Question

What would be some pros and cons of using acutal versus capacity cost driver rates and vice versus. this is the question i am ultimately answering, "Which cost driver rates should be used: actual or capacity based? Why?"

Answer 1

Actual cost drivers- pros

• · Helps in allocation of cost as per actual cost drivers
• · There will be no unabsorbed overheads after the allocation of activity based cost

Actual cost drivers- cons

• · Does not help in understanding capacity utilisation
• · Does not help in understanding which activities are unused
• · Does not help in decision making like cost of unused capacity. Sometimes benefit of unused capacity can be realised by alternative usage.

Capacity cost drivers- Pros

• · Helps in arriving at cost of unused capacity
• · Helps in decision making like allocation of unused capacity to other production. Thus helps in generating additional revenue

Capacity cost drivers- Cons

• · There will be always unused capacity which is not allocated to products
• · Unused capacity cost may be sunk cost and may not be relevant in decision making

The choice of actual cost driver vs. capacity cost driver depends on how activities are consumed and how management wants to perceive the cost of unused activities. If management feels the cost of unused activities can be put to better alternative uses capacity based cost driver should be used since it helps in finding opportunity cost of alternative usage.