Profitability and Cost Management Shared Interest Group

How does Activity Based Costing contribute to Profitability?

Activity Based Costing (ABC) can significantly enhance profitability by providing a more accurate and detailed understanding of costs associated with respective products or services.

Some ways ABC contributes to profitability are as follows:

1. Accurate cost allocation- ABC allocates overhead cost based on actual activities that drives cost. This helps businesses understand the true cost of each product or service leading to better pricing decisions.
2. Improved Decision-Making- From detailed cost information managers can make better decisions. For example, determination of which products are most profitable and focus on resources or decide which product to discontinue.
3. Identify inefficiencies- Breaking down cost into specific activities, ABC highlights high and low value-added activities. For example, helping businesses to identify unnecessary expenses.
4. Enhanced Cost Management- ABC provide insights into how resources are consumed, enabling better management of overhead and direct costs. This leads to better budgeting and cost control.
5. Competitive Advantage- Understanding true cost structure, businesses can price their products more competitively while maintaining profitability.

In summary, ABC helps businesses see a clear picture of its cost structure leading to more strategic financial decisions and improving profitability.

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Karen Gayle EA
Accountant
Bronx NY
United States
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This is a good summary of what ABC methodology can do for companies.  One characteristic of ABC is its capability to deliver information in a more 'human language' by transforming the GL information into process and activities. This helps to identifty where the company needs to focus, especially in operating departments.  

Have you had experience with other cost methodologies?

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Abner Huertas
Business Consultant
Guatemala
contacto@...
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Abner, you asked an interesting question. I have used cost estimation for a project. In cost estimation project managers predict the amount they need to fund the project. The process entails direct and indirect cost of the project. The cost included utilities, materials, equipment, vendors and employee compensation.

In estimating the costs project managers considered other elements such as:

• Project duration.
• Size- the project was to remodel a health center.
• The cost of each step in the project.

Cost estimation is important to help achieve the following:

• Budget management.
• Improving profit margins.
• Preventing overspending.  

Overall, it was interesting to compare prices of the resources necessary to build cost-effective plan. The complexity of the cost estimation is reporting budget variances. My former job used the Analogous estimating method. The analogous estimating method combines historical data and expert judgment to anticipate the costs of the project.

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Karen Gayle EA
Accountant
Bronx NY
United States
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Original Message:
Sent: 02-09-2025 10:49 AM
From: Abner Huertas
Subject: Activity Based Costing and Profitability

This is a good summary of what ABC methodology can do for companies.  One characteristic of ABC is its capability to deliver information in a more 'human language' by transforming the GL information into process and activities. This helps to identifty where the company needs to focus, especially in operating departments.  

Have you had experience with other cost methodologies?

------------------------------
Abner Huertas
Business Consultant
Guatemala
<maskemail>contacto@...</maskemail>
------------------------------

I am extremely supportive of all efforts to improve financial internal decision support information and ensure it reflects the causal relationships of resources and processes.   ABC does this, BUT it does have limitations that practitioners must be aware of:

1. Most ABC models don't effectively track fixed costs.  They tend to be "allocated" with drivers.  Particularly when making decisions to drop products or services, this means most of the fixed costs will be redistributed and make other products or services look less profitable.
2. Cost assignments should only be done based on pretty strong causality.   The more you pool costs, the less accurate your drivers and "allocations" become.
3. The ABC surveys and model must be updated as processes and resources change.  This requires a tight connection to operations and personnel information.
4. ABC Cost pools tend to average costs.  You need to make sure this isn't hiding significant information about personnel or other resources.

I don't want to be negative, but before you launch into a solution methodology, it is important to know its benefits and risks.  I encourage you to look at the attached paper.   It is perhaps overly critical.   An ABC model can lead to improvements in cost and profitability, but it is important everyone understand the core principles associated with creating financial internal decision support models.

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Larry White CMA,CFM,CSCA
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I want to apologize for my last post; it may have focused in a little too critically on ABC. 

 The focus should have been on understanding the principles associated with solid, causal modeling for financial internal decision support.   IMA has a great body of SMA's on this topic for those interested in becoming more familiar with those principles:  (These are all available on the IMA website.)

Conceptual Framework for Managerial Costing | IMA

Developing an Effective Managerial Costing Model | IMA

The Profitability Analytics Framework | IMA

Costing System Attributes that Support Good Decision Making | IMA

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Larry White CMA,CFM,CSCA
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Original Message:
Sent: 02-11-2025 09:29 AM
From: Larry White
Subject: Activity Based Costing and Profitability

I am extremely supportive of all efforts to improve financial internal decision support information and ensure it reflects the causal relationships of resources and processes.   ABC does this, BUT it does have limitations that practitioners must be aware of:

1. Most ABC models don't effectively track fixed costs.  They tend to be "allocated" with drivers.  Particularly when making decisions to drop products or services, this means most of the fixed costs will be redistributed and make other products or services look less profitable.
2. Cost assignments should only be done based on pretty strong causality.   The more you pool costs, the less accurate your drivers and "allocations" become.
3. The ABC surveys and model must be updated as processes and resources change.  This requires a tight connection to operations and personnel information.
4. ABC Cost pools tend to average costs.  You need to make sure this isn't hiding significant information about personnel or other resources.

I don't want to be negative, but before you launch into a solution methodology, it is important to know its benefits and risks.  I encourage you to look at the attached paper.   It is perhaps overly critical.   An ABC model can lead to improvements in cost and profitability, but it is important everyone understand the core principles associated with creating financial internal decision support models.

------------------------------
Larry White CMA,CFM,CSCA
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