Generally, Activity Based Costing is necessary to every manufacturing concern. If the existing traditional cost accounting system provide the accurate cost information to know the product cost, there is no need of Activity Based Costing.
However, the following symptoms are the indicators for a need of Activity Based Costing in manufacturing concerns.
1. Profitability: Products are not premium priced but the products are produced with very difficulty. Under this circumstances, more expenses are incurred and there is a less profitability. Therefore, the products are to be premium priced to be profitable.
2. Cost Accounting: Profit margins cannot be easily explained. If the traditional cost accounting system suggests any one of the product is profitable, it may be necessary to analyze the costs using Activity Based Costing.
3. Cost of product: Some products are profitable which are not marketed by competitors. In other words, some products have monopoly market. If so, the competitors are showing interest to product such products and sell the same at lower price. Hence, there is a need of Activity Based Costing for analyzing the costs.
4. Examining of Costing System: Sometimes, some products are sold by the competitors at lower price. Now, the company can think of the costs incurred to produce such products. It calls for examining of the costing system.
5. Cost of Manufacturing: Some accessories of the main product are available at lower prices from the open market. In this case, it is better to buy such products from the open market instead of manufacturing the same internally. Moreover, the expenses incurred to manufacture such products should be examined through their costing system.
6. Allocation of overhead: Cost pools are to large and contain machines which have very difficult overhead structures. Hence, simplified procedures should be followed for allocating the overheads.
7. Cost of Marketing: The cost of marketing and delivering the products are high under the growing competitive market world. Traditional cost accounting system ignores these expenses. This is not good practice. Hence, Activity Based Costing is required.
In the present competitive business world, it becomes difficult to survive in the industry by any business unit unless the overhead costs are correctly accounted for, controlled and reduced so as to sustain, remain and grow in the industry.
There is no possibility of reducing direct cost i.e. cost of direct material, direct labour and direct expenses. If so, sub standard or interior quality materials can be used. This type of practice decreases the image of the company thereby leads to decrease in sales in the years to come. In other words, overheads can be controlled instead of controlling the direct cost.
The control of overheads is possible if one has the information of cost centres with respect to function or activity. Therefore, it becomes necessary to have a costing system based on activity done. Thus, Activity Based Costing has a wide scope in the context of cost reduction and cost control.