples of unit-level costs are materials, machine costs, energy and direct...
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