In cost accounting, direct costs are easily and economically traced to cost object. On the other hand, overheads cannot be economically traced to cost object. Therefore, allocating overheads is considered as the main problem in cost accounting, whereas traditional methods such as Single plantwide factory overhead rate method and Multiple production department factory overhead rate method have been used. In addition, developed methods such as Activity based costing method (ABC) has been used to enhance the allocation of overheads to cost object.
Students are required to criticize both traditional methods and explain how is ABC being applied to a manufacturing company? What are the disadvantages of the ABC method?
Accounting experts have criticized the single plantwide factory overhead rate method because it might distort costs. Similarly, the departmental overhead rate at times skews when every department is responsible for multiple products. In large departments, this is likely to create redundancy. Manufacturers mainly use the ABC method because it enhances cost data reliability, thus, produces nearly true costs. However, it becomes limited, especially if the overhead costs are mainly volume-related.