Activity-based costing refers to a methodology that identifies various activities within an organization and classifies them into different categories. Each category is assigned a cost and
the cost is then applied to the products and services based on the actual usage by each person in the organization. This methodology also assigns indirect costs to direct costs.
Activity-based costing has many advantages. It is cost-effective as it does not include other costs which are generally added into the budget. It has high validity because it is based on the
actual usage patterns and results. It is flexible because it can be customized according to the requirement of the organization. It is applicable to any type of business.
In any organization, there is usually a particular department or group of people involved. The activities of these individuals will vary based on their individual needs and their roles within the
organization. However, they will be using the same processes such as pricing, planning, accounting, etc.
Allocating the cost based on the activities performed by these people enables the organization’s performance to be judged fairly and accurately. This results in the organization achieving its
intended goals with a great degree of success. Activity-based Costing methodology makes use of the principle of comparative analysis and decision procedure. In simple terms, this is a technique that applies comparative methods in order to assign costs to specific activities in the organization. It also applies decision procedure in order to make decisions about the correct course of action for the organization. Based on the results of the activity-based costing analysis, the appropriate course of action is taken. The activities that are being classified in this way include the production of goods and services, purchasing of goods and services, sales, advertising, distribution, and financing activities. Activity-based costing has many advantages. It is cost effective because it takes into
consideration only those activities which are actually performed by the individuals involved in the organization. It is flexible because it can be modified based on the need of the organization. It is
applicable to any type of organization. It is also applicable to any type of business. The results obtained during the activity-based costing process enable the organization to create accurate reports and evaluations about the organization’s financial reports. These reports help the management to make critical decisions about the organization’s future financial requirements
and needs. It also helps the management to design and develop strategies to enhance the efficiency of the organization. It enables the management to set up a cost-control mechanism. It
also enables the management to decide the future direction of the organization by helping the management to set the correct costs for the organization.
Activity-based costing has many disadvantages. It can be used effectively for measuring the cost effectiveness of the organization but if a small amount of money is spent, there is no guarantee
of results. Also, it is very time-consuming.
Activity-based costing can be used to improve the efficiency of the organization. For example, the organization could start to implement the idea of using customer service surveys to assess
the level of satisfaction of customers with certain aspects of the organization. In the process of implementing this, the quality of service provided by the employees should be determined. This
can then be improved. This way, the employees will be able to identify areas where they can make improvements and this will lead to the improvement of the quality of the service offered by
The cost of the implementation of such an approach is much lower than resource allocation and the impact of resource allocation is also lower. This means that the resources involved in the
implementation process are used up in a more efficient manner. There is also less loss of productivity. inefficiency associated with such an approach compared to allocation of resources.
However, since the cost per person in this case is higher, the approach may not be applicable for every particular area of the organization. However, as an organization gets better at identifying the cost of doing business and finding the right activity, the cost of activity-based costing could be used as an indicator of cost efficiency in the organization. One drawback of activity-based costing is that it is not appropriate for all types of businesses. There are certain situations when it may not be appropriate. There are instances where the approach cannot be applied because the organization could be running into problems of cost over-utilization. For example, if the activity involved in the estimation of the total cost of the project is something that is done at the end of the year, then the cost over-utilization can be substantial.