Question

Q1. Activity-based costing (ABC) is a costing methodology that identifies activities in an organization and assigns the cost of each activity with resources to all products and services according to the actual consumption by each. Do you think Activity-Based Costing (ABC) has any advantages if so discuss few advantages and also the challenges of this system and how we can resolve it?        

Answer 1

Answer:

Under the Activity based costing the fixed or variable costs are allocated based on the cost drivers. As a part of that allocation the activities are divided as Unit level costing, Batch level costing, Product line activities and facility support activities.

For an example:

1. Salary of factory supervisor.
2. Straight-line depreciation of plant and equipment
3. Property rent on plant and equipment

Will come under facility support activities which are necessary for development and production to take palce.Such costs are kept separately and not included in the product cost because the allocation will be done on arbitrary bases such as square feet for rent, no of personal for salaries and no of equipments for depreciation.

So, with the above example ABC cost allocation can be very advantages in allocating overheads same can be a challenge with ABC costing when the overall portion of overheads is less in the total cost.

Also there should be correct estimation in choosing the activities and cost drivers if the same is not done correctly then overall cost allocation will go wrong which turns to be a disadvantage.