Why do companies adopt activity-based costing?

Companies adopt activity-based costing (ABC) primarily to gain a deeper understanding of the resource demands associated with their products and services. This method allocates costs based on actual activities and usage rather than spreading costs across products or departments uniformly. By accurately tracing expenses to specific activities, organizations can identify the true cost drivers behind their products, leading to more informed pricing, budgeting, and operational decisions.

This level of detail helps companies to identify which products are actually profitable and which may be consuming more resources than they generate in revenue. It supports better strategic decisions regarding product development, discontinuation, or re-engineering.

In contrast, the other approaches do not provide the nuanced insights that ABC offers: reducing the number of cost pools or focusing on output unit-level costs ignores the complexity and varied resource demands of different products. Additionally, using ABC is not about hiding inefficiencies; rather, it aims to uncover them, allowing for improvements in efficiency and cost management.