Activity-based costing has the potential to improve the accuracy of product costs, however, it is important for management to understand its limitations. Identify and explain two limitations.

While ABC has the potential to improve the accuracy of product costs, it is important to understand its limitations:
Facility-level costs.
Some proponents of ABC recommend that virtually all costs, including facility costs, be assigned to products. However, facility-level activities may bear no obvious relationship to products. If these facility-level costs are assigned to products, the allocation basis must be arbitrary. The higher the proportion of allocated facility costs, the greater the arbitrary element of the product costs. Of course a business must cover its facility-level costs to make a profit but, in the income statement, it is better to deduct them after estimating the product-related profit margin, rather than include them in the product costs.
Use of average costs.
Activity-based estimates of the cost per unit of product, such as the costs of the Hensley Tooth and the Custom Cast Tooth in Exhibits 8.7 and 8.8, are average costs. Unit level costs are incurred for each unit of product, but batch-level, product-level and facility-level costs must be divided by the number of units produced to estimate the cost per unit of product. It is important that managers understand this. Many product-related decisions are better based on either unit-level costs in the short term or total product costs in the longer term, rather than looking at the average cost per unit of product.
Complexity.
When ABC is set up as an ongoing costing system, it involves more detailed recording and analysis than for conventional costing systems. If the company is changing rapidly, the data in the activity-based system must be updated frequently to avoid the production of outdated, irrelevant information. This can be expensive. The level of complexity increases dramatically when the system is used for activity management as well as for product costing, because activity management requires a more extensive and detailed analysis of costs and activities.