Question

Assume that your client company uses job costing, you, as the consultant, are writing a memorandum to your client company and recommending ABC. In the writing, please describe the reasons and benefits of changing to ABC. How would you separate the information in the memorandum? Like what kind of categories to explain the benefits.

Answer 1

The major reason why the company must opt for ABC Costing is as follows-

1. Accuracy- Activity based costing provides more accurate information. It bring reliability in product cost determination as it focuses on cause and effect relationship. As the name applies, the costing approach is based on activity and not on products and it is product which consume activities. In large manufacturing environment ABC provides more realistic product costs. Traditional costing system is likely to bring errors and approximate value in product cost determination due to absorption method.

2. Cost Behaviour Information- ABC helps in identifying activities which do not add value to the product and hence reducing cost. It also help control fixed overhead cost by exercising control over activities which caused fixed overheads.

3. Overhead cost identification- Apart from product costs, it also helps to trace cost which pertains to managerial responsibility, processes, customers etc.

4. Better decision making- ABC majorly improves the manager’s decision making as the product data is more reliable.

5. Special advantage to service industry- Traditional costing has been considered inappropriate for service organizations. With the advent of ABC costing, it has helped in decision making to service organizations since these organizations do not hold stocks of service as the service is consumed when it is produced.

ABC system provides better costing information and help effective and efficient management by gaining perspective on strengths, weaknesses and advantages. In case of erroneous pricing which results in inaccurate costing data, the management tends to opt ABC method.