Question

Discuss the basic components of a simple cost system. Define an ABC cost system. What are the advantages of an ABC system versus a simple cost system? Are there disadvantages to an ABC system?

Answer 1

Basic components of a simple cost system are as follows:

1) Direct material

2) Direct labor

3) Overhead (Variable and Fixed)

Activity Based Costing (ABC):

Activity Based Costing (ABC) is method of costing which identifies all the activities that are performed by an organization and then costs are assigned indirectly to the products which are manufactures by the concern.It determines the relationship between the products, activities and the cost and then it assigns the indirect cost so the appropriate cost is given to the products.

Advantages of an ABC system:

1) It makes the cost data more reliable and provides accurate costs to the products by the classification of the costs into the various processes and products to which it applies.

2) . It a very popularly applied method and helps the management to focus and make strategies as per the nearly true costs of the products.

3) It helps the company to identify and eliminate the products which are not earning profits for the company.

4) It helps to reduce prices of the products which are currently overpriced and also helps to identify and eliminate the production processes which are inefficient.

Disadvantages to an ABC system:

1) There is no use of activity based costing if overheads are relatively small.

2) Activity based costing cannot be applied if only single product or few products are produced.

3) Activity based costing is not useful to small companies.