If you are a manager or a manager in the making then you are most probably going to make certain important decisions regarding pricing, product mixes and process technologies. These decisions will be based on the cost information.
In most companies that deal with multiple products, this cost information tends to get distorted as the costs cannot be linked directly to the individual product. Thus, managers today, often, tend to have distorted cost information when making decisions. Decisions made using distorted cost information may be disastrous and only be recognised once the point of no return has been reached. Hence, it is important for you as a manager to measure your costs right.
In the current day scenario, direct labor costs are a small part of the overall costs. A large part of the overall costs now includes other support operations, engineering, marketing, distribution, and other functions involving overhead costs. It is thus important to allocate resources correctly. Moreover, in order to allocate these costs reducing direct labor costs may not always be the right move.
In the current digital scenario with rapidly reducing costs of digital technology, accurate allocation of costs and correct cost based information are extremely crucial to the competitive success of a company.
One of the better ways to generate accurate costs in the current day scenario is to use activity-based costing. The different activities can be grouped under the heads of – logistics, productions, sales and marketing, distribution, service, technology, general administration, finance and information resources.
For an effective cost generation system, it is important to consider the complexity of fluctuations in cost in the short term as well as the fluctuations over the years due to changes made to the technology, product mix or design.
Activity based cost accounting may show exactly where a product stands and whether or not it is making a profit. This is especially true for companies that have multiple products. It is easy now to divide and allocate costs to individual products for individual activities. Even when a small number of products from a particular group generate the larger amount of revenue, it may be found through activity based accounting whether they are actually generating a profit or a loss. This can help managers in making some very important decisions.
Most companies and CEOs tend to stick to existing product cost systems and engaging in a complete system overhaul may be difficult. However, with the help of digital technology it is possible to create cost systems separate from the official cost accounting, specifically for the purpose of strategic decision making.