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Activity-based costing (ABC)


This is a costing methodology that establishes operations in a company, and it gives the cost of each activity with resources to entire commodities and services concerning the specific consumption by each. The model tends to assign more indirect costs into the direct cost as opposed traditional costing. Therefore, the system aims at reducing the overhead costs and it performs highly in complex environments where they are a lot of equipment and goods hence tangled processes cannot be easily be sorted out. The following are the activity based costing flows:

  • The identification of costs and it is a crucial step because it allocates the amount needed for the entire project thus it minimizes on time.
  • It creates the secondary cost pool, and at the same, it provides alternative services to the company instead of directly supporting products and services for a company.
  • It creates original cost pools especially for those costs which are aligned with the manufacture of commodities or rendering of services.
  • The measurement of activity drivers by using data collection methodology that gathers details thus assigning the charge in secondary cost pools to primary tariff pools.
  • Allocating charge costs to charge objects with the aid of activity drivers for each pool.
  • Formulation of reports through conversion of an outcome obtained by ABC system into reports management consumption.
  • Finally, the managers have to act on the information as outlined by an ABC report and as a result, they can reduce the level of activity drivers applied by each cost object.

At the completion of ABC allocation for overhead costs to the cost object that require to be charged with overhead expenses. As results, stewards will able to determine the activity drivers that are appropriate to be reduced thus decreasing the amount of overhead cost.

The activity based costing is used in projects due to its advantage and is said to be more precisely in determining the overhead that is used. Therefore, the ABC usually tracks the cost of operations to determine the value of a company which goes in hand with its standards. It raises customer profitability through simply product costs with an additional of overhead components. It retains distribution cost by making appropriate channels using overhead hence unprofitable ones can be eliminated. The ABC also gives a detailed view for each cost utilized in the manufacturing of commodities to know which product can easily be removed if the item is outsourced. Finally, it facilitates in production cost because it is usually easy to separate overhead costs to a significant level plant and comparison can be determined by the expenses of production. To accomplish these uses, your ABC system has to be designed in a way that it can determine cost benefit analysis for the decisions that are required to help, and if the cost obtained in the system is worthy beneficial of the resulting information.

The activity based costing is also faced with challenges because at times this project many fail or the time set for completion of the task may elapse. These may be facilitated by high use of cost pool volume because of the more the cost poor, the higher the cost of mitigating the system. Therefore, to cut off the costs run on continuing analysis of the cost to retain each cost pool in connection with the benefit of resulting information. The ABC systems are hard to install; thus it can take a lot of time for complete installation to be complete. Therefore, it is challenging to maintain the level of management and cost for support as time goes by without a proper installation. The ABC information is required to be obtained in different data set hence it was difficult to sustain additional database because it may still need more time which was not budgeted. The overall resolution is constructing an extremely targeted ABC technique which gives vital information at a reasonable cost. This will ensure the company has expanded hence bringing along with huge benefits. The installation of a substantial and comprehensive ABC approach should be avoided because they are expensive, it may fail, and you are likely to meet with highly resistance system.

Relationship between ABC with cost and managerial accounting

The advantage of ABC is most noticeable when the cost accounting details are challenging to discern because of several presences of product channels, equipment being use process a lot of goods, and many machines setup. Therefore, to gain such benefits the system has to operate in complex production environments but if the system fails to function in such circumstances, it ends up using a lot of resources for installation. The ABC directs the firm resources costs through operations to the goods and services rendered to customers. Managerial accounting uses ABC tool to understand products and customer cost and earnings based on the production or successful processes. It is also used to enhance strategic decisions such as pricing, measurements of process improvement projects, outsourcing, and identification.

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