A reflection on a crucial accounting concept

A reflection on a crucial accounting concept

Various concepts of accounting have been discussed during the course. Most of the concepts can be better described as tools that enable the organization leaders to enhance their decision-making qualities and plan the business processes more efficiently. Among the primary concepts, I have found the concept of activity-based costing (ABC) very interesting.

Activity-based costing – what is it?

The term ‘activity-based costing’ is used to refer to a method of costing, which is used for the identification of organizational activities for assigning the costs related to the identified activities. The assignment is done as per the products or services and the actual rate of consumption of each time. In comparison to the traditional costing approaches, the ABC approach assigns more of the overhead cost (indirect charges such as utility expenses, salary, and so on) into the direct costs of the activities (Cooper & Kaplan, 1992).

Most of the organizations in the market use the ABC approach to make a sound estimation of the various elements of cost for the entire range of activities, products, or services that can help the organization to make a more informed decision. The main principle behind making an informed decision is that the unprofitable products or services are identified and eliminated cut down the prices of the products or services that are considered to be overpriced. Alternately, the concept also enhances informed decision making through the identification and elimination of processes (production or service) that are ineffective. In addition, the processing concepts are often finely allocated using the ABC approach to enhance the yield from the same product through process reengineering efforts.

Benefits of the ABC approach

There are a variety of benefits that the ABC concept provides the organization leaders with. Some of the most common ones are discussed below.

• Increased accuracy and reliability in determining the product cost through a focus on cause-effect association within the cost incurrence.
• Ease in the identification of the cost behavior nature to cut down cost and identify activities that add no product value.
• Outlining the cost object activities becomes more natural as the concept uses numerous cost drives – a majority of which are based on the transaction instead of product volume.
• Using the concept makes the outlining of overhead costs easier, especially in the sections of managerial responsibility, customers, processes, and departments other than the product cost.
• Cost management and improved decision-making are some of the unavoidable benefits that are associated with the ABC concept (Stiles & Mick, 1997).

Uses of ABC

The concept of activity-based costing finds a wide range of applications in the manufacturing industry, primarily due to its ability to enhance cost data reliability. It produces almost actual costs, thus classifying the organization’s incurred costs during the production process to a better extent. It often finds applicability in product costing, target costing, analyzing the profitability factors in the product line, customer profitability, as well as the service pricing analysis (Swenson, 1995). The concept is used in the industry to gain a better understanding of the costs, permitting the organizations to incorporate a pricing strategy that can be more effective.

Reference

Cooper, R., & Kaplan, R. S. (1992). Activity-based systems: Measuring the costs of resource usage. Accounting horizons, 6(3), 1-13.

Stiles, R. A., & Mick, S. S. (1997). What is the cost of controlling quality? Activity-based cost accounting offers an answer. Journal of Healthcare Management, 42(2), 193.

Swenson, D. (1995). The benefits of activity-based cost management to the manufacturing industry. Journal of management accounting research, 7, 167.