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Faizan
Activity-based costing is a managerial accounting system that divides the products of a company into core activities and assigns costs to those activities. On the other hand, traditional costing assigns costs based on machine billing hours. Activity-based costing has increased in popularity as manufacturing costs have increased within companies. Activity-based costing offers advantages and disadvantages, and the size, products, services and budget of a company determines whether activity-based costing is the appropriate costing system to implement.
Attributing Costs More Accurately
Activity-based costing breaks products down into activities and assigns all costs associated with completing the activities. This allows a more accurate view of how much a particular product cost. It shows the direct relationship among activities, cost and products. Activity-based costing assigns to activities both manufacturing and non-manufacturing costs. It also eliminates the process of attaching some unrelated manufacturing cost to products. Overhead costs associated with activities are shown more accurately as well.
Budgeting
Activity-based costing allows management to effectively create budgets by clearly showing the relationship between costs and service production for different service levels. Activity-based costing clearly shows a company's overhead costs, and management is able to budget for such costs accordingly. Budgeting based on activity-based costing can replace traditional budgeting that is based solely on a company's expenses. Budgeting is an important aspect within an organization because the allocation of resources is based on the budget.
Expensive to Implement
Implementing an activity-based costing system is more expensive than implementing a traditional costing system. Not only is the implementation expensive, but the costs to maintain the system are high as well. Companies must train employees to use the activity-based costing system. These are major disadvantages for many small firms that do not have a lot of services, products or resources. Even some large companies have abandoned the model because of the high costs associated with activity-based costing.
Conforming to GAAP
Activity-based costing does not conform to generally accepted accounting principles (GAAP), meaning companies need to implement another costing system in addition to the activity-based costing system. GAAP requires that a company's external reports include all manufacturing costs. Activity-based costing does not include all manufacturing costs and includes other costs, such as product costs. It is possible for companies to make adjustments to their activity-based costing information to comply with GAAP, but it takes additional work. Some companies do not believe the additional work required is cost effective, and, therefore, use another costing system.
Attributing Costs More Accurately
Activity-based costing breaks products down into activities and assigns all costs associated with completing the activities. This allows a more accurate view of how much a particular product cost. It shows the direct relationship among activities, cost and products. Activity-based costing assigns to activities both manufacturing and non-manufacturing costs. It also eliminates the process of attaching some unrelated manufacturing cost to products. Overhead costs associated with activities are shown more accurately as well.
Budgeting
Activity-based costing allows management to effectively create budgets by clearly showing the relationship between costs and service production for different service levels. Activity-based costing clearly shows a company's overhead costs, and management is able to budget for such costs accordingly. Budgeting based on activity-based costing can replace traditional budgeting that is based solely on a company's expenses. Budgeting is an important aspect within an organization because the allocation of resources is based on the budget.
Expensive to Implement
Implementing an activity-based costing system is more expensive than implementing a traditional costing system. Not only is the implementation expensive, but the costs to maintain the system are high as well. Companies must train employees to use the activity-based costing system. These are major disadvantages for many small firms that do not have a lot of services, products or resources. Even some large companies have abandoned the model because of the high costs associated with activity-based costing.
Conforming to GAAP
Activity-based costing does not conform to generally accepted accounting principles (GAAP), meaning companies need to implement another costing system in addition to the activity-based costing system. GAAP requires that a company's external reports include all manufacturing costs. Activity-based costing does not include all manufacturing costs and includes other costs, such as product costs. It is possible for companies to make adjustments to their activity-based costing information to comply with GAAP, but it takes additional work. Some companies do not believe the additional work required is cost effective, and, therefore, use another costing system.
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