Advantages, Disadvantages and Limitations of Activity Based Costing (ABC) System:

Learning Objectives:

1. What are the advantages and disadvantages of activity based costing system?

Contents:

• Advantages of activity based costing system
• Disadvantages of activity based costing system

Advantages of Activity Based Costing System:

Activity based costing system has the following main advantages / benefits:

1. More accurate costing of products/services, customers, SKUs, distribution channels.
2. Better understanding overhead.
3. Easier to understand for everyone.
4. Utilizes unit cost rather than just total cost.
5. Integrates well with Six Sigma and other continuous improvement programs.
6. Makes visible waste and non-value added activities.
7. Supports performance management and scorecards
8. Enables costing of processes, supply chains, and value streams
9. Activity Based Costing mirrors way work is done
10. Facilitates benchmarking

Disadvantages or Limitations of Activity Based Costing System:

Activity based costing system help managers manage overhead and understand profitability of products and customers and therefore is a powerful tool for decision making. However activity based costing has a number of limitations or disadvantages.

These limitations or disadvantages are briefly discussed below:

1. Implementing an ABC system is a major project that requires substantial resources. Once implemented   an activity based costing system is costly to maintain. Data concerning numerous activity measures must be collected , checked, and entered into the system.

2. ABC produces numbers such as product margins, that are odds with the numbers produced by traditional costing systems. But managers are accustomed to using traditional costing systems to run theirs operations and traditional costing systems are often used in performance evaluations.

3.  Activity based costing data can be easily misinterpreted and must be used with care when used in making decisions. Costs assigned to products, customers and other cost objects are only potentially relevant. Before making any significant decision using activity based costing data, managers must identify which costs are really relevant for the decisions at hand.

4. Reports generated by this systems do not conform to generally accepted accounting principles (GAAP). Consequently, an organization involved in activity based costing should have two cost systems – one for internal use and one for preparing external reports.

You may also be interested in other relevant articles from “activity based costing system” chapter:

1. Definition and Explanation of Activity Based Costing System
2. Treatment of Manufacturing, Non-manufacturing and Idle Capacity Costs Under Activity Based Costing System
3. Activity Based Costing And Top Management
4. Activity Based Costing System and External Reports
5. Designing and Implementing Activity Based Costing System
6. Targeting Process Improvements (Activity Based Costing + Activity Based Management)
7. Advantages or Benefits | Disadvantages or Limitations of Activity Based Costing System
8. Activity Based Costing Example