Solution to part 1
Activity based costing is much different from traditional costing system due to following reason:
- In traditional costing system only one or limited number of cost pools are used for ascertaining overhead rates whereas in ABC system many cost pool reflecting different activities are used.
- Traditional system is best suited for labour intensive and low overhead companies whereas ABC system is best suited for capital intensive and high overhead companies.
- Traditional costing is not much expensive to implement and maintain whereas ABC system is relatively expense to implement and maintain.
- In traditional costing system problem of over costing and under costing arises as allocation of overhead cost based on different cost driver is not done whereas in ABC system accurate information is provided as overhead cost is allocated based on different cost driver which in turn supports managerial decisions (Nan 2019).
- In traditional costing all manufacturing cost is assigned to products whereas in ABC system manufacturing as well as non-manufacturing costs are assigned to products.
Comparison of total cost under both method
Calculation of overhead cost has been done by using both the method. Based on calculation it has been seen that total cost under traditional costing in July and August is £1730 and £1340 whereas total cost under ABC system in July and August is £1430 and £1535. Total cost under both the method differs due to the reason that in ABC costing indirect cost pools are used for allocating cost to specific products and in traditional method only single cost pool that is machine hour has been used for allocating cost to product. Hence, cost ascertained under ABC system is more accurate. As compared to traditional costing system ABC costing system is most accurate as more precise breakdown on indirect cost is shown under this method. Therefore, for ascertaining overhead cost ABC system must be used and implemented (Desti 2015).
Solution to part 2
Arguments in favour of absorption costing includes:
- In this method of costing importance of including fixed production overhead in product costs is recognised. All cost that is fixed and variable costs that are related to production should be charged to units produced. Pricing products which are on this method also make sure that each cost have been covered.
- All product costs are incurred with a motive to create product for sales hence, all cost of production should be attached to product till it is sold. Under this method, all production cost should include closing inventory.
- This method conforms with GAAP.
- In this method separation of costs into fixed and variable elements is avoided as cannot be done easily and accurately (Gersil and Kayal 2016).
- Calculation of over or under absorption of overhead denotes efficient utilisation of production resources.
Arguments in favour of marginal costing includes:
- This method is very simple and easily understood as in this method complex allocation of fixed production overhead to units of output is avoided.
- In this method overhead absorption rate is not calculated and as a result there is no situation of over or under absorbed overhead due to which calculation becomes easy and simple (Hasan 2015).
- In this method carrying forward a portion of fixed production overhead of current period to next period is avoided due to which comparison of cost becomes meaningful.
- In this method cost control is exercised in better way as more efforts are given in controlling marginal cost.
- This method helps in predicting impact of fluctuation in sales volume on profit and it also provides reliable measure for making short term decision.
Desti, K., 2015. Activity Based Costing (ABC): is it a tool for company to achieve competitive advantage?. International Journal of Economics and Finance, 7, pp.275-281.
Gersil, A. and Kayal, C., 2016. A comparative analysis of normal costing method with full costing and variable costing in internal reporting. International Journal of Management (IJM), 7(3), pp.79-92.
Hasan, M., 2015. Variable Costing and its Applications in Manufacturing Company. International Scholar Journal of Accounting and Finance, 5(1).
Nan, N., 2019. Comparative Analysis of Marginal Costing Method and Absorption Costing Method.