Once you step into the vast world of accounting, you should know of the ABC systems, also known as the Activity-Based Costing systems. This system is considered the backbone of the accountant because it helps you and your company make decisions based on the production process. But what are the main costs and limitations of implementing ABC systems? Let’s dive in!
First, What Is The ABC Systems?
To tackle the loaded question “what are the main costs and limitations of implementing ABC systems?”, we must first understand what it is.
The ABC Systems, or as we all know it as the Activity-Based Costing System, is an accounting method that’s used to calculate the costs of all the activities needed for a product to be out in the market. The system labels each activity made by the design, production, delivery, etc., phases with a price tag, and the result is an approximate cost report to consider.
The ABC Systems are preferred for a number of reasons. Some methods may not include the overhead costs of production, and not all overhead costs are equal among each type of product. These systems offer a way to include all of these outliers into one table, proving to be convenient and useful.
To use the ABC Systems, you must follow these steps:
- List out the necessary activities.
- Group the activities into their own cost pools and determine the overhead costs of each pool
- Assign cost drivers (elements that control cost variables) to each cost pools
- Dividing each cost pool’s total overhead by their respective total number of cost drivers, we can calculate the cost driver rate
- And lastly, punch in the amount of hours, units, parts, etc., that the activities consume and multiply it by the cost driver rate.
These steps can be quite tricky. But the result that comes out of the process is worthwhile.
If this article so far has convinced you to apply this system to ease your accounting work, not so fast!
What Are The Main Costs And Limitations Of Implementing ABC Systems?
1. Costly and Complicated:
Well, what are the main costs and limitations of implementing ABC systems?
Let’s do a little experiment. Take a piece of paper and start writing down all the steps and activities your company will have to take to send a product into the market. Not as easy as you initially thought, right?
Now take that list and ask someone from another department to take a look at it. You’ll receive a list of activities that easily doubles what you just wrote. That’s the process you have to go through (multiple times, even!) at the first step of the process. If that’s the first step, imagine how difficult it is to execute the next steps with all those factors!
And that’s not all the complexity of this method. Once you’ve successfully collected all the variables, you have to find a way to measure and give an estimate calculation for them, too.
To attain all data necessary for your calculations, you’ll have to call for an external source, whether you like it or not or how expensive it can be. There’s no easy way to go about it.
2. Drivers Selections:
That should be all, shouldn’t it? You’ll have to continue to ask yourself, “what are the main costs and limitations of implementing ABC systems?” because we’re just getting started.
“Costs drivers” is a term that you might hear here and there, but you won’t really be encountering it until you decide to use the ABC Systems. It’s quite a niche type of data, so it’s definitely not easy to determine.
And because cost drivers are hard to put a pin on, cost driver rates can also fluctuate drastically once you get to calculate them. If one cost driver changes, the cost pool’s rate changes, and of course, the overhead rate changes as well. That’s a lot of redos!
3. Unsuitable for Smaller Firms:
The ABC systems are useful to different degrees to different companies.
Big manufacturing firms can utilize it way better than smaller ones for a lot of reasons. They have better management in each level, so employees report every activity no matter how small, which helps the accounting department. They benefit from the ABC systems better since they depend on cost-plus pricing rather than market-based pricing.
The involvement of technology and the environment also changes how effective the ABC systems can be.
So, what are the main costs and limitations of implementing ABC systems? That depends on the extent of your production firm as well!
Like every accounting method, the ABC systems can have some downsides. Therefore, it’s important to know when to properly implement it into your pricing process.
So, to sum it up, what are the main costs and limitations of implementing ABC systems? Its complexity, difficulties in determining cost drivers, and thus, its unsuitability to smaller establishments.