Question

Why would an activity-based costing (ABC) system appeal to some companies, and what is the criterion for utilizing an ABC system?

Describe the advantages for using the ABC method versus a single plantwide rate or multiple departmental overhead rates; and specify any limitations that exist when using these conventional type overhead rates?

Answer 1

1. An activity based cositng system allocates overhead to products based on the activity usage done to manufacture the products. An organization which has a large overhead cost and wants an accurate overhead rate so that pricing decisions can be taken correctly would find activity based costing appealing.

To utilize the activity based costing system, the activities used to manufacture the products and the cost incurred for each activity must be distinguishable. This data is used to derive activity rates .

2. The advantages of using the ABC method versus the traditional method are mentioned below:

- The product cost using ABC is more accurate.

- The real nature of the cost object is identified.

- Activity bsed costing helps in better decision making.

The conventional type overhead rate is a blanket overhead rate which might result in over / underapplication of overehad for certain products. This will affect the pricing of the product.