How can you use activity-based costing to streamline job order costing?

1 What is activity-based costing?

Activity-based costing is a way of allocating overhead costs to products or services based on the activities that cause them. Overhead costs are the indirect expenses that are not directly related to the output, such as rent, utilities, depreciation, and administrative costs. In traditional costing methods, overhead costs are usually allocated based on a single cost driver, such as direct labor hours or machine hours. However, this can lead to inaccurate and distorted cost information, especially when different products or services use different amounts of resources and activities. ABC recognizes that different activities have different cost drivers, and assigns costs to each activity based on the resources they consume. Then, the costs of each activity are allocated to the products or services that use them, resulting in a more accurate and fair cost allocation.

4 What are the challenges of activity-based costing?

Activity-based costing can present challenges that you need to be aware of before deciding to adopt it. It requires more data and analysis, involving more activities, cost drivers, and calculations, which can increase workload and complexity. Additionally, implementation and maintenance costs may be higher due to the need for more resources, software, and expertise. Furthermore, resistance and skepticism may arise as a result of changes to the way costs are allocated and reported; this can affect performance evaluation and incentive systems, and it may be met with opposition from those who prefer the status quo or have different interests. Lastly, activity-based costing needs constant review and revision in order to reflect any changes in the production process due to technological, market, or customer factors that could affect activity costs and drivers.

5 How to overcome the challenges of activity-based costing?

To overcome the challenges of activity-based costing, you need to take some actions, such as simplifying your ABC system by focusing on the most significant and relevant activities and cost drivers, and using estimates or averages when precise data is not available or necessary. You should also justify your ABC investment by demonstrating its benefits and value to stakeholders, as well as how it can improve your competitive advantage and bottom line. It is important to communicate and educate by explaining the purpose and process of ABC to managers and employees, providing them with training and support to use and understand the ABC information. Additionally, you should update and adapt by monitoring and evaluating your ABC system regularly, making adjustments and improvements when needed to reflect changes in the production process and environment.