Activity-Based Costing: Advantages and Disadvantages - Essay Example

Accounting Marginal costing, also known as contribution, variable and direct costing, refers to the method ofcost accounting whereby marginal costs are the ones charged to cost units and the fixed costs are the ones treated as a lump sum. Refers to the method where only variable costs are used in making decisions. On the other hand, absorption costing refers to the method of coming up with a full product cost that sums up direct costs and a proportion of the production overhead costs through overhead absorption costs. There are various advantages and disadvantages of implementing the marginal costing method over the absorption costing method (Goektuerk, 2005). First, there are numerous advantages of using marginal costing over absorption costing. It is easier to carry out the control and determination of production costs. This is through the management avoiding the arbitrary allocation of the fixed overhead costs thus having an achievement and maintenance of a uniform and marginal cost that is consistent (BANERJEE, 2006). Second, marginal costing helps in planning for short-term profit. This is through the easy demonstrations using the break-even charts and profit graphs. Unlike the absorption costing, comparative profitability can easily be assessed and hence be brought to the notice of the management so that there is decision making (Avis, 2009). Third, with the implementation of marginal costing, there is ready appreciation and assessment of the effects of the production policies and alternative sales. This ensures that there will be maximum yield to the business due to the decisions arrived. This gives it a notch higher than in using absorption costing (V., 2010). The method eliminates any large balances that are left in the overhead control accounts. This thus indicates that there is a difficulty in ascertaining the accurate recovery rate of overheads. With the elimination, it becomes easier to determine the accurate overhead rate of recovery (Drury, 2007). On the other hand, there are the disadvantages of using marginal costing over the absorption costing technique. First, there is difficulty in separating costs into the fixed and variable costs. This is because, in the long run, all costs are variable. Such classification may sometimes lead to misleading results to the cyber firm (Hill, 2012). Second, under the marginal costing, stocks and the work in progress are usually understated. The exclusion of fixed costs, especially from the inventory, affects the profit. With this, the true and fair view of the financial affairs of the cyber firm may not thus be transparent. It might hence bring a dispute between the shareholders and the management whereby shareholders might think the management has tempered with the financial affairs (Debarshi, 2011). The third disadvantage is that volume variance in standard costing discloses the effect of the output that fluctuates on the fixed overhead. Marginal cost data thus becomes unrealistic especially in the cases of the levels of production that fluctuate so highly. With this, the unrealistic marginal cost data may mislead the management hence making it make decisions are not worth to the firm. This may thus lead the firm to running into a loss during the financial year (Drury, 2007). As earlier stated, absorption costing refers to the process of tracing the fixed and variable costs of production to the product. Besides, Activity Based Costing (ABC) is a methodology that assists companies identify activities and assign the cost for each activity and also estimating costs. There are thus advantages and disadvantages of using absorption costing and ABC (V., 2010). There are thus numerous advantages for the methods. First, absorption costing recognizes the fixed costs that are in the product costs. This is due to the pricing that are based on the absorption costing technique ensures that all the costs have been covered (Avis, 2009). Second, the absorption costing method shows less or no fluctuation in net profits especially in cases of constant production but changing sales. This contrasts with the marginal costing (Lal, 2009). Third, ABC method allows the firm to have the very accurate costing of the products or services. The method majorly focuses on costing of the products or services thus being done accurately because the entire process is being monitored. This allows the company to know the best both for the manufacturer and the consumer (BANERJEE, 2006). Fourth, ABC is easily understood, and it is a method that does not require a very deep way of understanding it. It has never been hard to understand because it is focusing on how the process is taking place (Hill, 2012). Finally, ABC is the best method especially during the integration of improvement programs that are continuous in the company (Debarshi, 2011). On the contrary, there are also the disadvantages or limitations of the successful implementation of these methods. First, it is unsound to carry over a portion of fixed costs to the subsequent accounting period in absorption costing. It is because it is not allowed for the costs for a certain period to be vitiated by the inclusion of costs from the previous period (Goektuerk, 2005). Second, absorption costing depends on the levels of the output that may vary from period to another. This leads to cost per unit to change because of the presence of the fixed overhead. Lest such fixed overhead rate bases on normal capacity, such like distorted costs are usually not important for the purpose of control and comparison (Drury, 2007). Third, in ABC, substantial resources are required. This is because the actualization of this project is usually seen significant. The aspect of heavy costs is because of there being various measures that should be implemented so that the business gets the best out of the use of the system or method. (Hill, 2012). Finally, the data gathered by the ABC method could be misinterpreted. Such a problem would be prevented only if the input of the data and figures is being done in a more precise manner with utmost care. The data is the one that usually serves as the decision basis when the managers are coming up with decisions regarding the firm (Debarshi, 2011). In conclusion, companies pick the best method that has more advantages than disadvantages and which cannot run the firm into trouble. With this, the managers can hence come up with more excellent and competitive decisions. References Avis, J. (2009). Performance Management: Managerial Level, Paper. 4th ed. Tampa, FL: Elsevier. BANERJEE, B. (2006). COST ACCOUNTING: THEORY AND PRACTICE. 1sted. New Delhi: PHI Learning Pvt. Ltd. Debarshi, B. (2011). Management Accounting.3rd ed. Noida, Uttar Pradesh: Pearson Education India. Drury, C. (2007). Management and Cost Accounting.12th ed. Boston,MA: Cengage Learning EMEA. Goektuerk, H. (2005). Activity-Based Costing (ABC) - advantages and disadvantages: How ABC can be applied to institutions of higher education. 1st ed. Munich: GRIN Verlag. Hill, A. V. (2012). The Encyclopedia of Operations Management: A Field Manual and Glossary of Operations Management Terms and Concepts.1sted. Upper Saddle River, New Jersey: FT Press. Lal, J. (2009). Cost Accounting 4E.3rded. New York: Tata McGraw-Hill Education. V., R. (2010).Cost Accounting.2nded.Noida, Uttar Pradesh : Pearson Education India. Read More