Question

Discuss how traditional methods of allocating overhead to products may not provide a good measure of overhead resources used. How might activity based costing overcome these limitations?

Answer 1

Conventional CVP analysis assumes volume based measures. An alternative approach is activity based costing. In an activity based costing system, costs are segregated into unit and non-unit based categories. Activity based costing acknowledges that some costs vary with units produced and some costs do not. However, while activity based costing admits that non-unit costs are fixed with respect to production volume changes, it also argues that many non-unit-based costs vary with respect to other cost drivers. In contrast, volume based approach combines the cost of these activities and treat them as fixed costs since they do not vary with output volume. Activity based costing provides a more accurate determination of costs because it seperately identifies and traces non-unit based costs to products rather than combining them in a pool of fixed costs as volume based approach does.

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