Why organisations' production overheads costs differ under Activity Based Costing (ABC)?

Query no.1: 

Why Traditional Absorption Costing (TAC) has been replaced by Activity Based Costing (ABC)? 

Solution:

ABC is an extension of TAC since it consider the reasons of changes in Production Overheads (POH) related to each product when organisations produce a large range of products with similar costs.

Query no.2:

What opportunities can be created by the use of ABC?

Solution in the bullets below:

• To control cost as well as reduce cost by efficient management of cost drivers. 
• To better understand costing information for reasonable pricing decisions.
• To re-analyse product mix decisions in relation to production.
• To create realistic estimate of costs & profits related to products.

Query no.3:

Why ABC has become a need of current economic environment?

Solution:

ABC has become a need of current economic system due to large range of products produced along with dissimilar costs. In the past, only single product produced along with similar costs but now situation has been changed. For example, In the earlier age, Businesses were labour or machine intensive so POH are likely to be absorbed on the bases of direct labour hours or direct machine hours because at that time POH were small portion of product unit cost. 

In the same way, Modern business environment facing many challenges in relation to POH because now we have multiple options in every product. Now we have variety of products means one product produce in different colours, tastes, sizes, along with different techniques according to the customer specifications. And this situation create complexity in the current production process in relation to POH. So these factors become a need to implement ABC.

Query no.4:

What is the important role of ABC in this current economic system?

Solution:

ABC play a vital role to simplify the complexity of POH considerably since it is based on cause & effect relationship. ABC identify cost of main supporting activities & factors that drive the cost of each activity.

Query no.5:

What are the main ideas behind ABC?

Solution in the bullets below:

• Activities cause costs i.e. ordering, material handling, machining, assembling, production scheduling & dispatching.
• Manufacturing products creates demand for support activities.
• Costs are assigned to the product on the basis of product's consumption of these activities.

 

 

Overheads	Cost drivers
Production setup costs	No. of production set us
Machine oil & repairs costs	No. of machine hours
Supervisory salary costs	No. of labour hours
ordering cost handling customer orders	No. of customer orders
Material handling costs	No. of production runs

 

Query no.6:

What are the steps to implement ABC?

 

Solution in the steps below:

• Identify organisation major activities.
• Cost pool (Group overheads into activities according to how they are driven).
• identify cost drivers for each activity.
• calculate cost per unit of cost driver
• Absorb activity costs into production based on usage of cost drivers.

Query no.7:

What are the problems to implement ABC?

 

Solution:

Although ABC is very helpful to control POH costs but some responders has addresses their concerns in relation to ABC:

• It is time consuming & expensive.
• It will be limited helpful if POH are mainly related to volume.
• The benefits of ABC is limited if company produce single product or a range of products with similar costs.
• some arbitrary apportionment still exist i.e. General overheads.