Accounting Costing Valuation
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Cost accounting systems provide managers with cost information about the products or services that their business sells. Traditional, or simple, cost systems have been used for the allocation of indirect costs and to calculate product pricing. This method is effective when a company offers a limited assortment of products, otherwise traditional cost systems can lead to inaccuracies in costing. Activity-based cost systems provide an alternative that is more precise and representative of variations in the use of resources.
Traditional cost systems use broad averaging or “peanut butter” costing to allocate costs evenly between different products that may use uneven amounts of various resources. This method can result in product undercosting, or sales that actually represent losses, because the product is worth more than its selling price. The opposite of this is product overcosting, whereas the product is overpriced. In more competitive markets, mispricing can result in the revenue losses.
Activity-based cost systems identify activities that contribute to the production of products or services. These activities (ex. Design, Distribution, etc.) are assigned costs on an individual basis, then dispersed among the products or services that a business offers. The costs assigned to each product or service depends on the activities needed to produce it. This helps to prevent products and services from being over or under costed by the activities that contribute to production.
Activity-based costing utilizes relevant cost drivers, unit of measurement, for each activity, whereas traditional costing systems only use units of output or other closely related variables (e.g. labor hours). When all indirect costs are associated with unit-level costs this makes it difficult to discern how products are using different resources. Activity-based costing systems implement a cost hierarchy that classifies costs based on relationships with specific cost drivers. This provides an accurate base for cost allocation, while helping to facilitate communication and decision-making between different departments. This transparency of costs can be expensive to maintain, but more than likely the benefits of an activity-based cost system outweigh the expense of implementation and maintenance.
Activity-based costing has been successful in practice as many well-known companies use some variation of activity-based accounting for cost management. One example is LG Electronics, who used an activity-based cost analysis to reduce costs and reallocate resources for various tasks. Another example is Charles Schwab Investment Services; they used a variation of activity-based costing to pursue an alternative channel for trading in order to reduce processing fees. It would have been difficult for a traditional cost system to yield the same results since both companies offer an array of different