Question

Discuss the usefulness of ABC accounting for Management and the Stockholders through the eyes of non accountants.

Give several examples.

Answer 1

Activity-based costing (ABC) is a method of assigning indirect costs such as wages, administrative costs to goods and services. It allocates these costs to products based on activities which are drivers of cost.

Usefulness of ABC accounting to Management:

Better grasp on costs: ABC allows management to acertain costs of product with precision. Costs which were earlier considered as general overheads can be allocated specifically to a product thereby enabling the firm to find true profit/loss on it's sale.

For example, consider Company Jackinson that has a $500,000 per year electricity bill. The number of labor hours has a direct impact on the electric bill. For the year, there were 25,000 labor hours worked, which in this example is the cost driver. Calculating the cost driver rate is done by dividing the $500000 a year electric bill by the 25000 hours, yielding a cost driver rate of $20. For Product ABC, the company uses electricity for 10 hours. The overhead costs for the product are $200, or $20 times 10.

Eliminating non value added activities: The management will be able to identify and remove non value adding actitvities.

For example, with ABC, managers are able to control many fixed overhead costs by exercising more control over the activities which have caused these fixed overhead costs.

Better decision making: Due to availability of precise information activity wise, management will be able to identify reduntant processes/loss making products. It will enable the company to remove these products. It will guide the management regarding expansion of product lines across globe.

Make or buy: The management can take make or buy decisions by considering the cost of manufacture of a product or sub contract the same with an outside agency through Activity Based Costing analysis.

Usefulness to shareholders:

Transparency to shareholders: The shareholders will have better visibility to the margins the company is making on its products and they can accordingly take decisions whether to further invest or not.

Wealth appreciation: Since the company will benefit overall due to efficiencies introduced as a result of implementation of ABC, the stockholders will see their wealth rising.

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