Activity-Based Costing

Activity-Based Costing (ABC) has the potential to enhance strategic management by reducing cost distortions. Occasionally, product costs are used solely to establish prices. In other cases, however, open competitive markets effectively establish prices. In the latter more common context, the strategic use of product costs is twofold: first, to determine if the organization is able to compete effectively in the market, and second, to identify opportunities for target costing. Uncertainty or error in understanding the cost of providing a product to the customer may negatively affect profitability, organizations may miss market entrance and exit opportunities or miss opportunities for cost improvements. Hence, accurate understanding of product costs within a complex multi-production organization can provide a valuable competitive edge in a market of shrinking profit margins.Increasing the accuracy of cost data via ABC also allows an organization to implement its market strategy more effectively. Another strategic use of the ABC model is its ability to trace activity costs to a number of different cost objects. This allows a company to determine the value to the organization of various cost objects. For example, it is not difficult to trace revenues generated by a geographic region, customer, or product group. By accurately tracing activities (and attendant costs) associated with cost objects, profits generated by various cost objects can be determined. More importantly, with this information, management develops insight into various cost objects, such as employees, customers, regions, or product groups, leading to better management of activity costs.