Cost Reduction Through Activity-Base Costing

Cost Reduction through Activity-Base Costing

Cost Reduction through Activity-Base Costing

How does a company become or continue to profitable during a recession? This is a question that many managers, investors, and business owners have been pondering the last few years. It is a difficult question to answer; however, managers must provide a cost efficient plan to owners and investors. In tough economic times, managers are looking for ways to reduce cost in order to increase profits. Though there are many costing systems available, activity-based costing can help many companies narrow in on the cost associated with the product or service they provide. With a specific implementation process, accountants and managers are able to create an activity-based costing system that allows the company to become more profitable by providing a system that managers and employees will use to make decisions.

For many companies, switching to activity-based costing (ABC) has help with making profitable decisions about the operation of the company. Essentially, "the goal of ABC is to measure and then price out all the resources used for activities that generate the production of goods and services for customers" (Chea, 2011, p. 5). Once a company identifies the need for ABC, there at seven steps they would use to implement this costing system. The company will name which products are the cost objects then they will trace the direct cost to those specific products. Next, from the activities that the company performs, they will choose the activities that most define segments of their company and define the cost-allocation bases, which would be used to assign indirect cost to products. This step is important because it really dives into understanding the activities that the company performs and how each cost should be associated with that product and activity. These pools should have the same cost driver that is related to that activity. Once the cost-allocation base is complete, the company must figure out the indirect cost that relates to the cost-allocation bases. Indirect cost can be complex because not all cost fit nice and neat into specific categories. For example, it may be difficult to trace specific cost back to administration activities because relationship may not be apparent. Breaking activities and cost down is what helps build a good ABC system. The last three step deal with computing the actual "rate per unit of each cost-allocation base," "indirect cost allocated to the products", and "the total cost of the products by adding all direct and indirect costs assigned to the products" (Horngren, Datar, Rajan, 2012, p. 152-153). These calculations will assign cost to the activities being performed and the products being produced. This implementation is a extensive process that takes dedication and thorough understanding of