Question

1. What do you think are some advantages for using the ABC method versus a single plant-wide rate or multiple departmental overhead rates.
2. Why would an activity-based costing (ABC) system appeal to some companies and not all companies.
3. Provide at least 3 examples of companies you think would and wouldn't want to use the ABC method. Please help!

Answer 1

Activity based costing method allocates cost based on activities consumed with activity cost rate. Single plant wide rate or multiple department rates is traditional method calculated based on direct labor hours, direct labor cost or machine hours

ABC Costing system should be used because it has advantages. Below are the listed advantages

· It helps in accurate product costing and taking reliable decisions like continue or discontinue of product lines, bidding, etc

· It helps in decision making like Product level profitability, customer level cost analysis, elimination of non profit making products, etc

· It helps in new product launch and accurate Product pricing and ensure target margin is delivered

· It helps in implementation of cost management strategies through cost control and cost reduction

· It helps in analysing value adding and non value adding activities in an organisation. Elimination of non value adding activities reduces the cost of the firm

· It helps in target setting and performance appraisal of employees based on the same.

Activity Based costing would not appeal to some of the companies because of some of the limitations it has

Limitations of ABC Costing System

· ABC costing method is time consuming since it needs identification of activities and calculating activity cost driver rates

· It needs specialized knowledge to apply the ABC costing method throughout the organisation

· ABC method is not useful if cost is more than benefits involved in implementing it

· There may be change resistance from the employees in implementation of ABC costing

3 examples of companies which would want to use ABC method

· Companies which are frequently doing business through bidding and serving special orders where pricing is important

· Companies which are engaged in multiple products manufacture

· Companies which are engaged in products which are competitive and price sensitive for demand.

3 examples of companies which wouldn't want to use ABC method

· Companies which are engaged in single product manufacture without much activities

· Companies where there is only one cost or two cost driver in overheads incurred

· Companies which do not see benefit in implementation compared to the cost of its study