ADVANTAGES OF

ABC COSTING
GROUP MEMBER:
 RIMSHA HANIF 1395-FMS/BBAIT/F19
 USWA JABBAR 1390-FMS/BBAIT/F19
ABC COSTING:
a method of measuring the cost and performance of activities and cost objects.
Assigns cost to activities based on their use of resources and assigns cost to cost
objects based on their use of activities. ABC recognizes the causal relationship of
cost drivers to activities."

IT CAN BE DEFINE BY FOLLOWING EQUATION:

 C/A = HD + M + E + S

 C/A = Estimated cost per activity

H = Number of labor hours required to perform the activity one time
D = Wages per labor hour
M = Material costs required to perform the activity one time
E = Equipment costs to perform the activity one time
S = Subcontracting costs to perform the activity one time
 CONT…
The total cost for performing the activity will be based on the number of times the
activity is performed during a specific time frame. An activity-based costing system first traces
costs to activities and then to products and other cost objects.

The operation of the ABC system involves the use of the following terms:
Cost object: It refers to an item for which cost measurement is required. a product, a service, or a
customer.
Cost pool: A cost pool is a term used to indicate grouping of costs incurred on a particular activity
which drives them.
Cost driver: A cost driver is any factor or force that causes a change in the cost of activity.
 ADVANTAGES:
ACURATE PRODUCT COST:
 ABC brings accuracy and reliability in product cost determination by focusing on cause-and-
effect relationship in the cost incurrence. It recognizes that it is activities which cause costs,
not products and it is product which consume activities. In advanced manufacturing
environment and technology where support functions overheads constitute a large share of
total costs, ABC provides more realistic product costs.

Overhead decisions
 The ABC system shows you how you use overhead costs, which helps you determine whether certain
activities are necessary for production.
 Activity-based costing helps you identify where you’re wasting money. If you find that some activities
cost more than they should, you can find new methods to do something. Or you can cut out steps (and
even products) entirely.
PRODUCT PRICING:
 Another benefit of ABC is accurate product pricing. Pricing products can be one of the most
difficult decisions you make in business. 
 Failing to take all of your costs into consideration could result in setting your prices too low.
As a result, you might not wind up with a healthy profit margin. 
 With an ABC system, you can assign costs to each activity in the production process. This
shows you all the costs that go into producing a specific product. You can use this data to set a
price that more accurately accounts for how much it costs you to create the product.
BUDGETING
 When creating your budget for the year, you probably try to get as specific as possible when it
comes to your incoming and outgoing money. 
 Activity-based costing can help you to set an accurate budget that breaks down exactly where
your money is going—and which products are the most profitable. 

COST MANAGEMENT AND DOWNSIZING

ABC helps to reduce costs by providing meaningful information on the opportunities available
for reducing costs. If the company’s financial performance is not satisfactory, it may have to
resort to extreme measures like layoffs. ABC helps in making the right decisions as it clearly
defines the various activities. Thus, one can focus on value adding activities and eliminating the
non-value adding activities.
Determination of Products Service Costs:
 Now-a-days, non-manufacturing costs can no longer be neglected as they constitute a
substantial portion of the total cost. e.g., soft-drink giants of the world, Coke and Pepsi have
huge Marketing and Advertising Costs. On the contrary manufacturing costs constitute a very
small proportion of the total cost. These non-manufacturing costs can be allocated easily using
ABC because the relationship between costs and its causes is better understood. Wrong
allocation of these costs leads to a tendency of overvaluing the high-volume products and
undervaluing the low volume products which causes cross subsidization of one product by the
other unknowingly. This may lead to a faulty pricing policy. ABC enables the management to
fix the product/service prices by formulating an effective pricing policy. ABC helps in price
fixation by providing information about the product/service cost.
INCREASE PROFITABILITY
 The main goal of using the activity-based costing method is to increase the profitability and
overall performance of an organization. The ABC method does this by identifying accurate
overhead costs and cost drivers leading to more streamlined business processes. When all
direct and indirect costs are allocated to a product, managers begin to get an idea of which
business processes are performing well and which are inefficient. They can then streamline
these processes by allocating more resources to profitable activities and eliminating practices
that are costly and wasteful. As a result of the ABC process, companies are better able to
manage manufacturing performance and improve the quality of products and services. Overall,
profitability is increased as a result of more accurate product pricing which can allow
companies to offer competitive pricing while maximizing their returns.