Cost Accounting

What is ABC analysis? Benefits and Drawbacks of ABC Analysis

ABC Analysis

ABC analysis is a method for classifying materials based on the quantity consumed and their relative values.

Some materials may be consumed in smaller quantities, but for an extended length of time. These resources are stored in group “A.” Similarly, certain materials may be consumed in big amounts but have reduced worth. These materials are stored in category C. In between these two extremes, certain items may be consumed in moderate quantities at moderate prices.

Under ABC analysis, these materials are stored in group ‘B’ Strict control is exercised over the materials in group ‘A’, but very little control is exercised over the materials in group ‘C’.

The benefits of ABC analysis are that it can help managers make better decisions about inventory and allocate resources more efficiently. It can also help identify areas where cost savings can be made.

Benefits of ABC Analysis

The following are some of the advantages of ABC analysis:
a. Investment reduction: under ABC analysis, items from group “A” are purchased in the smallest quantities practicable. With this, efforts are also made to minimise the delivery time. These in turn serve to lower the material investment.
b. Strict control: under ABC analysis, the more valuable materials in group A can be subject to strict supervision.
c. Minimum storage costs: as materials from group ‘A’ are purchased in the smallest quantities possible, the storage costs are minimised as well.
d. Time savings: as a significant effort is made to manage the material from group ‘A,’ it also helps to save time.
e. Economy: This process is inexpensive since not all sorts of materials require equal amounts of time and labour.

Limitations of ABC Analysis

The drawbacks of ABC analysis are that it can be time-consuming and expensive to implement, and it may not be suitable for all businesses. It can also create a sense of competition among employees, which can lead to conflict. Other limitations are discussed below:

• An ABC analysis will be ineffective if the materials are not appropriately divided into groups.
• It is not ideal for organisations where material costs do not fluctuate dramatically.
• There is no scientific basis for the classification of substances according to ABC analysis.
• Classifying the resources into distinct groupings may incur additional expenses. Consequently, it may not be appropriate for a small organisation.

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