Question

What are some of the limitations of activity based costing (ABC) ? please provide an example of using the wrong activity-driver to measure the level of activity and apply costs. (For example, number of passengers would be the wrong activity driver for landing fees for an airline if the landing fees are based on the number of flights).

Answer 1

Limitations of Activity Based Costing:

1. Overhead costs are sometimes quite difficult to allocate to the activities.

2. Wrong cost driver allocated to the costs can result in a blur picture of the actual scenario. For example, Training cost of $500,000 allocated on the basis of existing cost is the wrong allocation. For training cost, number of personnel trained should be the appropriate cost driver.

3. As compared to the Traditional costing, it is a complex system. In traditional costing system, cost is simply allocated with respect to the production levels.

4. The system to implement the cost is more than the benefits availed which renders the implementation useless.