Management accounting uses various methods to analyze costs and profitability. Two of the most popular methods are Activity-Based Costing (ABC) and Center-Based Costing (traditional method). Here is a detailed comparison of these two approaches to better understand their respective advantages and disadvantages.
If you are not yet familiar with the ABC Method, we recommend first reading our article on the ABC Method (Activity Based Costing) to understand its concepts and workings.
If you want to learn how to allocate Direct and Indirect Costs to Cost Centers, we recommend reading this article: Allocate Direct and Indirect Costs to Cost Centers in your organization.
Activity-Based Costing assigns costs to activities based on their consumption of resources. This method identifies specific activities for each product or service and assigns costs accordingly.
The Center-Based Costing method allocates indirect costs using global allocation bases, often based on simple indicators such as direct labor hours or machine hours.
The Activity-Based Costing method offers greater accuracy in cost allocation as it takes into account specific activities and their resource usage. It allows for a better understanding of the true costs of products or services.
The Center-Based Costing method can be less accurate as it uses global allocations that do not always reflect the true resource usage costs. This can lead to underestimation or overestimation of product or service costs.
The Activity-Based Costing method is generally more complex to implement as it requires detailed identification of activities and resources consumed.
Creating a new ABC model takes between 3 to 6 months, depending on the size and complexity of the company. The annual update of this model takes about 1 to 2 months to adjust activities and associated costs.
The Center-Based Costing method is simpler and quicker to implement as it uses global allocation bases and requires less detail on individual activities.
Creating a Center-Based Costing model takes 1 to 2 months. The annual update of this model is also quicker, often completed in 2 to 4 weeks.
The Activity-Based Costing method generates detailed data on activities and costs, facilitating an in-depth analysis of profitability and inefficiencies. It is particularly useful for companies with complex processes or a wide variety of products.
It helps managers make more informed decisions about pricing, production, and process improvement by providing precise data on activity costs.
The Center-Based Costing method provides a more general overview of costs, which may be sufficient for companies with simpler processes or less product diversity.
It is less useful for strategic decision-making as it lacks precision in cost allocation and does not provide as much detail on specific activities.
| Method | Strengths | Weaknesses | Opportunities | Threats |
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| Activity-Based Costing |
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| Center-Based Costing |
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The Activity-Based Costing (ABC) method and the Center-Based Costing method both offer distinct advantages depending on the needs of the company. The Activity-Based Costing, with its increased precision and detailed approach, is ideal for companies with complex processes and a diverse range of products. On the other hand, the Center-Based Costing method, which is simpler and faster to implement, may suffice for companies with simpler cost structures. The choice between these two methods largely depends on the specificities and objectives of the company.
