Introduction
This blog will assist A2 students for their Paper 4 in which very often the question is asked whether to opt ABC or not by the business. Although the question’s weightage is may be 20% of the whole question but worth out of 25 total marks of the question.
Overview of Absorption Coting and ABC
It is when the overheads are apportioned using a blanket rate e.g. total overheads are apportioned using labour hours or machine hours or per unit basis, whereas ABC follows cost pool and cost drivers in which cost pools are the individual overhead costs and cost drivers are the activities based on which overheads are apportioned.
Why Prefer ABC over Absorption Costing?
The issues with Absorption costing are that blanket rate leads the apportionment of overheads towards over/under casting of the costs and then prices of the products might be unrealistic which results in further over or under pricing. If the price is too high, then the business may lose its customers and if the price is set too low, then the business may face loss.
The above consequences may be avoided in ABC, because this costing method apportions the overheads according to their activities and brings more cost to the product if the more resources are allocated to that product and thereby the sales price will be set at higher level. On the other hand, if lesser resources are allocated to the product then the cost will be lower and therefore sales price will be set at lower level.
This way over/under pricing of the products might not be faced. Moreover, the costing method is a scientific method which is based on greater research on identifying the cost drivers.
Dark Side of ABC
ABC brings some complexity and longevity in calculations and it is more time consuming to list down the activities involve in production of a product. Moreover, greater professional skills are required for handling the costing method.
Conclusion
The key to success of a business is right costing and sales pricing to avoid two extremes, i.e. losing customers or loss to the business. Then, why not ABC instead of absorption costing despite some difficulties in ABC adaptation by the businesses.