Respond to 2 of your fellow classmates with at least a 100–200-word reply about their Primary Task Response regarding items you found to be compelling and enlightening. To help you with your discussion, please consider the following questions:
- What did you learn from your classmate’s posting?
- What additional questions do you have after reading the posting?
- What clarification do you need regarding the posting?
- What differences or similarities do you see between your posting and other classmates’ postings?
STUDENT 1:
Two pros of activity-based costing (ABC) are as follow:
- ABC provides a more accurate representation of the costs involved in producing a specific good or service. It is because of the identification and assignment of costs involved in these activities that ABC allows managers to gain a better understanding of the true costs of what they produce which leads to better decisions regarding production and pricing.
- ABC provides superior cost control. Through braking down costs into smaller and more manageable parts, ABC allows companies to determine those areas where costs can be better controlled and, over time, this leads go improved profitability.
There are, however, cons associated with ABC, too:
- It is, or can be, excessively expensive to implement an ABC system, and this excess is in terms of both time and other resources. It may prove necessary to invest in new technology and/or take on additional staff to manage the process and this can be burdensome.
- ABC can also be very complex to implement, as ABC required a great amount of data collection and analysis which can be a considerable hurdle to overcome.
(Hicks, 2002).
The case of a manufacturing company that produces several products, some of which are profitable and others are less profitable or even consistent money losers is a situation where ABC costing can be used effectively. In this situation, ABC can be used to gain a better understanding of the true costs associated with the various product lines and thereby make more and better informed decisions regarding production and pricing these products. In this scenario, ABC would be used to break down the costs into smaller, more manageable and more easily understood bits and pieces to identify where the costs are incurred and where they might be reduced or even eliminated. In this situation, ABC would be used to determine the specific activities used in production, such as the handling of materials or the time used in machine set up, and then assigning costs to each activity, thereby gaining a thorough understanding, in quantitative terms, of the true costs of each of these product lines. Once this is fully understood, the company can then adjust production and pricing accordingly. As an example, if the company discovers through ABC methods that one product line requires more machine setup time than the others, it can then increase that product’s price to reflect its true production cost, or the company could seek ways to reduce the machine setup time to reduce the costs. In this scenario, ABC does not solve the problem, but it gives managers the information they need to solve that problem. One might say that ABC is a tool, the decisions to solve the problem are still in the managers’ hands, it is still possible to make an incorrect decision, and it is also quite possible that there is no solution to the problem, other than to discontinue the product line. All this said, whatever decision is made and regardless of the outcome, ABC provides the means of making an informed decision (Kaplan & Anderson, 2007).
References
Hicks, D. T. (2002). Activity-based costing: Making it work for small and mid-size companies (2nd ed.). New York, NY: John Wiley and Sons.
Kaplan, R. S. & Anderson, S. R. (2007). Time-driven activity-based costing: A simpler and more powerful path to higher profits. Boston, MA: Harvard Business School Press.
STUDENT 2:
“Activity-based costing (ABC) is a costing methodology used by businesses to allocate indirect costs to their products or services based on the activities involved in their production or provision. ABC works best in complex environments, where there are many machines and products, and tangled processes that are not easy to sort out”. (Bragg, 2022) ABC is used to provide a more accurate understanding of the costs incurred during production or service delivery, compared to traditional cost accounting methods. Which typically allocate indirect costs based on a single driver, such as direct labor hours or machine hours. While ABC has several benefits, it also has some drawbacks.
Two pros of Activity-based costing are accurate product costing, and improved resource management. ABC provides a more accurate understanding of product costs than traditional methods because it recognizes the cost of each activity involved in the production process. This can help businesses make better informed decisions about pricing, profitability, and cost reduction strategies. Improved resource management is a pro of ABC by helping companies manage their resources more efficiently by identifying the activities that consume the most resources. By understanding each activities associated costs, companies can identify areas where they can reduce costs or improve efficiencies. This results in improved profitability and better resource utilization.
Two cons of Activity-based costing are costly to implement and complexity. ABC requires a great amount of resources and time to implement, which can be a deterrent for smaller businesses with limited budgets. It also requires a high degree of expertise to design and implement effectively. “ABC requires a large number of data concerning numerous activity measures to be collected, checked, and entered into a system. (Francis, 2018). The second con of ABC is complexity. ABC can make it difficult to understand and manage, especially for non-accounting professionals. This difficulty can create a problem if one does not posses a detailed understanding of the company’s operations. Additionally, the complexity of the system can lead to errors in cost allocation and misinterpretation of results.
An example of a situation where activity-based costing being used effectively is ABC being used in manufacturing businesses that produce a wide range of products that require different levels of resources and activities to produce. For example, a bicycle manufacturer might use ABC to accurately allocate indirect costs to different product lines based on the activities involved in producing each product. For example, assigning a cost to each separate activity, such as material handling, assembly, and painting. This will provide a more accurate understanding of the cost of each product line and allow the company to make more informed decisions about pricing and profitability.
In conclusion, ABC is a powerful tool for accurately determining the cost of a product or service. It provides a more precise understanding of product costs, which can help companies make better decisions about pricing, profitability and resource management. However, implementing ABC can be costly and complex, requiring significant resources and expertise. Despite these challenges, the benefits of using ABC can be significant for companies with diverse product lines or complex operations.
References:
Bragg, S. (2022, June 25). Activity-based costing definition. AccountingTools. Retrieved April 4, 2023, from https://www.accountingtools.com/articles/activity-based-costing
Francis, A. (2018, May 22). Advantages and disadvantages of activity based costing (ABC). MBA Knowledge Base. Retrieved April 4, 2023, from https://www.mbaknol.com/business-finance/advantages-and-disadvantages-of-activity-based-costing-abc/
