## ABC — Core Theory: Why, When, Pros, Cons and How to Implement
### Factors prompting the development of ABC
| Factor | Explanation |
|---|---|
| Growing overhead costs | Automation has increased overhead expenses |
| Market competition | Accurate cost allocation is essential for competitiveness |
| Product diversity | A wider product range helps achieve economies of scope and market share |
| Lower information processing costs | Advances in IT make cost data cheaper/easier to manage |
### Usefulness / Suitability of ABC
ABC is particularly needed when:
| Situation | Why ABC helps |
|---|---|
| High overhead costs | More effective than traditional costing when overheads are significant |
| Diverse product range | Ideal for companies with multiple or varied products |
| Non-volume related activities | Better allocates material handling, inspection, set-up costs; highlights non-value-adding activities for elimination |
| Stiff competition | Ensures accurate costing/pricing and identifies cost-saving opportunities |
### Advantages of ABC
1. More accurate costing of products/services.
2. Overhead allocation on a logical basis.
3. Enables better pricing policies via accurate cost data.
4. Utilises unit cost rather than just total cost.
5. Identifies non-value-added activities → facilitates cost reduction.
6. Helpful for organisations with multiple products.
7. Highlights problem areas needing management attention.
### Limitations of ABC
1. More expensive than traditional costing.
2. Not helpful to small organisations.
3. May not suit organisations with limited products.
4. Selecting the most suitable cost driver can be difficult/complicated.
### Requirements for ABC Implementation
| Stage | Description |
|---|---|
| Staff training | Workforce cooperation is crucial; training builds awareness of ABC's purpose/benefits |
| Process specification | Interviews map production stages, resource commitments, processing times, bottlenecks |
| Activity definition | Define activities early to manage data overload and ensure proper codification |
| Activity driver selection | Identify the cost driver for each activity to allocate costs accurately |
| Assigning cost | Use a representative activity driver to assign costs from pools to cost objects |
### Practical Applications of ABC
| Application | Role of ABC |
|---|---|
| Performance & profitability | Improves organisational performance/profitability |
| Wholesale distribution | Correlates costs to activities; aids new-product / vendor decisions |
| Facility & resource expansion | Evaluates relocation, new facilities, expansion (e.g. logistics & freight) |
| Human resource decisions | Links activities/costs to individuals (branch/sales analysis) |
| Cost-based pricing | Supports cost-plus pricing with accurate cost allocation |