ABC vs OAR - Lecture notes 3 PDF

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these notes describes the difference between ABC and OAR...

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Weaknesses of OAR: - In its simplest form (blanket overhead absorption rates) it is inappropriate if products do not consume department overheads in uniform proportions - It tends to use arbitrary bases of apportionment and absorption, where no cause and effect relationship exists - It gets involved in the arbitrary re-apportionment of service department overheads - It tends to assume that all overheads are directly related to volume of production - In its calculations it tends to rely on broad averages and to ignore the controllability principle - It has proved less than appropriate in service environments where prime cost is not the majority element of cost - It is based on an underlying assumption that overheads are directly linked to departmental structure, which is by no means true in many cases - Its use of budgeted overhead absorption rates creates the complexity of under/over-absorption of overheads.

ABC vs OAR The blanket overhead absorption rate is quick and easy to calculate but fails to identify the additional costs associated with low volume products. These costs are not related primarily to volume of input or output. The ABC system identifies these costs and correctly charges them to products using the appropriate activity cost drivers, thereby producing more accurate product costs and leading, therefore, to more accurate pricing and product strategy decisions. Traditional absorption overhead allocation methods, based on volume (eg. direct labour hours) are of limited use when the product or service being costed is unique. Increased product and service diversity (arising from products consuming resources in different proportions) favours a more sophisticated costing system, because increased diversity results in increased distortion based on traditional absorption costing methods. Activitybased costing emphasizes the need to understand how activities cause overheads. It is a model of resource consumption rather than spending and, therefore, provides a more effective mechanism for managing overhead costs....