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    ABC Costing; Examples from Manufacturing and Hospital Settings

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    Simpson Brothers Manufacturing Company has been using a traditional overhead allocation method to allocate costs to products since the company began. Although operations have been running fairly smoothly, the owners have been wondering if they should investigate a new method known as ABC costing. Some of the company's products are highly labor-intensive, while others are manufactured using highly automated production lines.

    They like the sound of the name, but they don't understand in what way the method differs from the method they already use. The method they use allocates overhead based on labor hours used for each product. Since labor is certainly an "activity," they are having trouble understanding how their costing system would change.
    1.Discuss the main differences between ABC costing systems and traditional overhead allocation systems. Based on your knowledge and experience, which method you prefer and why?
    2.How might your company benefit from using ABC? Describe any experience you have with ABC?
    3.Are there any circumstances for which you would not recommend that your company switch to an ABC costing system?
    4.In your opinion, discuss why is overhead allocation necessary in most manufacturing environments?
    5.What problems are caused by the allocation of overhead? In your judgment, which of the problems associated with the allocation of overhead are overcome if ABC costing is used and do any problems remain?

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    Solution Preview

    Hi there! Please see my below response to ABC costing systems.

    The main differences between traditional overhead allocation and ABC costing are that ABC costing accounts for the fact that there may be more than one cost driver for an expense. ABC costing is the more accurate form of costing since it breaks out expense buckets into what is termed "costing pools" and assigns one or more cost driver to each costing pool. There is much more flexibility in ABC costing compared to traditional costing methods.
    An organization can benefit from an ABC costing system because it tends to be a better measurement of actual resource consumption. Its results are more accurate than other traditional methods. In addition, the implementation of an ABS costing model is very detailed and requires an organization to review how it runs its business. This is a good thing, as often discoveries are made that lead to process improvements.

    Although the ABC method is the preferable method, it does have its drawbacks. For one, it ...

    Solution Summary

    Benefits of ABC costing systems when compared to traditional costing systems.