1.5 Comparing costs per driver and per unit using traditional methods and ABC

　　Traditional absorption costing charges overhead costs to products (or services) in an arbitrary way.

　　The assumption that overhead expenditure is related to direct labour hours or machine hours in the production departments is no longer realistic for the vast majority of companies.

　　This will lead to very different values of overheads absorbed per unit.

　　1.6 Advantages and disadvantages of ABC

　　ABC has a number of advantages:

　　§ It provides much better insight into what drives overhead costs.

　　§ ABC recognises that overhead costs are not all related to production and sales volume.

　　§ In many businesses, overhead costs are a significant proportion of total costs, and management needs to understand the drivers of overhead costs in order to manage the business properly. Overhead costs can be controlled by managing cost drivers.

　　§ It can be applied to derive realistic costs in a complex business environment.

　　§ ABC can be applied to all overhead costs, not just production overheads.

　　§ ABC can be used just as easily in service costing as in product costing.

　　§ Criticisms of ABC:

　　§ It is impossible to allocate all overhead costs to specific activities.

　　ABC costs are based on assumptions and simplifications. The choice of both activities and costs drivers might be inappropriate.

　　§ ABC can be more complex to explain to the stakeholders of the costing exercise.

　　§ The benefits obtained from ABC might not justify the costs.