Advantages and Disadvantages of Activity Based Costing

Advantages of Activity Based Costing

The following are the main advantages of Activity Based Costing.

Advantages of Activity Based Costing
Advantages of Activity Based Costing

1. Activity Based Costing helps to reduce costs by providing meaningful information on the opportunities available for reducing costs.

2. Activity Based Costing is working only on the activities. Hence, the management can take the quality decision by knowing the nature of each activity.

3. The activities can be classified into two i.e. value adding activities and non-value adding activities. The Activity Based Costing helps the management on focusing the forces on value adding activities and eliminate non-value adding activities.

4. Some costs are termed as non-manufacturing costs, for example, advertisement. Even though, advertisement is a non-manufacturing cost which constitutes a major portion of the total cost of any product. These non-manufacturing costs can be easily allocated since the relationship between costs and its causes can be properly understood by using Activity Based Costing.

5. The accurate allocation of costs to various products leads to proper pricing policy.

6. The statement of expenditure is prepared on activity-wise and compare the costs of each activity with one another to find the activities which are to be eliminated or improved for better performance.

7. The accurate cost information helps the management to adopt productivity improvement approaches like Total Quality Management (TQM), Business Process Re-engineering (BPR) etc.

8. The management can take make or buy decisions by considering the cost of manufacture of a product or sub contract the same with an outside agency through Activity Based Costing analysis.

9. If the available resources can not be used properly even after sub contracting the manufacture of any product, the management can do the activity of manufacture of such a product within the firm.

10. Whenever the finished goods of Department “A” is transferred to Department “B”, the cost of the product to Department B can be easily known. In this way, transfer pricing is fixed.

Disadvantages of Activity Based Costing

Disadvantages of Activity Based Costing
Disadvantages of Activity Based Costing

The Activity Based Costing has some limitations which are presented below.

1. Activity Based Costing is not useful to small companies.

2. If the overheads are relatively small, there is no use of Activity Based Costing.

3. Some companies are producing only one product or few products. If so, the Activity Based Costing cannot be applied.

4. Activity Based Costing method should not be used to prepare monthly profit statements.