Activity-Based Costing: Weaknesses and Cost Driver Selection
This paper examines activity-based costing (ABC), a method that allocates overhead costs by tracing expenses to specific activities rather than broad organizational units. The paper first outlines the theoretical shortcomings of ABC, including its high implementation cost, the distortion caused by fixed-cost allocation, the need for detailed analysis, non-conformity with SSAP 9, and the potential for misleading management decisions. It then explains the decision process for selecting cost drivers, covering the identification of cost objects, evaluation of prospective drivers, assessment of causal relationships, management control effects, and cost measurement considerations. Together, these discussions illuminate both the promise and the practical limitations of ABC systems.
- Introduction to Activity-Based Costing: Defines ABC and contrasts it with traditional costing
- Theoretical Weaknesses of Activity-Based Costing: Examines cost, distortion, complexity, and compliance flaws
- How Cost Drivers Are Chosen for an Activity: Steps for identifying and evaluating appropriate cost drivers
- Conclusion: Summarizes ABC strengths, weaknesses, and driver-selection factors
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What makes this paper effective
- It systematically enumerates multiple theoretical weaknesses of ABC, supporting each point with concrete numerical examples (e.g., the $10,000-per-unit fixed-cost illustration) that make abstract concepts accessible.
- The paper balances critique with constructive analysis by devoting equal attention to how cost drivers are properly selected, offering a practical counterpart to the theoretical discussion.
- Citations are consistently integrated throughout, grounding each claim in recognized accounting scholarship rather than relying on unsupported assertions.
Key academic technique demonstrated
The paper demonstrates comparative analysis: it consistently measures ABC against traditional costing methods, clarifying where ABC improves on older approaches while honestly identifying where it falls short. This technique prevents the discussion from becoming one-sided and shows the writer understands the system within its broader accounting context.
Structure breakdown
The paper opens with a definitional introduction that situates ABC within the broader costing landscape. The body is divided into two main analytical sections — theoretical weaknesses and cost driver selection — each organized around a numbered sequence of sub-points. The conclusion synthesizes key takeaways from both sections. This parallel structure makes the argument easy to follow and signals clear organizational thinking.
Introduction to Activity-Based Costing
Activity-based costing (ABC) employs numerous cost groups, organized by activity, in the allocation of overhead costs. The underlying idea is that activities are required to generate products — activities such as procuring materials, setting up machinery, assembling products, and inspecting finished goods. These activities carry costs, and therefore the cost of activities should be apportioned to products on the basis of how the products use those activities. Costs are assigned to products according to each product's individual consumption of every activity (Hansen et al., 2007).
In the traditional product costing system, costs are not linked or mapped to activities; instead, they are traced to an organizational unit — such as a department or division — and then allocated to products. Both the traditional and ABC systems share a second stage in which costs are linked to the product. However, by focusing on activities, the activity-based costing system attempts to identify the factors that cause each key activity, the cost of those activities, and the relationship between activities and the products produced (Lal, 2009). The purpose of this paper is to discuss the theoretical shortcomings of activity-based costing and the decisions involved in selecting cost drivers for an activity.
References
Bendrey, M., Hussey, R., & West, C. (2003). Essentials of management accounting in business. Cengage Learning EMEA.
Cokins, G., & Capusneanu, S. (2010). Cost drivers: Evolution and benefits. Theoretical and Applied Economics, 8(8), 7.
Gill, S. (2015). Cost and management accounting: Fundamentals and its applications. Vikas Publishing House.
Hansen, D., Mowen, M., & Guan, L. (2007). Cost management: Accounting and control. Cengage Learning.
Heisinger, K. (2009). Essentials of managerial accounting. Cengage Learning.
Lal, J. (2009). Cost accounting (4th ed.). Tata McGraw-Hill Education.
Way, J. (2017). How to determine cost drivers. Chron. Retrieved from http://smallbusiness.chron.com/determine-cost-drivers-40992.html
Weygandt, J. J., Kimmel, P. D., & Kieso, D. E. (2009). Managerial accounting: Tools for business decision making. John Wiley & Sons.
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