Question

a)Why would a product costing system based on a single, volume-based cost driver tend to overcost high-volume products in comparison to an activity-based costing system?

b) The first ‘Real Life’ in ‘When should ABC be used?’ suggests that the adoption of activity-based costing in Australia and New Zealand has not been as high as one might expect. What limitations and other challenges to implementing activity-based costing may be impacting the adoption of activity-based costing?

Answer 1

A. Product Costing based on single cost driver tend to be overcost while comparing to ABC because all the overheads are pooled and allocated on the basis of single cost driver. Thus due to this type of allocation, products with lower volume of production cost driver tend to have lesser cost than their actual and those with higher volumes have a higher cost allocated than what is actually supposed to be. Due to this the costs are overcasted.

B. Challenges while applying activity based costs are as follows:

• Not all costs have related underlying cost drivers. General overhead. Hence Allocation of such costs may be arbitrary.
• It is complicated and requires expertise to understand the costs and implement the said system. Thus buisness tend to avoid them or postpone the implementation.
• It is also costly on terms of time and money.
• Activity based costing is done at unit level, batch level, product levels. However managers further process them into average cost per unit. This makes information wrong as costs are to be allocated based on levels of activity and cost drivers. Thus