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Where Activity-based costing should be applicable?

Managers in many manufacturing companies are concerned about the product costing information being provided by the traditional cost accounting systems. The general consensus is that product costs currently being developed are useful in preparing financial statements, but are often of limited use for management decision making. Activity-based costing, on the other hand, is useful in companies having the following characteristics:

1.the production or performance of a wide variety of products or services;

2.high overhead costs that are not proportional to the unit volume of individual products;

3.significant automation that has made it increasingly more difficult to assign overhead to products using the traditional direct labor or machine-hour bases;

4.profit margins that are difficult to explain; and

5.hard-to-make products that show big profits and easy-to-make products that show losses.

Companies having the above characteristics may want to reevaluate their cost systems and implement activity-based costing.
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