Benefits of Activity Based Costing Essay Example for Free

Benefits of Activity Based cost EssayIn crop to make a profit on action, the firm would have to charge a price that is wideer than the cost of overlapion. Generally, the cost of production is understood to be the cost of producing a good plus the cost of transportation to the consumer. In order to stay in business, and in that respectfore, to avoid losses at all possible costs the firm must cover all costs related to the production of the good and include all costs to deliver the same to the consumer at a price that is higher than the cost of production.The operating or overheard expenses of an enterprise ar generated by its activities to perform its business and/or manufacturing processes successfully. As its name implies, activity based costing relates the costs facing the enterprise to its various activities. By so doing, this arranging of costing provides pretty accurate information about costs, allowing businesses to effectively manage their overhead expenses in or der to increase their revenues (Cooper, 1988). It is but commonsensical that companies whitethorn work on cutting their costs once they know what is driving these costs.By improving their processes in order to cut costs, businesses may realize greater profits than before. What is more, by identifying high costing activities needed to produce certain goods or serve certain customers, companies may decide to direction instead on low costing products or customers by reducing their production of or service to high costing products or customers. In this way, they may shift their focus to products or customers that be more profitable to produce or to serve. Thus, management experts cite the following benefits of activity based costing as opposed to traditional method actings of costingIdentifying the most and least profitable customers, products and channels. Determine the true contributors to and detractors fromfinancial performance. Accurately predict costs, profits and resource requir ements associated with changes in production volumes, organizational construction and resource costs. Easily identify the root causes of poor financial performance. Track costs of activities and work processes. Equip managers with cost intelligence to drive improvements. Facilitate best Marketing Mix.Enhance the bargaining power with the customer. Achieve better Positioning of products. (Activity Based Costing, 2008). Businesses that benefit the most from activity based costing are those with high manufacturing operating expenses or overhead costs. These costs may result from a diverse range or products, intensity of capital, or vertically compound system of manufacturing. Activity based costing may inspection and repair such businesses non only to understand but also to control their operating expenses so as to increase their revenues (OGuin, 1991, p. 76).Organizations with large marketing, sales or distribution costs may also reap great benefits from activity based costing. A s mentioned previously, this method of costing identifies those customers that are most profitable from those that are least profitable. This provides insight to management on how to improve operations. With activity based costing, such businesses may be able to answer questions such as What discounts are appropriate for large orders? What size accounts should salespersons no longer call on? How effective is advertising to contrary markets? (OGuin, p. 76). Firms that are experiencing sluggish or low profitability on increasing sales may be suffering from growth that is unmanaged. It may very easily be that these businesses are selling products at losses to a number of customers. The accounting system of accurately measuring costs, that is, activity based costing, would allow these firms to sterilize which of their customers and products are generating revenues and which are not (OGuin, p. 76). OGuin describes another benefit of the activity based costing system thusEven with a di verse product line or customer base and very high profitability, a company lacking an ABC system is surprisingly vulnerable. Product profitability plausibly varies widely across the company. Highly profitable products present an irresistible target to new market entrants. Management should know which products are reaping enormous margins, so they tolerate erect barriers to entry. (p. 76). Also according to OGuin, the activity based costing system provides not only strategic but also tactical benefits to businesses that fulfill it.Whereas benefits that are strategic in nature may be realized only once in a blue moon, for the simple reason that organizations cannot be expected to change their pricing, business operations, distribution or manufacturing processes each year tactical benefits may be realized constantly. Indeed, activity based costing could help businesses not only with simplification of overhead costs, but also just-in-time support, improvement of quality, decisions about design, and investment in capital. Thus, businesses that implement the activity based costing system may improve their profitability on an ongoing basis (OGuin, p.76). In the twenty first century, companies that have a competitive edge are those that entertain flexibility, a trend that has been recognized as a critical factor for success since the 1990s. Life cycles of products have been shortened and focus on the customer has rick increasingly important. As economies of scale virtually disappear, manufacturing plants that are successful are those that are able to quickly introduce innovative products and economically produce weeny quantities. Activity based costing system can help businesses tremendously to light upon these goals.What is more, this system of costing could assist businesses of the twenty first century to achieve their goal to increase employee motivation. With the activity based costing system in place, employees increase their understanding of business ac tivities and therefore their involvement in business operations. So, for example, whenever they notice a mound of papers they would see overhead costs, leading them to the following questions Why do we have so many bills? Why are there so many process involved in our purchase orders (OGuin, p.76)? Thus, the activity based costing system encourages businesses to push their rates of cost drivers down. This helps in the reduction of time to setup, streamlines buying, in addition to time taken to development a product. When costs are attached to each of these processes or activities, management may not only measure but also plan improvement (OGuin, p. 76). As mentioned before, some of these improvements may entail reducing production of goods or service to customers that cost more to produce or service than the others.Hence, the activity based costing system may also lead the business that implements it to improve upon its marketing immix or positioning of its products. If products an d customers that cost more than the others are required by the company to produce or serve in the same quantity as before, however, activity based costing system helps the organization to improve its processes in order to decrease its costs without reducing the quantity to produce or serve. by and by all, it is only possible to improve inefficient processes.Because activity based costing allows the company to weigh the costs of activities against their benefits, firms that use it are in a great position to increase the efficiency of all of their processes so as to gain competitive advantages. References Activity Based Costing. (2008). Value Based Management. Retrieved Jan 27, 2009, from http//www. valuebasedmanagement. net/methods_abc. html. Cooper, R. (1988, Summer). The Rise of Activity-Based Costing Part One What is an Activity-Based Cost System? Journal of Cost Management, pp. 45-54. OGuin, M. C. (1991). The Complete Guide to Activity-based Costing. Chicago, IL CCH Tax and Acc ounting.