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The first reason why senior management should be convinced enough to implement an ABC system, is to look at the comparison of traditional costing system vs. Activity-Based Costing.
Traditional costing systems simply apply indirect costs to products based on a predetermined overhead rate. Unlike ABC, traditional costing systems treat overhead costs as a single pool of indirect costs. Also, traditional costing is ideal when indirect costs are low compared to direct costs. The traditional costing systems tends to be simpler and easier to implement than ABC systems. However, it is not as accurate as ABC systems, and can also result in significant under-costing and over-costing. Activity based costing systems, on the other hand, are more accurate than traditional costing systems. This is true because it provides a more precise breakdown of indirect costs. Even though, the ABC systems are more complex and more costly to implement, it increases understanding of overheads and cost drivers, and makes costly and non-value adding activities more visible, allowing managers to reduce or eliminate them.
The second reason why senior management should be convinced to implement an ABC system, is to seek ways to add value to their products and services. With the implementation of value chain analysis, it exists to create value to their products and customers. A company can be more effective once it evaluates their internal capabilities by identifying and examining each activity. Each activity should be focused on adding value; which is very critical to customer satisfaction and market success, and will be considered a potential source of competitive advantage.
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