Activity-Based Costing. When is it appropriate?

It would be appropriate for companies to use activity-based costing when products they offer or manufacture are: labor intensive, costly to produce, current strategy for cost effective manufacturing is imprecise, and/or convoluted due to variety and quantity.

How Activity-Based Costing can be used.

My partners and I have used “activity-based costing (ABC)” in our previous years of business and continue to do so. Although at the time we had no particular name to the methods we incorporated, I find these methods used to fall under ABC. Our business operated on providing custom signage products for businesses and the government. Initially, prior to our ownership, the previous owner’s possessed complex projects and outsourced most of their business to other businesses for labor services, supplies, and equipment to manufacture their product; also, they merely provided minor installation and minor manufacturing. Throughout our experiences, we learned that outsourcing increased our direct and overhead costs; our diversity of custom made signage brought upon major difficulties in setting definite costs on contracts with outsourcers, and our direct and overhead costs compared to the amount of profits was far too high. Considering these factors, we launched a strategy to lease and purchase equipment, to purchase supplies, and began manufacturing the products we provided ourselves to eliminate outsourcing. As a result, we decreased overhead costs, are able to produce a greater amount of custom-made products with fewer complexities, and decreased our independence on outsourced resources, thus decreasing our direct and overhead costs, which provided greater profits.

Differences between ABC and traditional costing.

ABC concentrates and disperses overhead costs on indirect expenses, such as the cost for equipment and supplies of the cost objects; whereas, Traditional costing disperses overhead costs to the cost objects, such as workforce costs and equipment usage.