Question

truths about activity based costing

Answer 1

Truths About Activity Based Costing

Activity Based Costing also known as ABC system is the most efficient way of allocating overheads to different departments. ABC helps allocation of overheads according to actual amount of activity in each department.

Let’s take an example

Say a company has two departments one for tire and other for automobiles.

Overheads are allocated on the basis of labor hour worked instead of ABC.

The company’s overhead includes ordering cost, rent, and Supervisor salary. The companies statements shows that Orders are only given by automobile departments, 90% of space is used by Automobile department and Supervisor spend his 70% time in Automobile department.

The Above example indicated that assigning Overheads on the basis of Labor hour Worked would not be justified and ABC system is best for allocation of overheads.

Unlike Other methods of allocation such as

On the basis of Labor hour

On the basis of Machine hour

On the basis of Units Produced etc ABC is considered most unbiased method of Overhead allocation.

There may be different costs difficult to allocate, which can be easily done by ABC system. The data provided by ABC system is considered reliable and decisions such as continuance or shutdown of a department can be taken fairly with ABC analysis.