Question

List and describe five main advantages and five main disadvantages of the activity-based costing system

Answer 1

5 Main Advantages of Activity Based Costing System:

1. Activity based costing system provide more detailed and accurate method of allocating overheads to the various departments as compared to the traditional based costing system.
2. Activity based costing system considers multiple cost drivers and hence provides better insight of various overheads when compared to the traditional based costing system which considers only one single blanket rate to allocate overhead costs.
3. ABC system provides meaningful information as to which process consumes what level of overheads thereby enabling means to reduce various unnecessary costs.
4. When overhead costs are allocated based on ABC system, the products can be priced properly and at competitive rates thereby enabling the organization to increase the level of margin at product level.
5. ABC system enables comparison of costs of various activities and provides management with the requisite information for make or buy decisions.

5 Main Disadvantages of Activity Based Costing System:

• Collection and preparation of data is time consuming.
• It is not useful for small enterprises and for companies producing only a single product.
• It is not a cost effective process, i.e., the costs incurred in ABC analysis is more than the benefits derived from it.
• It involves a complex process which might not be practical in day to day operations of the enterprise.
• ABC analysis is not useful for external reporting, i.e., reporting to the stakeholders.