Question

Suppose an organization uses the activity-based costing (ABC) model. How do you think this model differs from traditional costing approaches? What do you see as advantages or disadvantages for this healthcare organization?

Answer 1

In the traditional system of assigning manufacturing overheads, overheads are first allocated and apportioned to cost centres (production and support service cost centres) and then absorbed to cost objects (e.g. products/services). Under ABC, overheads are first assigned to activities or activity pools (group of activities) and then they are assigned to cost objects. Thus, ABC is a refinement over the traditional costing system. Usually cost centres include a series of different activities. If different products create different demand on those activities, the traditional costing system fails to determine the product cost accurately. In that situation, it becomes necessary to use different rates for different activity or activity pools.

Advantages of ABC :-

1. More accurate costing of services.
2. Better understanding overhead.
3. Makes visible waste and non-value added.
4. Supports performance management and scorecards.

Disadvantages of ABC :-

1. Problems are often encountered in identifying appropriate cost pools and related activity cost drivers.
2. ABC implementation is costly and time-consuming.
3. ABC systems may be too complex for the needs of the organization. Complexity is brought about by a desire to cater for a vast number of activities, cost drivers, services and cost elements. However, ABC systems that are too complex often fail to meet management requirements.