Traditional Costing Versus Activity-Based Costing Advantages and Disadvantages

Overhead costs are not in proportion to the production output because of the method they are using. This leads to inaccurate pricing and costing decisions. An Activity Based Costing System would help find the real relationship between the products produced and overhead.

Activity-based costing can be defined as the managers allocate costs depending on the quantity of resources a product or service consumed in the manufacture of goods and services. The activity based

Activity-based costing is a system of accounting that puts emphases on activities performed to produce products or services (Schneider, 2012). In this costing system every activity is assigned a cost (Schneider, 2012). The goal of activity-based costing is not to allot common costs to products but to measure and then price out all the resources used for activities that sustain the production and delivery of products and services to customers (Mazumder, 2007). Activity-based costing is a cost system that is useful in business because of the fact that it does account for the cost of the products, resources used to produce the product and delivery of the product.

Glaser Health Products manufactures medical items for the health care industry. Production involves machining, assembly and painting. Finished units are then packed and shipped. The financial controller is interested to introduce an activity-based costing (ABC) system to allocate (or distribute) indirect costs to products. Indirect costs, as distinct from direct costs, cannot be unambiguously linked to specific products. The controller would like to calculate product costs based on ABC for planning and control, not inventory valuation.

This paper provides a brief presentation of Activity-Based Costing methodology, how is used as well as its short comings.

Costing systems are components of a broader accounting system used by a given company or organization. Their main function is to keep a focused eye on expenditures made by the company in question. Synthesis of Existing Cost Models to Meet System of System Needs, p.86. G.G. Toy's production process for dolls started with the basic raw materials needed for the bodies of the dolls, wool and things for the hair and clothing and all of these things were consist in production initially. Then, in its modern Chicago manufacturing facility, the company machine-molded the vinyl and resin into doll bodies and even had varies different styles and designs for the

The activity based costing (ABC) has the basic characteristic to seek to lower the misrepresentation generally occurred by the incorrect allotment of indirect cost acquired in traditional process (Stefano & Filho, 2013). Activity-based costing (ABC) is a costing methodology that identifies activities in an organization and assigns the cost of each activity with resources to all products and services according to the actual consumption by each. However in 1980’s the hospitals used to use coding system for medical tariff. Under this, medical services were divided into three number code, but due to a lot of weaknesses in tariff method a lot of hospitals started using “Diagnosis Related Group” method under which instead of fixed tariff the cost of

An organization costing system is a system that helps the management with the strategy planning while the system plays an important role in providing accurate cost information about the products and customers (Curtin, 2006). UPS utilizes the Activity-Based Costing (ABC) system. ABC assumes that activities cause costs and that cost objects create the demand for activities (Marx,

Typically, produce more diverse product entails more overheads and costs to the whole manufacturing process, for example, products which require more timing consumption in the production stage needs to assign more cost and overheads regarding other short-term production time product and incurrence more wages, electricity, storing, supplies .as such the firms required to assign more costs for the allocation base to these activities measured. In addition, some other cost driver influence another cost like the administrative and the selling costs. This charge would contribute in raise the total overheads cost insurance in the production. applying the activity based costing assist the organization to charge back these expenses for the consumer of the product.

Nowadays, we know that activity based costing system assigns overhead costs to products or services products that using a two-stage process, which focuses on activities. ABC is a relatively new and very important topic in managerial accounting. ABC allows us to find a way that we could determine the profitability of every product, profitability of every customer we serve, and the profitability of our process. Contents in brief, first that comparing potential advantages of ABC versus traditional costing methods. The

Activity-based management, activity-based costing and continuous improvement, all these help in the improvement of the efficiency in manufacturing, better control of overhead costs and the accurate costing of products. With this in mind, We disagree with the advice that Chuck Davis, the firm’s controller, gave Leonard Bryner. The traditional way of costing produce average costs that severely overstated or understated. Without the accurate costs, the firm would not be able to price properly their products and that would be damaging to the firm. With activity-based costing and management, all costs are accounted for with the help activity-drivers and overhead costs are decreased. In turn, the costs that the firm has for their products are more accurate and pricing is much easier.

At present PC4U apportions its production overheads based on direct labour hours. With a range of products available and opportunity for customising these products individually to meet the retailer’s needs, this report aims to assess the effectiveness of this traditional method of allocating production overheads. It will discuss the drawbacks of the current approach used by PC4U, as well as an alternative approach in the Activity-Based Costing system, which “is intended to overcome the weakness of the traditional method by having various pools of costs and then allocating each pool’s costs on the basis of its root cause.”(Averkamp 2007) As well as comparing the benefits and drawbacks of these costing systems to determine what recommendations should be given regarding the approach PC4U should adopt, the report shall also discuss the impact an activity based management system may have on the company.

Comparision two methods presents DRURY: “ Both use a two- stage allocation process. In the first stage a traditional system allocates overheads to production and service departments and then reallocates service departments costs to the production departments. An ABC systems assigns overheads to each major activity ( rather than departments). With ABC systems, many activity- based cost centres ( activity costs pools) are established, whereas with traditional systems overheads tend to be pooled by departments, although they are normally described as cost centres. (DRURY P.253) In other words the traditional method concludes that products cause the costs, ABC assumes that “ activities cause cost and that cost objects create the demand for activities” (Turney, p.51). Therofore, this system can be answer for companies seeking “true” cost information. Comparision of two methods is in ABC favour, as “is more accurate cost allocation method compared to traditional approach and, thus, is a better approach for managerial decisions such as pricing strategy, particularly, in heterogeneous product settings.” (RUHUPATTY P.5).

Traditional management systems rely on volume to allocate overhead. Indirect cost is allocated to items such as direct labor hours, units produced or the production of machine hours. Using only single cost drivers, potentially distorts cost estimates especially when dealing with high volume production. The implementation of Activity Based Costing serves as a solution to this downside in traditional systems. ABC utilizes various cost drivers both volume and non-volume related to estimate costs, providing more accurate estimations. Although this method benefits managers in providing the information needed for decision making and improving efficiency of business processes, it still is only limited to the internal aspect of

The management of a company needs to develop cost and management accounting systems which will provide adequate information about main impacts on cost characteristics and companies performance. The cost and