Question

Analyze the major benefits and major weaknesses of traditional Activity-Based Costing (ABC) in determining accurate overhead costs over an ABC system.Provide a rationale for your response. Suggest the manner in which a business can achieve a competitive advantage in the marketplace through the use of ABC. Provide two (2) reasons to convince senior management that they should implement an ABC system.

Answer 1

Advantages of Activity-Based Costing

• Provides realistic costs of manufacturing for specific products
• Allocates manufacturing overhead more accurately to products and processes that use the activity
• Identifies inefficient processes and target for improvements
• Determines product profit margins more precisely
• Discovers which processes have unnecessary and wasted costs
• Offers better understanding and justification of costs in manufacturing overhead

  Disadvantages of Activity-Based Costing

• Collection and preparation of data is time-consuming
• Costs more to accumulate and analyze information
• Source data isn't always readily available from normal accounting reports
• Reports from ABC don't always conform to generally accepted accounting principles and can't be used for external reporting
• Data produced by ABC may conflict with managerial performance standards previously established from traditional costing methods
• May not be as useful for companies where overhead is small in proportion to total operating costs    ABC produces more accurate costing of products by essentially converting broad indirect costs into direct costs of production. It determines the costs of the various sources of indirect costs and allocates these expenses to the specific activities that use them.