ABC

d) The pitfalls of using ABC information are:

 To calculate unit product costs, batch level activity costs are divided by the
number of units in the batch and product sustaining costs are divided by the
number of products produced. This unitizing approach is an allocation which
yields a constant average cost per unit of output which will differ depending on
the selected output level.

 For decision-making there is a danger that what started out as a non-volume-

related activity cost will be translated into a cost which varies with production
volume. Example: Consider a situation where the cost per set-up is $1000 for a
standard batch size of 100 units for a particular part, giving an average set-up cost
per part of $10. If a special order requiring the part is received for 50 units then
the batch size will differ from the standard batch size and the average cost of the
set-up for processing the parts of $10 is not the appropriate cost to use for
decision-making. There is a danger that costs of $500 could be assigned to the
order. However, if the special order required one set-up then the activity
resources consumed will be $1000 for and additional set-up, and not $500. Care
must therefore be taken when using ABC information.

 ABC does not conform specifically with generally accepted accounting principles
(GAAP). ABC would suggest that some non-product costs (such as those in
research and development) be allocated to products, whereas certain other
traditionally designated product costs (such as factory building depreciation) not
be allocated to products. Therefore, most companies have used ABC for internal
reporting, while continuing to maintain their general and subsidiary ledger
accounts and prepare their external financial statements on the basis of a more
“traditional” system – requiring two product costing systems and causing even
more costs to be incurred. As ABC systems become more widely accepted, more
companies may choose to refine how ABC and GAAP determine product cost to
make those definitions more compatible and thereby, eliminate the need for two
costing systems.
 And few others.