Question

How is activity-based costing approach a superior costing method when compared to traditional costing approaches? What are the criticisms of activity-based costing approach? Explain in detail.

Answer 1

Benefits of an ABC system are numerous. The fundamental differences in the traditional and ABC cost systems that make ABC approach a superior costing method over Traditional method can be summarized as below: Basis Explanation 1 Cost Pool One or limited number of cost pool is available in Traditional system, whereas many cost pools are available in ABC (activity based costing system) to reflect different activities 2 Rate applied In traditional system, rate applied is usually volume based where ABC system has the practical approach where it applies rate based on activity. 3 Suitability Traditional method requires large workforce, hence it is labor intensive & thus suitable for low-overhead companies. |ABC approach on the other hand, although capital-intensive, is product-diverse & hence efficient for high-overhead companies. 4 Accuracy Traditional costing method, though it is considered simple & inexpensive, activity-based costing approach is considered a superior costing method over it in terms of Accurate product costing possibleelimination of non-value-added activities, etc. Criticisms of activity-based costing approach are: 1 Time consuming This method is extremely time consuming. 2 Complexity This method is usually considered complex as it gathers information from from a lot of resources for analysis. 3 Expensive method Low budget companies at times find it difficult to design & carry out detailed ABC study which will cost them to pay specialist or consultants employed for such analysis. Hence, this method becomes costly. 4 Detailed records Dertailed records of every aspect is generally expected under this aspect where such detailed source data can't always be expected to be readily available at the moment. 5 Managerial performace Data produced by ABC analysis gives accurate reports, hence may create situation of conflict with regard to management's conflict perforamce appraisal as established by traditional costing method. 6 Difficulty in change It is usually considered difficult to implement changes in the current process as this would be more complex & may require lot of implementation time for such implementaion. 7 Not suitable for Due to its being complex & expensive in nature, small organisations can't afford it, nor it is suitable for them. small organisations