Question

1. What do you think are some advantages for using the ABC method versus a single plant-wide rate or multiple departmental overhead rates. Why would an activity-based costing (ABC) system appeal to some companies and not all companies. Provide at least 3 examples of companies you think would and wouldn't want to use the ABC method.

Answer 1

ABC method means Activity Based Costing method.

Generally, in every business overheads are incurred and to be be apportioned to individuals products to know the exact cost of producing that product (or product line) and this in turn will help in price fixation.

These overheads are allocated to product based on a specific rate called as overhead rate. This can be derived in two ways

1. Plant wide overhead rate or single overhead rate

2. Multiple departmental overhead rate (Activity rates in ABC costing)

Plant wide rate means, there is only one overhead rate for all types of overhead costs and this rate is used to allocate those costs to products.

In ABC method, there are different overhead rates for different types of overhead costs and based on the respective overhead rates, overhead costs are allocated to products

Advantages of ABC method

1. Following ABC method for overhead allocation will help in determining the cost of product more accurately

2. Under ABC costing, we find the activity drivers of different overhead costs which are the reason for increase in those respective overheads. This will help us in understanding the real nature of those overhead costs

3. As this helps us in determining accurate costs, this will help in fixing a competitive price and knowing the present exact profit margins

4. As we have the details of the cost drivers, this will help in better cost management and thereby reducing the overhead costs by managing those cost activity in better manner

5. The information provided by ABC method will help in taking better decision making by segregating the efficient and inefficient product line

But their ABC method is not suitable/good for all types of businesses

1. ABC method requires skill and knowledge of persons to maintain the records, this requires investment in personnel. Some companies may not afford it

2. ABC method is not suitable for small level of business

3. Companies with single or very few overhead costs of similar nature doesn't require ABC method because for them Single plant wide overhead rate works well

Example of Companies that would use ABC costing

1. Ford Motor Company (Automotive companies)

2. Atlas games (Toy and game boards manufacturers)

3. United Parcel service (logistics)

Example of Companies that wouldn't use ABC Costing

1. Tata Consultancy Services (Information technology services)

2. Delhi Public School (Educational institutions)

3. Reliance Jio Infocom p Ltd (Telecommunications)