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ABC And Traditional Costing Approach

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Question:

Discuss about the ABC And Traditional Costing Approach.
 
 

Answer:

Introduction

A method facilitating in conveying expenditure to each component of organization is termed as costing. The main purpose of this report is to appraise the two approaches used by the companies that is Activity Based costing and traditional costing. An effective costing system is the one which can minimize the waste using the information given by the system. Hence to obtain absolute benefits of the resources it should be used cost-effectively.

Traditional Costing System

In this costing approach cost is allocated as per activity basis and therefore product cost is indistinct. According to this approach cost is incurred on its manufacturing when a product is manufactured. The approach followed is not completely valid since these theories not extent to work which are not completely related to the product.

Main difficulty with this method is, it consigns expenses completely to the product. This theory does not have many indirect cost pools for each branch. In traditional costing, expenses are initially related with cost centers afterwards to products.

Activity Based costing

This accounting method assigns cost to activities and not to a particular product or services. ABC method takes operating expenses, utilization of resources and productiveness of resources is obtained from the information system of the company which is collectively by the management. This approach was formed with the purpose to decipher troubles dealed in traditional costing approach (Innes, Mitchell and Sinclair, 2000). Traditional costing approach allocates cost on the averaging basis which is altogether different in ABC since overhead are allocated by forming a liaison between cost and its related activity.

Difference in two costing methods

  • Total overhead is allocated to each product using indirect methods in traditional costing while in ABC cost is held as direct cost and appropriation is completed rationally to individual service or product which shows definite usage of cost for every product.
  • Exhaustive information is required of all the resources in ABC though in traditional costing total overhead cost is required as straightforward allocation is done.
  • Different elements of cost are defined by ABC for diversified range of products. Conversely traditional costing recognizes fewer classes for cost components.

Strengths and weakness of ABC

Strengths
  • ABC facilitate in distinguishing products which utilize less resources manager can take decisions relating to price of product efficiently.
  • Activity Based Costing can discover cost-effective products which facilitate the manager to eradicate the products not creating higher profit and consuming major amount of resources thus escalating the effectiveness with no added consumption of resources.
  • One of the significant benefits of ABC is evaluation of individual product or service precisely. ABC facilitate in recognizing products or activities which are not generating profits making it a instrument for decision making by the management (Turney, 1992).
Weakness
  • Main criticism about ABC is exploitation of information. Productivity of ABC requires diverse information which requires huge resources.
  • Since ABC requires information additional problem arises in gathering and dealing with the information. Kaplan and Anderson (2003), also believe this dilemma and recommended that desertion is not the solution.
  • Management also confronts challenge to alter the arrangement of organization for successful implementation of ABC. The major cause for the amplified disapproval against ABC is prolonged schedule of time, scantiness of computer resources and surpassing budget (Cohen, 2005).

Conclusion

Both methods are uniformly significant for analyzing product cost. ABC is used as an alternate to traditional costing. The significance of ABC is to examine the non value adding products and other supporting activities. The main purpose of  using this method is it reduces the cost, develop the process and other activity’s based on precedence. ABC can be useful in every organization. Such as entity can assign its advertisement cost straightly to product where cost is used and hence providing a accurate image in comparison to traditional costing. Hence it can be said that company should adopt Activity based costing for better presentation.

 

References

Cohen, S. Venieris, G. Kaimenaki, E. (2005). ABC: adopters, supporters, deniers and unawares. Managerial Auditing Journal. Vol. 20. No. 9. pp. 981- 1000.

Innes, J., Mitchell, F., & Sinclair, D. (2000). Activity-based costing in the UK’s largest companies: a comparison of 1994 and 1999 survey results. Management accounting research, 11(3), 349-362.

Kaplan, R. S., & Anderson, S. R. (2003). Time-driven activity-based costing.

Turney, P.B., (1992). Activity based costing. Management Accounting Handbook”(4 th Edition), edited by C. Drury, Butterworth-Heinemann and CIMA.  

Cooper, R. (1992). Activity-Based Costing. In Handbuch Kostenrechnun. Gabler Verlag.

Cooper, R., & Kaplan, R. S. (1992). Activity-based systems: Measuring the costs of resource usage. Accounting Horizons, 6(3), 1.

Drury, C. (1992). Activity-based costing. In Management and Cost Accounting. US.

Gosselin, M. (1997). The effect of strategy and organizational structure on the adoption and implementation of activity-based costing. Accounting, organizations and society, 22(2), 105-122.

Ittner, C. D., Lanen, W. N., & Larcker, D. F. (2002). The association between activity?based costing and manufacturing performance. Journal of accounting research, 40(3), 711-726.

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