Question

Some would argue, utilizing activity-based costing (ABC) can be an advantage for the company, is that true and could you explain?

Answer 1

Activity based costing is a method of allocating the overheads to different departments or units or products on the basis of some of cost drivers which are used by departments. Under activity based costing total overheads expenses are divided into various activities and are allocated on the basis of cost driver which are used into those activities. For example if 5000000 are allocated to production overhead and cost driver for production overhead is number of total production schedules held (total 10 productuion schedule held) now 4 production schedule held are used for product A so production overhead to the product A would be allocated on the basis of number of production schedule held i.e. (5000000/10)*4 =2000000 would be allocated to Product A.

Major advantage of Activity based costing is that overheads are allocated on the basis of units of cost driver used in the production of a product or allocated to a department. Activity based costing is having an advantage over traditional based costing where overheads are allocated on the basis of traditional method like production hours used or no, of units produced. Activity based costing is helpful in allocating the overheads in a rational manner and fixation of correct cost and price for the product.