Activity Based Costing Disadvantages

The Activity Based Costing is a costing model developed by professors Robert Kaplan and Robin Cooper of Harvard University in late 1980's as an alternative to the traditional costing system. Traditionally, the costs were assigned based on the volume of a cost driver, such as the amount of hours needed to produce an item. But this model did not allow to precisely assigning indirect costs. Changes in the economic world had important impact on the cost structure: the shorter life cycle of the products increased the costs linked to the conception and end-of-life stages, and the new production technologies increased the costs related to services. However, the overhead part of total costs increased, between 15% and 75% in most companies using machines

First, the resources are assigned to activities, according to the economic logic established by the company. The ABC system is very flexible and fits the functioning of each company. This method can also become a strategic tool for the organizations, as the costs are easier to interpret for internal management. It can be an effective way to target cost reduction. It can help the development of non-financial performance measures as well. But the best advantage of this method is the costing accuracy; it enables to stop allocating irrelevant cost to a product. Costs are only assigned to the products that require the activity for production. The greatest benefit of the activity-based costing is to improve understanding of overhead

The selection of cost drivers may be problematical. Even with this method, some indirect costs remain difficult to assign to products, such as the chief executive's salary for example. These costs are then unallocated and called ‘business sustaining’. The ABC system is not the perfect solution to allocate every single overhead cost. Some of them remain hard to identify and assign to an activity within the company.

Another disadvantage of using activity-based costing is that it represents a significant cost of implementation, which may be prohibitive for companies with limited funds. Plus, the quality of the information driven by the ABC system depends on the precision of cost pools used. But in a long-term perspective, managing a large number of cost pools is expensive. ABC systems are also complex to implement. It takes time, sometimes several years, before the system is completely installed across all product lines and