A brief guide to activity-based costing

July 21, 2017

Using smart accounting to uncover the true cost of business

A quick guide on activity-based costing

Determining the true cost of a business' activities can be more challenging than simply looking at the cost of producing a good or service and weighing that against the revenue it generates. Business, after all, involves many different factors - from research and development, to marketing, maintenance, and beyond. Ignoring factors such as these could lead to a skewed perspective on just what it costs to offer a given product. Activity-based costing (ABC) is a method of accounting that strives to take a great many factors into consideration when determining the cost of business, and may be a superior option for executives striving for a more effective system of financial management. Here's a brief guide to how this system works.

Activity-based costing calls for more than just production variables

For businesses that only use a traditional approach to costing, it's typical to only look at a handful of variables when determining cost. For a manufacturing business, for example, the number of hours it takes to run the production machines for a particular product line would be one of the most important factors to consider. Machine A, which needs to run less of the time to produce a product, would be considered by this accounting to be less costly than Machine B, which takes longer to produce the same product. However, activity-based costing holds that this view is incomplete. Perhaps Machine A requires a greater amount of energy to run, or needs much more oversight by managers and more interaction with engineers than Machine B does, making it more expensive to run overall.

ABC can help EMBA graduates boost their careers

By taking into account any factors that contribute to the true cost of production - including research, development, maintenance, and more - it is possible to use activity-based costing to achieve a more detailed perspective on the amount it really costs to make a product. This method offers the potential for greater accuracy, and therefore a better chance for making informed decisions when it comes to allocating budget to products or methods of production. For this reason, graduates of EMBA courses looking to do a deep examination of manufacturing methods in their own workplace would do well to consider employing ABC and taking a close look at many cost-related variables. It could lead to the kind of insight for improvement that can greatly enhance their careers.

Students listen attentively
ABC allows for analysis of many factors, which can lead to more accurate cost information

EMBA graduates should remember that activity-based costing is not always best

The trouble with performing a deeper analysis of business costs is that the process itself is more costly. There may be initial setup costs to add sensors, data tracking, or other measuring instruments or processes, as well as added ongoing costs to maintain the gathering and analysis of the data. This makes activity-based costing an expensive undertaking, such that students in an EMBA program may find it is too difficult or expensive to implement at smaller companies.

There are also other limitations and difficulties inherent to using activity-based costing. Several factors examined in an ABC context may not be important in some decision-making situations, and data gathered during ABC is not appropriate for financial reporting purposes. This means that ABC must be implemented alongside, and not instead of, the traditional method of costing, which adds again to the cost of having such a system.

Activity-based costing is more resource intensive, and may be too expensive for some businesses. Photo © Andrej Dosek

Though the benefits of having activity-based costing as part of a business' operations can be significant, it is important that executives think carefully about whether ABC is right for their business before implementing it. Attending the executive MBA program at WU Executive Academy can help you determine whether or not ABC will be right for your career and workplace. Engage with the instructors and guest lecturers for perspectives drawn from the highest reaches of the academic and corporate worlds to gain greater insight into the practicality of activity-based costing, and learn if it is a good fit for you.

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