The benefits of activity-based costing in helping businesses understand costs and reducing expenditures is varied, because this costing method takes many costing factors into account. Unlike other costing methods, which normally cannot estimate production costs, activity-based costing offers more accurate estimates. Businesses typically have to compare an item's price and selling record to see if it is worth producing, and one of the benefits of activity-based costing is better analysis of both good and bad products. Overhead costs can be a major problem with some products, but this system better shows those costs and helps reduce overhead. Managers often can work better under this costing system, because they have more accurate information.
When traditional costing methods are used, they have ways of estimating product creation, but the metrics used are rarely accurate. This is because these methods typically only estimate the entire production cost and only take labor and other broad metrics into account. One of the benefits of activity-based costing is a more accurate product-creation cost. With this costing method, analysts can figure out the per-product cost and, thus, more realistic metrics are used for estimation.
After a product is created, it is sold, but businesses rarely continuously sell a product without it being profitable. To ensure they are not losing money, businesses analyze the product to see if they are making a profit. Another one of the benefits of activity-based costing is better analysis of a product to see if it is worth the expenditure to keep producing. This is because the activity-based costing method better analyzes the product’s price and uses more factors when determining profitability.
Before a product is created, businesses typically will analyze overhead costs to know if there is enough available money to make the product. As with the per-product price, activity-based costing is able to produce many factors that directly affect cost, such as production costs, labor hours and part requirements. The product is not being made yet, so businesses can analyze these factors and find ways to decrease them to limit the product’s overall price when production does starts.
With traditional costing methods, selling and production managers both work with inaccurate information, because these costing methods rarely accurately estimate the product’s price. This means managers may make devastating decisions, wrongly thinking they are not hurting the business. One of the benefits of activity-based costing is that managers usually receive better information, leading to better decisions.
