Activity-Based Costing 2
Differences between Activity-Based Costing and Traditional Cost Strategy
Activity-based costing (ABC) is a costing model that identifies overhead activities in an organization and assigns the cost of each activity resource to all products and services according to the actual consumption, while traditional costing equally distributes all overhead expenses. Thus, an organization employing ABC, can precisely estimate the cost of its individual products and services for the purposes of identifying and eliminating those which are unprofitable and lowering the prices of those which are overpriced. ABC is generally used as a tool for understanding product and customer cost and profitability. As such, ABC has mainly been used to support strategic decisions such as pricing, outsourcing and identification and measurement of process improvement initiatives. Due to its nature, traditional costing gives less freedom in that respect.
In the past, accountants divided all costs into variable costs and fixed costs based on the relationship between the cost and output (business volume) changes, where only the short-term costs that vary with the cost of production were viewed as variable costs. However, although short-term costs do not necessarily change with the yields, they will change in a period of time with the product design, product mix, company’s product range and customer scope. Therefore, ABC provided further visibility and divided costs into short-term and long-term variable costs. The short-term variable costs are consistent with the original definition of the variable costs, such costs are quantity-based, and change in proportion with product output. Long-term costs, however, are based on activity levels, and change with the activity volume. In the ABC system, the fixed costs only refer to those costs that do not change with the amount of any activity in a given period of time. Some studies have shown that the fixed costs are only a small proportion of the entire
Activity-based costing (ABC) is a costing model that identifies overhead activities in an organization and assigns the cost of each activity resource to all products and services according to the actual consumption, while traditional costing equally distributes all overhead expenses. Thus, an organization employing ABC, can precisely estimate the cost of its individual products and services for the purposes of identifying and eliminating those which are unprofitable and lowering the prices of those which are overpriced. ABC is generally used as a tool for understanding product and customer cost and profitability. As such, ABC has mainly been used to support strategic decisions such as pricing, outsourcing and identification and measurement of process improvement initiatives. Due to its nature, traditional costing gives less freedom in that respect.
In the past, accountants divided all costs into variable costs and fixed costs based on the relationship between the cost and output (business volume) changes, where only the short-term costs that vary with the cost of production were viewed as variable costs. However, although short-term costs do not necessarily change with the yields, they will change in a period of time with the product design, product mix, company’s product range and customer scope. Therefore, ABC provided further visibility and divided costs into short-term and long-term variable costs. The short-term variable costs are consistent with the original definition of the variable costs, such costs are quantity-based, and change in proportion with product output. Long-term costs, however, are based on activity levels, and change with the activity volume. In the ABC system, the fixed costs only refer to those costs that do not change with the amount of any activity in a given period of time. Some studies have shown that the fixed costs are only a small proportion of the entire