Advantages, Disadvantages and Limitations of Activity Based Costing (ABC) System:
Learning Objectives:
- What are the advantages and
disadvantages of activity based costing system?
Contents:
Activity based costing system has the
following main advantages / benefits:
- More accurate
costing of products/services, customers, SKUs, distribution channels.
- Better understanding overhead.
- Easier to understand for everyone.
- Utilizes unit cost rather than just
total cost.
- Integrates well with
Six
Sigma and other
continuous improvement programs.
- Makes visible waste and
non-value
added activities.
- Supports performance management and
scorecards
- Enables costing of processes, supply
chains, and value streams
- Activity Based Costing mirrors way
work is done
- Facilitates
benchmarking
Activity based costing system help managers manage overhead and
understand profitability of products and customers and therefore is a powerful
tool for decision making. However activity based costing has a number of limitations or disadvantages.
These limitations or disadvantages are briefly discussed below:
-
Implementing an ABC system is a
major project that requires substantial resources. Once implemented an
activity based costing system is costly to maintain. Data concerning numerous
activity measures must be collected , checked, and entered into the system.
-
ABC produces numbers such as
product margins, that are odds with the numbers produced by traditional
costing systems. But managers are accustomed to using traditional costing
systems to run theirs operations and traditional costing systems are often
used in performance evaluations.
-
Activity based costing data can be easily
misinterpreted and must be used with care when used in making decisions. Costs
assigned to products, customers and other cost objects are only potentially
relevant. Before making any significant decision using activity based costing
data, managers must identify which costs are really relevant for the decisions
at hand.
-
Reports generated by this systems
do not conform to
generally accepted accounting principles (GAAP). Consequently, an
organization involved in activity based costing should have two cost
systems - one for internal use and one for preparing external reports.
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