Activity based costing can be defined as distribution of indirect costs to various cost units on the basis of benefits received by them. Following are the various advantages of using activity based costing –
1. It brings precision and dependability in product cost determination by focusing on cause and effect relationship in the cost incurrence which traditional costing fails to do.
2. It discloses a wide variety of opportunities for cost reduction and hence increases the margin for the company.
3. It helps in fixing the selling price of products because due to it more correct and accurate data for cost is available with managers and hence it performs very important function because those companies which operate in a tough competitive business have to decide the selling price as accurately as possible in order to survive in the industry.
4. It improves the overall reporting, control, effectiveness, efficiency in the company as a whole.
5. It also helps with upcoming product planning e.g. the cost of all activities related with a product can be precisely determined before it is launched which in turn helps the company in determining the price as well whether it is feasible to launch the product or not.
Hence from above one can see that there are many advantages associated with activity based costing however there are certain limitations like it is costly to set up and also it is quite time consuming and hence these factors should be kept in mind before going for activity based costing.