Question

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Please discuss the concepts and benefits of using Activity-Based Costing (ABC)and provide examples to support your response. Is ABC better than using a single overhead base (such as direct labor hours) to allocate overhead? Can using ABC improve profitability and increase efficiencies?

Answer 1

Activity based costing (ABC) is based upon the concept that the costing of a particular type of products would be based upon their productivity level.
Activity based costing acts as a cost driver, which allots the costs of the products according to their activity.

Activity based costing have various benefits. These are as follows :

• It provides a more accurate method for costing.
• It is helpful in making pricing decision more accurate.
• It provides a clear understanding about various costs and help in elimination of these costs.
• It helps the management in decision making.
• It helps in tracing various types of overhead costs.

For example, a company producing two types of Soaps (i.e soap a and soap b).
Now, activity based costing helps in right allocation of costs among these two types of soaps.

It can be considered that activity based costing is better than using single overhead base (such as direct labour hours) to allocate overheads because single overhead base uses a single rate to allocate overheads to all types of products, whereas there can be certain products which are required to be allocated less overheads.
In activity based costing, this demerit is overcome and proper allocation of overheads is done.
So activity based costing is better than single overhead base.

Yes, using ABC profitability can be improved and efficiency can be increased as ABC focuses on the activity and productivity.
And if an activity is closely watched than efficiency of such activity can be improved by using various methods and in terms profits can be increased.