Question

1. Activity-Based Costing Define activity-based costing (ABC) systems. What benefits does implementing an ABC system bring to the company? Explain at least two benefits. What are the disadvantages to implementing an ABC system? List and explain at least two. Would the proposed changes make ABC a universally applicable costing method in your opinion? Why or why not? Elaborate your response.

Answer 1

An activity-based costing system is defined as two-stage process of assigning costs to products. In the first stage, activity-cost pools are established and in the second a cost driver is identified for each activity-cost pool. Afterwards the costs in each pool are assigned to each product line according to the proportion to the cost driver amount consumed by the product line.

Activity based costing (ABC) was developed to overcome the shortcomings of the traditional method. Instead of just one cost driver such as machine hours, Activity based costing will use multiple cost drivers to allocate a manufacturer's indirect costs. A few of the cost drivers that is used by ABC include the cost of material purchased or used, the number of machine setups involved, counting the number of engineering change orders, and the number of machine hours

Advantages of ABC Costing:

--Helps in cutting costs by providing reliable information on the opportunities available for reducing costs. It assists managers to adopt productivity improvement approaches such as TQM, BPR etc and discovers the processes which have wasted and unnecessary costs. It identifies processes which are inefficient and target for improvements

--Assists management in making quality decision by knowing the nature of each activity. It helps managers on focusing the forces on value adding activities and eliminating non-value adding activities. Activity-based costing is helpful in providing the management relatively accurate cost information about the product. A proper cost allocation to various products leads to proper pricing policy

Disadvantages of ABC Costing:

-- Data collection and preparation take loads of time. Moreover there is a high cost for accumulating and analyzing the information

-- ABC reports don't always conform to generally accepted accounting principles and thus not to be used for external reporting. The data produced by ABC can conflict with management performance standards previously established from traditional costing methods

In my opinion the ABC can become universally applicable costing method because the time-driven ABC system can result to high reliability. It can assist the firm to be more accurately with its product costs and analysis. It can help to reduce idle time, thereby enhancing productivity and reducing cost