Question

Apple Inc. must assign overhead costs to its products. Activity Based Costing is generally considered more accurate than other methods of assigning overhead. If this is so, why don't all manufacturing companies use it?

Answer 1

First of all, let's understand what activity based costing is and why is it generally preferred for manufacturing companies.

Activity based costing is a costing method which identified the different types of activities within an organization and assigns the indirect costs and overheads of each such activity to the products offered by the company. It provides a clear and precise classification of costs and makes the data much more reliable. It allocates manufacturing overhead more accurately to products and processes that use the activity and hence it is generally very famous for and used by many manufacturing entities across the globe.

However, activity based costing might not be suitable for all the manufacturing entities due to the following reasons :

1. Time-consuming : Activity based costing requires the data to be properly organized and classified. Collecting the data regarding every process and then preparing and processing the same is very time-consuming and it might not be feasible for small or any other organization to spend this much time on such activity.

2. Costly : For the data to be precise and accurate it requires more time and it becomes very expensive.

3. Cannot be used for external reporting : Activity based costing reports are almost never consistent with the reports as per GAAP and they cannot be used for external reporting at all. Hence it is not even a statutory obligation for the entity and it is additional to the external reporting which is a statutory obligation.

4. Conflicting with traditional costing methods : The output produced from activity based costing may conflict with the managerial standards which were established by using traditional costing methods.

5. Might not be suitable for manufacturing entities not offering a variety of products : Activity based costing is generally not suitable for organizations which are offering only a few products as setting up an ABC system is time-consuming and expensive to maintain.

6. Difficult to find a cost driver/allocation base for every process : Activity based costing involves allocating the costs to products on the basis of certain cost drivers or cost allocation basis. However it becomes very difficult to find such allocation basis for certain types of costs and it might also become difficult to accurately determine how much cost has been spent on which product as there might be a lot of common costs involved in the manufacturing entities.