It recognises the reality in advanced manufacturing environments that overheads are not related to direct labour since the proportion of direct labour costs is small in the total costs of a product. Instead activities cause overheads.
Traditional costing systems tend to understate the overhead cost of a low volume complex product and overstate the overhead cost of a high volume product. ABC tends to allocate overheads to products which consume activities which in turn cause the overheads to arise.
Since ABC produces more accurate product costs, decisions taken by management are better informed eg. pricing decisions.
More accurate product profitability analysis can be produced.
It creates an awareness of the various activities that take place in an organisation and focuses on non-value added activities to ascertain whether they are needed or not.
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