Question

Why Activity-based costing is not relevant and difficult to implement in the service industry？

Can you explain specifically why activity-based costing is not relevant? It's hard to understand why ABC is not relevant，thanks

Answer 1

The name 'Activity based Costing' itself a self explanatory term. Its the Cost based on each activity.

Eg. in a salon different activities are involved such as; in a retaurant, fuel is used for cooking pasta, noodles, burger etc., same spices are used for more than 1 dish. So as per activity based costing, if we want to allocate the cost for noodles, we need to identify how much fuel is used for cooking noodles, which is practically not possible.

ABC was developed to accurately measure cost and benefit but it is possible only when the cost is traced accurately to final object which is a very complex method and is too expansive to build and maintain.

The other major problem is tracing overhead cost to final cost object.

Allocation of an overhead cost which is commonly used say for 3 services is sometimes very difficult to trace that which cost object to allocate how much overhead cost. eg. in a resturant, a chef cooks noodles, pasta and  burger. So in order to detemine cost of all three items seperately, it becomes difficult to allocate cost of chef to these 3 dishes. Hence, the very purpose of ABC is not acheived and if the overhead cost is not allocated properly, the cost of final object will also be incorrect.

Apart from this, information of cost of all activities in an organisation is also a task.

If allocation is done somehow, then it does not neccessarily means that it reflects how the business consumes resources.

Since ABC demands a whole lot of time, the information regarding accurate cost is not timely which hampers business decisions.

All togather, it requires experts supervision for an extended period of time and involves a lot of time, efforts and money which could be invested in some other methods which could yeild results in less time and involves less excercise and gives nearly accurate results also