What are the benefits of activity-based costing (ABC)?
The main benefits of activity based costing are as follows
- ü With ABC (Activity Based Costing), production costs can be ascertained more correctly. For example, between items which differ at the end but have common primary manufacturing functions, only with ABC, can one know the exact overhead costs of each item type which is accurate and fair. Without ABC, sometimes one may end up making losses in production and not knowing anything about it if the profit percentage is very low.
- ü Since costs are known more accurately, optimum production levels at different times for maximizing profit can be thought of. This is possible because separate overhead costs for separate activities are known and therefore profitability of each product can be easily found out.
- ü Inventory costing is known for work-in-progress and not completed yet. Financial figures are more accurate and stock-holders can know the appreciation of inventory value. At any point in time considering the work-in-progress to be of the same value as the cost of materials, does not show the accurate picture. The labor and overhead costs of work-in-progress are not reflected in financial statements despite some costs being incurred.
- ü Costs controlling can be better done through ABC or rather overhead costs controlling. This is because through ABC, the costs of each activity are taken into account, along with the production volume. Without ABC, costs are based only upon the production volume which can give one an inaccurate idea of what it is costing to manufacture customer customized products.
- ü From inventory values, a more accurate idea of delivery periods can be obtained. As the exact conversion values are known, knowing the appreciation of inventory, it is possible to estimate the amount of work left. Therefore, approximate delivery schedules can be realistically given by sales with the help of daily inventory data from stores.
Q To what type of business would you apply ABC?
Activity Based Costing or ABC is best applied to production facilities where different types of products or versions of the same product are made as per the preference of the customer, or where specific tailored products are made as per customer specifications. Applying ABC to a production facility where the same product is manufactured will not be of much advantage. ABC is immensely advantageous in those production companies where production is done along assembly lines.