Activity Based Costing and Traditional Costing for Creations Ltd
Even though “ABC has emerged as a tremendously useful guide to management action that can translate directly into higher profit” (Kaplan and Copper1991) It is not fair to say that Absorption costing is no longer relevant. In fact ABC does not conform to GAAP (generally accepted accounting principles). Absorption costing is conventionally used for external reports, filings and other statutory compliances; where all of the manufacturing costs and only manufacturing costs are needed. For example auditors are unlikely to be comfortable with “allocations that are based on interviews with the company’s personnel. Such objective data can be easily manipulated by management to make earnings and the key variables look more favourable” ABC costing is primarily used for “reporting information to external stakeholders, primary shareholders” (Lowder 2006) Therefore if a business wishes to undergo ABC, it must prepare two sets of accounts, which as explained, can be tiresome.
When considering which method is superior, it must be remembered that both methods have strengths for various aspects of a business. Although absorption costing is a valid method, organisations with diverse products and services will use just a single cost driver to absorb overheads, which leads to distorted cost estimations. Also by excluding certain non-production costs in absorption costing, management can make uninformed decisions. However Absorption costing is very easy and affective to implement for companies that provide only one product. As ‘Creations’ has 2 productions, ABC can give managers a “clear picture of how products brands, customers, facilities, regions, or distribution channels both generate revenues and consume resources”… “And helps managers focus their attention and energy on improving activities that will have the biggest impact on the bottom line” This said, it is claimed “the predicted benefits of ABC… may be an unreliable costing technique” (Dugdale and Jones 2003)
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When considering which method is superior, it must be remembered that both methods have strengths for various aspects of a business. Although absorption costing is a valid method, organisations with diverse products and services will use just a single cost driver to absorb overheads, which leads to distorted cost estimations. Also by excluding certain non-production costs in absorption costing, management can make uninformed decisions. However Absorption costing is very easy and affective to implement for companies that provide only one product. As ‘Creations’ has 2 productions, ABC can give managers a “clear picture of how products brands, customers, facilities, regions, or distribution channels both generate revenues and consume resources”… “And helps managers focus their attention and energy on improving activities that will have the biggest impact on the bottom line” This said, it is claimed “the predicted benefits of ABC… may be an unreliable costing technique” (Dugdale and Jones 2003)
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