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I agree with the statement that activity-based costing does a better job of allocating both direct and indirect costs than traditional methods do. That said, the optimal costing method depends on the manufacturing process itself (Kenton, 2020). If the manufacturing process involves labor and machine hours, traditional costing methods are able to allocate these costs appropriately (BCcampus, n.d.). If the manufacturing process requires a large input from technology, which involves several different cost-drivers, activity-based costing is the more apt choice because it specifically allocates direct and indirect costs (Kenton, 2020).

Activity-based costing makes it easier for technology-heavy manufacturers to calculate exact production costs (Kenton, 2020). This more advanced method allows firms to attribute indirect costs to product manufacturing on a per-unit basis. These indirect costs can include salaries and utilities (BCcampus, n.d.). Manufacturing processes involving technology to a great extent can be more complicated and have several different activities involved. Activities involved in these processes include any and all events involved in the manufacturing process (BCcampus, n.d.). One example that demonstrates the wide-ranging nature of these activities is the cost of receiving and communicating purchase orders is considered a cost-driver (Kenton, 2020).

To calculate activity-based costs, one must recognize all of the activities involved in making a product, calculate the total overhead of these activities, and categorize the activities by measurable units (BCcampus, n.d.). The total overhead is then divided by these measurable units and these numbers are then further divided by the total number of categories of units to find the cost driver rate. This rate is then multiplied by the number of cost drivers (Kenton, 2020).

The issue with activity-based costing is that it can be a time-consuming and expensive process for a firm’s accounting department (BCcampus, n.d.). It costs money to gather and study cost drivers and to accurately allocate these costs to production. In this way, the money saved by the accuracy of activity-based costing my actually not make up for the cost of performing these accounting methods in the first place (Kenton, 2020).

If production costs are largely made up of direct labor, overhead typically consists of a small number of cost drivers. These cost drivers are usually direct labor hours, direct labor dollars, or machine hours (BCcampus, n.d.). There is typically a direct correlation to these few cost drivers and overhead costs in labor-heavy production, making activity-based costing an unnecessary and overcomplicated step. The disadvantages of traditional methods lie in their lack of specificity. One or two cost drivers are measured, so it is possible that traditional methods over-value the overhead to one product and under-value the overhead to another (BCcampus, n.d.). This creates ambiguity as to the exact per-unit production costs and the exact breakdown of overhead costs (BCcampus, n.d.).

References

BCcampus. (n.d.) Compare and contrast traditional and activity-based costing systems. Opentextbc. https://opentextbc.ca/principlesofaccountingv2openstax/chapter/compare-and-contrast-traditional-and-activity-based-costing-systems/#:~:text=Traditional%20allocation%20assigns%20overhead%20based,the%20activities%20that%20drive%20costs.&text=ABC%20costing%20is%20optimal%20when,that%20differ%20for%20each%20product.

Kenton, W. (2020, February 10). Activity-Based costing (ABC). Investopedia. https://www.investopedia.com/terms/a/abc.asp

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