Disadvantages and Limitations
The major disadvantage of activity based costing is that although activity based costing is a scientific approach, the method of implementation is complex, time consuming, and costly. The process of data collection and data entry requires substantial resources, and remains costly to maintain.
ABC reports do not conform to generally accepted accounting principles (GAAP), and as such, firms following ABC need to maintain two cost systems and accounting books, one for internal use and another for external reports, filings, and statutory compliance. This is a cumbersome duplication of efforts.
A primary disadvantage of ABC is that it is not possible to divide some overhead costs such as the chief executive's salary on a per-product usage basis. Similarly, employees rarely devote 100% of their working hours to productive activities, and not all productive activities add value to the product or process of the firm. For instance, the ABC method fails to account for the time employee takes part in a first aid awareness campaign, leading to substantial ‘cost leaks.’ There is no meaningful way to assign such 'business sustaining' costs to products on a proportionate basis, and products and services share such costs equally.
Finally, too much attention to detail and control might obscure the bigger picture or make the firm lose sight of strategic objectives in a quest for small savings, making the firm “penny wise and pound foolish." For instance, ABC might identify one distribution channel as non-remunerative, or an inspection as non-value adding. Such channeling or processes might be non-profitable, but placed in the first place to achieve some other strategic objectives.
Image Credit: Wikimedia Commons