The Disadvantages and Advantages of Activity-Based Costing

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The Disadvantages and Advantages of Activity-Based Costing
Activity-based costing became popular due to dissatisfaction with traditional ways of allocating costs. (Jupiterimages/Photos.com/Getty Images)

Activity-based costing is an accounting method that assigns costs to activities based on their use of resources rather than products or services. Activity-based costing seeks to change counted cost. This accounting method is an alternative to traditional accounting that allocates a business's overhead in proportion to an activity's direct costs.

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Set-up

Activity-based costing is not as simply task to introduce, because all business activities must be broken down into discrete components. A company should implement a pilot scheme before implementing the system throughout an organisation. An organisation should maintain its traditional accounting system and use the ABC structure as an extra that can be called upon when specific cost information is required to help make a particular decision.

Usage

Activity-based costing can be extremely useful for anyone involved in process improvement and cost reduction. The use of ABC means that all individual activities that are part of a process can have accurate cost. Activity-based costing can help illustrate costs of products and services and help establish the profitability of the individual products and services, which can be particularly useful in today's economies where companies are trying to differentiate and personalise products and services.

Advantages

Activity-based costing is a great method for assessing costs of individual activities, based on use of resources. This type of accounting method enables accurate costing of all activities throughout an organisation. Activity-based costing can help easily identify incurred high and low costs and the cause. Activity-based costing can help with future product planning, which can help with determining pricing and any associated expenditure.

Disadvantages

Activity-based costing can be a difficult system to set-up and establish, especially for organisation that use more traditional accounting methods. Activity-based costing is a rather time consuming process if all activities are to be at cost. This method of accounting can sometimes provide too much detail, which can obscure the bigger picture.

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