Traditional overhead apportionment and absorption systems were developed decades ago when most companies manufactured a narrow range of products and direct materials and labour were the dominant factory costs. Overhead costs were relatively small and the distortions arising from inappropriate overhead allocations were not significant.
Today companies produce a wide range of products; direct labour represents only a small fraction of total costs, and overheads are of considerable importance. Therefore, traditional absorption costing which includes many arbitrary apportionments does not provide an accurate indication of the resources consumed by each product or service.
Activity Based Costing (ABC) systems developed during the 1980’s to address the inherent limitations in traditional costing systems.
See Drury- Management and Cost Accounting 9th Ed. 2015 (Chapters 3 and 11)
Write a paper addressing the following…
Outline the historical development of the traditional system of overhead allocation and the changing manufacturing and production environment which gave rise to the emergence of activity based costing in the 1980’s.