Accounting

Limitations of Activity Based Costing

Activity Based Costing is a costing procedure whereby the cost will be determined based on the individual activity undertaken to produce a product or service. Activity Based Costing has various proponents and opponents in its application in the industry. There are some drawbacks or limitations of Activity Based Costing.

It has been emphasized by critics or management accountants that the limitations of activity based costing cannot be ignore and should be well studied before its implementation.

Limitations of activity based costing are :

(a) Cost and Benefit: Some argues that, the cost of implementing and maintaining an Activity Based Costing system can exceed the benefits of improved accuracy.

(b) If management is not thinking to use ABC information, an absorption costing system may be simpler to handle. Some argues that ABC is sometimes introduced because it is fashionable, not because it will be used by management to set reasonable product costs or extra information.

(c) Unless costs are originated by a real time activity that is computable in quantitative terms and which can be related to production output, cost drivers will not be working.

(d) Will a single cost driver represent the cost behavior of all items in an associated pool?

(e) Some basis of cost allocation may be required at the cost pooling stage for items like rent, rates and building depreciation.

(f) Some argue the implementing an ABC system is often difficult.

(g)  Activity based costing data may easily be misinterpreted and so it should be handled with care when used in making decisions. Costs assigned to products, customers and other cost elements are only potentially relevant. Before making any useful decision be means of activity based costing data, managers must identify which costs are really relevant for the decisions at hand.

Applicability of Activity Based Costing is limited to cost of required data capture. It drives the prevalence to slower processes in services and administrations. Therefore, the reported application for production tasks do not appear as favorable. But, if limitations of activity based costing can be eliminated cost would have been more transparent.

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