2.0 Question 2
Strengths and Limitations of Activity Based Costing (ABC)
Initially, many firms adopt activity based costing system to improve the profitability measures. It has the ability to reveal the hidden sources of profitability and embedded cost, and to serve as a catalyst for decisions to improve profitability (Turney, 2008). For example, manufacturing indus-tries, financial institutions have diverse products and customers, which can cause cross-product or cross customer subsidization. Since personnel expenses represent the largest single component of non-interest expenses in financial institutions, these costs must be allocated accurately to products and customers. Even though the activity based costing system was originally developed …show more content…
It has improved product costs which lead to better esti-mates of job costs for pricing decisions, budgeting, and planning. Activity based costing treats overhead costs essentially as direct costs, in that cost estimates reflect actual cost driver usage for each product (Do & Hoang, 2014). These costs, in turn can be reasonably be apportioned to indi-vidual product units. To put it simply, it provides better profitability measures and improve product costing that leads to a better estimate of job costs for pricing decisions (Blocher, Stout, Cokins & Chen, …show more content…
First, cons of the activity based costing system is that not all costs have appropriate or unambiguous activ-ity consumption cost drivers (Do & Hoang, 2014). There are some costs that require allocations to departments and products based on arbitrary volume measures due to the cost of the activity being impractical. As an example, facility-sustaining costs such as the costs of the information system, fac-tory manager’s salary, and factory insurance.
Besides, product or service costs identified by the activity based costing system is likely not to in-clude all costs associated with the product or service. Product or service costs normally do not in-clude costs for activities such as marketing, advertising, research and development, and product en-gineering even though some of these costs can be traced to individual products or services. Product costs do not include these costs because the generally accepted accounting principles (GAAP) for financial reporting requires them to be treated as period costs (Horngren, Datar & Rajan,
Strengths and Limitations of Activity Based Costing (ABC)
Initially, many firms adopt activity based costing system to improve the profitability measures. It has the ability to reveal the hidden sources of profitability and embedded cost, and to serve as a catalyst for decisions to improve profitability (Turney, 2008). For example, manufacturing indus-tries, financial institutions have diverse products and customers, which can cause cross-product or cross customer subsidization. Since personnel expenses represent the largest single component of non-interest expenses in financial institutions, these costs must be allocated accurately to products and customers. Even though the activity based costing system was originally developed …show more content…
It has improved product costs which lead to better esti-mates of job costs for pricing decisions, budgeting, and planning. Activity based costing treats overhead costs essentially as direct costs, in that cost estimates reflect actual cost driver usage for each product (Do & Hoang, 2014). These costs, in turn can be reasonably be apportioned to indi-vidual product units. To put it simply, it provides better profitability measures and improve product costing that leads to a better estimate of job costs for pricing decisions (Blocher, Stout, Cokins & Chen, …show more content…
First, cons of the activity based costing system is that not all costs have appropriate or unambiguous activ-ity consumption cost drivers (Do & Hoang, 2014). There are some costs that require allocations to departments and products based on arbitrary volume measures due to the cost of the activity being impractical. As an example, facility-sustaining costs such as the costs of the information system, fac-tory manager’s salary, and factory insurance.
Besides, product or service costs identified by the activity based costing system is likely not to in-clude all costs associated with the product or service. Product or service costs normally do not in-clude costs for activities such as marketing, advertising, research and development, and product en-gineering even though some of these costs can be traced to individual products or services. Product costs do not include these costs because the generally accepted accounting principles (GAAP) for financial reporting requires them to be treated as period costs (Horngren, Datar & Rajan,