§ It is impossible to allocate all overhead costs to specific activities.
ABC costs are based on assumptions and simplifications. The choice of both activities and costs drivers might be inappropriate.
§ ABC can be more complex to explain to the stakeholders of the costing exercise.
§ The benefits obtained from ABC might not justify the costs.
2Demo
On 15 January 2005 the Board of Directors of Shane voted to proceed with two reorganization schemes. Shane’s financial year end is 31 March, and the financial statements will be finalized and published on 30 June.
Scheme 1
The closure costs will amount to $125000. The factory is rented on a short-term lease, and there will be no gains or losses arising on this property. The closure will be announced in June, and will commence in August.
Scheme 2 The costs will amount to $45000 (after crediting $105000 profit on disposal of certain machines). The closure will take place in July, but redundancy negotiations began with the staff in March.
Required
Explain and calculate the year-end restructuring provision
Solution:
Scheme 1 The obligation arises in June, after the year end, and so there will be no provision. However, the announcement in June should be disclosed as an event after the balance sheet.
Scheme 2 Although the closure will not begin until July, the employees will have had a valid expectation that it would happen when the redundancy negotiations began in March. Therefore a provision should be recognized. The provision will be for $150000 because the expected profit on disposal cannot be netted off against the expected costs.
4. Environmental provisions
These are often referred to as clean-up costs because they usually relate to the cost of decontaminating and restoring an industrial site when production has ceased. Merely causing damage or intending to clean-up a site will not create an obligation. Generally, a provision will only be recognized if there is a legal obligation to repair environmental damage. However, some entities publish specific corporate guidelines that include environmental awareness. If these guidelines create a constructive obligation to clean-up then a provision will be required.
