Question

Why the ABC brings the greatest benefits in a larger corporation? Give the reason.

Answer 1

ABC costing is a method which identifies and assign costs to overhead activities first and then assign such costs to products.

An activity-based costing (ABC) system recognizes the relationship between costs, overhead activities, and manufactured products, and through this relationship, it assigns indirect costs to products less arbitrarily than traditional methods.

Activity-based costing (ABC) is mostly used in the manufacturing industry since it enhances the reliability of cost data, hence producing nearly true costs and better classifying the costs incurred by the company during its production process.

This costing system is used in target costing, product costing, product line profitability analysis, customer profitability analysis, and service pricing. It is also hugely popular since organizations can develop a much better corporate focus and strategy if costs are better grasped.

Activity-based costing enhances the costing process in three ways.

First, it expands the number of cost pools that can be used to assemble overhead costs. Instead of accumulating all costs in one company-wide pool, it pools costs by activity. It also creates new bases for assigning overhead costs to items such that costs are allocated based on the activities that generate costs instead of on volume measures, such as machine hours or direct labor costs. Finally, ABC alters the nature of several indirect costs, making costs previously considered indirect - such as depreciation, inspection, or power- traceable to certain activities.

Since the costs are attributed to different products based on the activities performed, the unit costs of higher products can be reduced and thereby generating higher profits for the same.