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Home Activity Based Costing System Advantages, Disadvantages and Limitations of Activity Based Costing

Advantages, Disadvantages and Limitations of Activity Based Costing (ABC) System:

Advantages of Activity Based Costing System:

Activity based costing system has the following main advantages / benefits:

  1. More accurate costing of products/services, customers, SKUs, distribution channel.
  2. Better understanding overhead.
  3. Easier to understand for everyone.
  4. Utilizes unit cost rather than just total cost.
  5. Integrates well with Six Sigma and other continuous improvement programs.
  6. Makes visible waste and non-value added activities.
  7. Supports performance management and scorecards.
  8. Enables costing of processes, supply chains, and value streams
  9. Activity Based Costing mirrors way work is done
  10. Facilitates benchmarking

Disadvantages or Limitations of Activity Based Costing System:

Activity based costing system help managers manage overhead and understand profitability of products and customers and therefore is a powerful tool for decision making. However activity based costing has a number of limitations or disadvantages.

These limitations or disadvantages are briefly discussed below:

  1. Implementing an ABC system is a major project that requires substantial resources. Once implemented   an activity based costing system is costly to maintain. Data concerning numerous activity measures must be collected , checked and entered into the system.

  2. ABC produces numbers such as product margins, that are odds with the numbers produced by traditional costing systems. But managers are accustomed to using traditional costing systems to run theirs operations and traditional costing systems are often used in performance evaluation.

  3.  Activity based costing data can be easily misinterpreted and must be used with care when used in making decisions. Costs assigned to products, customers and other cost objects are only potentially relevant. Before making any significant decision using activity based costing data, managers must identify which costs are really relevant for the decisions at hand.

  4. Reports generated by this systems do not conform to generally accepted accounting principles (GAAP). Consequently, an organization involved in activity based costing should have two cost systems - one for internal use and one for preparing external reports.

Relevant Articles:

Definition and Explanation of Activity Based Costing
Treatment of Costs Under Activity Based Costing (ABC) System
Activity Based Costing and Top Management
Activity Based Costing, GAAP and External Reports
Designing and Implementing Activity Based Costing System
Targeting Process Improvements
Advantages, Disadvantages and Limitations of Activity Based Costing
Activity Based Costing Example




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