Question

When activity based costing is implemented, the initial outcome is normally that:

A. The cost of all products will be higher.

B. The cost of all products will be lower

C. The cost of low volume products will be higher and the cost of high volume products will be lower

D. The cost of low volume products will be lower and the cost of high volume products will be higher.

Answer 1

Ans:)

C.) The cost of low volume products will be higher and the cost of high volume products will be lower.

Activity Based Costing (ABC) is a costing accounting methodology that identifies and allocates the total overhead costs of an organization based upon such different activities performed by the organization in the manufacturing of its products that cannot be directly associated with the direct production activity but their relationship with specific overhead costs can be established, these activities include machine setup, product design, sales calls by marketing team etc. which are called activity drivers.

Under the traditional costing methodology overhead costs are always bifurcated and allocated between two or more products based upon their production quantity which leads to higher costs being allocated to the products with the greater production volume, while in activity costing the overheads are allocated based upon the various activities performed in relation to the production.

Hence in case of implementation of Activity Based Costing (ABC) in place of traditional costing, the overhead costs allocated to low volume products will become higher as compared to the costs allocated to these products earlier under traditional costing, while the costs allocated to high volume products will become lower as the support activities being performed for the low volume product might be equal to or more than the same activities being performed for high volume products.