Question

Analyze the advantages and disadvantages of implementing a traditional Activity-Based Costing (ABC).

Provide a rationale for your response, including a discussion of how a company would benefit from analyzing costs using an ABC system.

Suggest the way 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

solution :

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 analyse 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

Activity-based costing (ABC) enhances the costing process in three ways. First, it expands the number of cost pools that can be used to assemble overhead costs. Instead of accumulating all costs in one company-wide pool, it pools costs by activity.

Second, it creates new bases for assigning overhead costs to items such that costs are allocated based on the activities that generate costs instead of on volume measures, such as machine hours or direct labor costs.

Finally, ABC alters the nature of several indirect costs, making costs previously considered indirect—such as depreciation, utilities, or salaries—traceable to certain activities. Alternatively, ABC transfers overhead costs from high-volume products to low-volume products, raising the unit cost of low-volume products.

ABC is used to get a better grasp on costs, allowing companies to form a more appropriate pricing strategy.