The most significant disadvantage is that the system relies on one allocation base, and the product costs cannot be appropriately reflected. For instance, such high-volume products could be overcosted because the price might need to appropriately reflect the complexity of production workers or other resources. On the other hand, low-quantity products may be undervalued, leading to a skewed idea regarding their real cost implications. This difference in cost allocations can cause serious consequences regarding decision-making processes within an organization. Managers who depend on traditional absorption costing may make suboptimal decisions simply because costing information is fraught with errors (Kitsantas et al., 2020). As a result, pricing, product development, and resource allocation, which are strategic decisions, may need to be revised, affecting a business’s whole performance and competitiveness. In this regard, side limitations of traditional absorption costing require a more detailed analysis of alternative ways, such as activity-based costing, to eliminate the mentioned shortcomings and improve cost allocation accuracy in a changing business environment.
Activity-Based Costing
Instead of the traditional absorption costing model, activity-based costing or ABC is a new paradigm for cost allocation that provides a more precise and sophisticated method. ABC recognizes an organization’s wide range of operations and guides the costs depending on the product’s actual use of these operations. This represents a departure from the outdated reliance on the amount of production. The ABC core principle identifies that the overhead costs are driven not just by the production volume. On the other hand, AB and C try to identify the specific activity responsible for these overhead costs and attempt to distribute them reasonably (Al-Dhubaibi, 2021). By doing so, ABC also gets closer to the actual factors that influence costs, thus there will be a more accurate representation of the resources used by each product.
ABC has the strength that its capability improves cost accuracy by linking indirect costs directly to activities required for production. This detailed and activity-oriented approach is also realistic as the actual cost is identified. Therefore, ABC becomes a potent instrument that helps managers decide. ABC helps managers make informed pricing strategies, product development initiatives, or resource allocation strategies by giving them a more transparent, more precise, and understandable notion of the actual price of each product or service.
Why Activity-Based Costing is Preferable
Identifying Cost Drivers: The thing that stands out about activity-based costing (ABC) stands out because it focuses on identifying and highlighting cost drivers. The specific factors that significantly impact the use of resources in an organization are called cost drivers. Unlike conventional absorption costing, ABC identifies and highlights those intricate factors influencing resource use. Identifying cost drivers is crucial as effective cost management and resource optimisation on recognising drivers. Businesses can create strategies that efficiently allocate resources by knowing the ones directly impacting resource consumption. This insight can be used to focus on the effort that will create the most significant results regarding resource allocation. For instance, ABC may reveal that certain goods or services unevenly impact the overhead costs due to specific activities performed in their production. Managers are now equipped with this knowledge and can make rational decisions to reduce tasks, cut out inefficient agencies and focus resources on those that contribute the most value to the firm.
Enhanced Decision-Making: In ABC, managers get a more precise and detailed view of cost structures to make better choices. This ability has shown to be helpful in such complicated business environments with a high level of product differentiation and a need for personalization. In a normal absorption costing structure, the overhead cost allocation is even and can mask the actual impact costs of various products or services. On the other hand, ABC gives a more intricate and refined image of costs by linking them to their respective activities. This granular view, where managers can differentiate among various products or services with a different pattern of continuous resource consumption, enables them to use more precise presuppositions regarding their economic impact. ABC enhances the decision-making ability of businesses, especially those worth working on or offering multiple offers of custocustomizeducts (ACA et al., 2021). In such environments, strategic decision-making must identify the real cost drivers associated with every product. Managers, equipped with insights created by ABC, can make informed decisions on price setting, allocation of resources and product development. This high level of understanding allows businesses to act immediately and adaptively in responsible movements,e, to design their strategies based on specific consumer requirements and menus and gain competitive superiority over others in the marketplace.
Resource Efficiency: Activity-based costing (ABC) promotes resource efficiency because it assigns costs based on the actual consumption of resources. This approach motivates organizations to look critically at their operations and identify those activities that are non-value added. Because ABC focuses on the specific activities that enhance value generation, it is easier to improve processes. This focus on the efficacy of resource use aligns with modern business goals for things like smoothing out processes and minimizing waste. ABC’s ability to identify resource-intensive activities and their corresponding costs offers a strategic framework for organ organizations that want to increase efficiency, eliminate unnecessary costs, and ensure that resources are used wisely in every dimension of their operations.
Conclusion
In conclusion, despite being essential, traditional absorption costing does not offer accurate pricing, as shown by the limitations. Activity-based costing ABC is a more nuanced and detailed one that addresses these shortcomings. Cheaper while at the same time being more accurate, granular, and focused towards cost drivers, ABC is therefore preferable to contemporary business management. Through activity-based costing, organisations enable themselves to make better-informed decisions and improve efficiency in resource utilization to keep up with the competition in the rapidly changing world of business. The ability of ABC to oa offer a more authentic reflection and accurate picture of actual cost and resource efficiency also meets the needs of the contemporary marketplace – it positions itself as a strategic option for businesses facing issues related to cost management decision-making.
References
ACA, M. H., ACTI, C., & KWANGA, Z. Y. (2021). DRIVING ORGANORGANIZATIONAL EFFICIENCY THROUGH THE IMPLEMENTATION OF ACTIVITY-BASED BUDGETING (ABB) MECHANISM (A THEORETICAL STUDIES). NVEO-NATURAL VOLATILES & ESSENTIAL OILS Journal| NVEO, 9437-9453.
Al-Dhubaibi, A. (2021). OptimOptimizingvalue of activity based costing system: The role of successful implementation. Management Science Letters, 11(1), 179-186.
Kitsantas, T., Vazakidis, A., & Stefanou, C. (2020). Integrating activity-based costing (ABC) with enterprise resource planning (ERP) for effective management: A literature review.
Zamrud, N. F., & Abu, M. Y. (2020). Comparative study: activity based costing and time driven activity based costing in electronic industry. Journal of Modern Manufacturing Systems and Technology, 4(1), 68-81.
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