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Hi,
I don’t understand why the statement below is wrong:
“Implementation of ABC is unlikely to be cost effective when variable production costs are in low proportion of total production costs”
Please help me to clarify my doubts.
Thank you in advance!
The main benefit of using ABC is to use the fixed costs more efficiently and therefore to be able to reduce fixed costs. I do explain why in my free lectures.
The lower the proportion of costs that are variable, then the more the proportion that are fixed and therefore the more the potential savings. To be cost effective we want the benefits to be more than the cost of implementing ABC and this is more likely to be the case if fixed costs are high (and therefore variable costs low) – which is the opposite of what this statements is saying.
Thanks for your reply sir.
I don’t understand why ABC costing can help to reduce fixed costs. I thought ABC costing allocated overhead costs by assigning them to activities so the overhead costs can be absorbed in a more fair value basis compared to conventional methods of costing?
ABC is indeed a fairer way of absorbing fixed overheads. However in order to apply ABC a company needs to decide what is causing the overheads in the first place and in doing this can look for ways of operating differently and possibly therefore reducing the fixed overheads.
This is the main benefit of ABC and I do stress this in my free lectures (and give examples).
Thanks!
If a company has high fixed costs compared to variable costs, is it more suitable for the company to use ABC costing rather than traditional costing?
Yes – although it is suitable for any company with high fixed overheads 🙂
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