Activity-Based Costing (ABC)


In today’s world of intense competition, one of the major concerns of an enterprise is how to achieve a low-cost price for the goods it produces. The mistakes in unit cost calculation can cause false management decisions, such as phasing out profitable produce or speeding up unprofitable ones. The introduction of activity based costing (ABC), a concept introduced in the 80s, can help the manager evaluate the costs of certain goods, especially when indirect expenses exceed direct ones.

Firstly, the ABC method helps calculate the latent correlation between direct and indirect expenses in the most efficient way. This is especially important nowadays, when a lot of enterprises function in the sphere of information technologies and there has been a shift in the cost structure. While traditional commodity production such as building houses, selling food, and sewing clothes has clearly direct and indirect costs, the IT sphere lacks such clarity. For example, in the production of virus protection software, the direct cost makes 10% of the bottom-line cost; the rest is spent on consulting, distribution, and training. It is possible to discover 40-50% of expenses that can be avoided as a result of ABC implementation. This method makes it possible to run production activities and evaluate their efficiency, as well as determine the real profit centers and subsequently adjust the investment strategy.

The method is also crucial for business process modelling, because it makes the performance of the enterprise completely clear to top management. This helps the company’s management evaluate the risks connected with the changes in quality, cost, and productivity of the enterprise. Having the information ABC suggests, top management is able to make well-founded strategic management decisions. This includes decisions concerning mastering of new products and markets, optimization of organizational set-up, and product portfolio policy.

However, the ABC method is rather complicated to introduce. It is labor-consuming and expensive because of the multiple level system of process analysis. This system includes various elements such as an activity center, resource drivers, activity cost pool, activity driver, cost element, and cost object. The method is said to be time-consuming as well. For instance, gathering and analyzing the collected data usually takes more than 12 months.

Overall, it is obvious that the ABC method is highly implementable in the modern business world. If the top management of a company chooses to introduce the method despite its high cost and time expenditures, it is sure to produce all the necessary data in order to make well-grounded decisions that can affect the future of the enterprise on different levels of production.

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