Using Traditional Costing And Activity Based Costing

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Many organisations have different products and services that they provide to their customers and it can be extremely difficult to disperse costs between them. Some may prefer to distribute variable costs evenly within cost objects or some may prefer to distribute costs per unit or batch taking into consideration other factors such as machine or labour hours. There are two main systems used; traditional costing and activity based costing (ABC). Included in this essay will be the definitions and comparisons of the two costing systems as well as how activity based costing can lead to higher profits. An example of a company will be given to see if adopting the ABC system can lead to an increase in profits and will then finish with a…show more content…
It is critical to find out the activities and the costs that occur from them so that they can then later be allocated to a cost object (customer, service or product) that necessitates the activity to be taken ahead. This technique is the more sensible approach for overhead allocation rather than just dispersing costs based on machinery hours or direct labour hours. Both traditional and activity based costing have identical models where by it starts with an overhead cost account followed by first stage allocations to cost centres, then followed by a second stage of allocations and finally ending at the cost object. A cost centre is a” location to which overhead costs are initially assigned” (Drury, 2011, pg. 295). The major difference is in activity based costing where after the first stage allocations instead of a cost centre it is allocated to an activity cost centre and during the second stage of allocations activity cost drivers (a measure that has major influences on the cost of a particular activity) are used rather than just direct labour or machine hours. The ABC system assigns overheads to major activities whereas the traditional system overheads are normally pooled by departments. This can be extremely beneficial to a company as they are able to spread the costs out more because they can look more into depth of a specific product or service rather than just a department helping
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