Advantages of ABC

Activity based costing based on the concept that it is activity which generates cost and therefore the cost should be allocated to generating activity. The activity based costing approach developed focusing on the fact that now a days there are many other cost involved in the production process and traditional costing concept of product is not relevant.

The activity based costing reduces the limitation of absorption based costing where the overhead are allocated using unfair bases like machine hour and labor hour which sometimes has no relevance with the cost incurred.

In activity based costing the cost driver are defined .in simple words cost driver is determinant of costs. Sometime more than one cost drivers are defined for one activity but such arrangement is not recommended. One activity one cost driver is the best suitable approach.

Advantages of ABC

Detailed information about activities: -

This costing system develops deep understanding about the cost structure in the organization. The critical activities and cost driver are become clearer to the management.

More realistic allocation of cost:- The second advantages is that under Activity based costing system the costs are allocated more rationally and more appropriately.

Disadvantages

How many activities

This is a difficult question to answer that how many activities would be define to server the process . some organization have a lot of activities and therefore the activity based costing is suitable option in that case.

Cost driver Define

The defining of relevant cost driver is also a difficult task and requires huge experience and deep understanding of the business and industry.

All overhead are not activity based

The other limitation that there are a lot overheads which are not activity based and therefore some kind of allocation bases are used for those overhead.

Not easy to implement

The activity based costing require deep understanding of underlying concept and sometime lower tier management find it a difficult and complex process whereas the absorption costing is simple to understand and easy to implement.