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) Do not overly rely on this text.
Write a paper addressing the following…
(a) 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. (10 marks)
(b) Outline the principles and benefits of ABC and the factors which would need to be addressed in order to implement it successfully in an organisation.
(c) Despite its undoubted benefits in terms of more accurate overhead allocation and product costing and its establishment in many Irish firms, its uptake has not been universal. Discuss any evidence you have found regarding its rate of use in Ireland and globally and outline the reasons for its success or otherwise. (20 marks)
(d) As a result of your research required to complete part (a), (b) and (c) above, give your opinion as to whether you believe the traditional system of overhead allocation has a future, clearly explaining your answer. (10 marks)