Introduction
How can you gain insights into your business costs with activity based costing analysis? It may be confusing to fully track the exact activities that your overhead costs are assigned to. You are not sure where exactly your indirect costs are going towards. Well, the answers to all of your questions as regards activity based costing analysis are addressed in this article. Activity based costing allows businesses that are into manufacturing of products to have a full grasp of the essential details. These cost details will help these businesses to assign their expenses in a better way. In clear terms, the business can correctly look into their expenditure. Not only their expenditure, they can also employ a better pricing strategy for their products. Activity based costing may not be the easiest process but when you learn about it, you get familiar with the process. That way you are able to gain insight into your business costs and how you can regulate them.
Activity based costing analysis explained.
Activity based costing analysis is a method you can adopt to get the total cost of production. This analysis will help you in breaking down the indirect costs involved in the total number of activities concerned with the production. The activity based costing analysis will allocate cost to each one of the activities that are involved in the production process. This includes the labor hours, machine hours and even the workers who are working as the product testers.
For businesses who are into manufacturing, there is a high probability that they will have high overhead costs. Therefore, in order to get a good understanding of the exact reason for a high overhead cost, they make use of activity based costing analysis. This analysis will help the business to have a clear understanding of the products that are literally profitable. And of course, it will give insight to the products that are not profitable. Activity based costing analysis will break down the total costs of production. This will give the company insights into specific ones with high and low volumes.
Why activity based costing analysis?
With the help of activity based costing analysis, every business will be able to discover the direct and indirect costs that are going into the production of all of their products. Companies are able to see that not all their products have a particular sequence of indirect costs. This will help them employ a better pricing strategy for their products. They will also be able to decide to cut off some indirect costs. Now, they have insight to the exact one that needs to be cut off.
Although activity based costing analysis can be complex when compared to the others. Instead of putting all the indirect costs under one umbrella of overhead costs, you need to be more focused and narrow down the expenditure. You will be considering the total hours a particular worker is exhausting on a particular activity. You will need to separate the cost of utility e.g waste disposal, electricity, for each activity. In addition, some companies lack the resources to keep up with an activity based costing analysis.
How is activity based costing different from the traditional methods of costing?
Instead of the regular traditional method of costing, businesses can decide to employ activity based costing analysis. The traditional method of costing analysis will use the median indirect cost rate to the rate of direct cost of production on the basis of a cost driver. This cost driver could be the hours of work, volume of work or other factors that drive the manufacturing process.
However, there are specific activities that are involved in the production process that do not align with this. They operate with higher overhead costs when compared to other processes. For this reason, using the traditional costing method in this case is not advisable. The estimate for the total production cost of that particular product will not be accurate. The traditional method of costing analysis is not as technical as the activity based costing analysis. However this is not a justifiable reason to settle for it. That is because the results are not as accurate as that of the ABC analysis.
Combination of traditional method and ABC method
One reason you may put the traditional method of costing into consideration is if your company does not produce so many products. There are also cases where your company can employ the two methods. For example, if you want to give an account to investors (external), you can employ the traditional method of costing. But if you will be giving accounts to managers (internal), then you should make use of the activity based costing analysis method.
Calculating your business cost with activity based costing analysis
If you have decided to adopt the ABC analysis for your company, then you need to have a clear understanding of how to allocate costs to all your activities individually. Here is a formula that breaks down how you can come about your business cost
For a particular cost pool:
(Total Overhead Cost/ Cost drivers) * total cost driver of activity