Traditional Costing Versus Activity-Based Costing Advantages and Disadvantages

Topics: Management accounting, Cost accounting, Activity-based costing Pages: 8 (2563 words) Published: January 11, 2011
Traditional costing versus Activity-based costing Advantages and disadvantages Costing systems are the programs that supply information about the value of direct labor hours and numbers of units produced. With the help of data such as product cost, the managers can generate estimation of cost associated with different activity carried in the organization. The costs systems operate by taking total cost as basic for calculation. Costing is essential for every organization, as every manufacturing and other department has to be assigned accurate budget for proper operation (Hansen, Mowen and Guan, 2006). Costing system provide information that is useful to managers for minimizing waste and allocating resources to different departments. However, it is important for the managers to understand that the resources necessary for designing and implementing the cost system should not exceed than the benefit drew out from the system (Thomsett, 2002).

Estimation of costs can be done with the help of two systems known as Traditional costing and Activity based costing. Traditional cost system was developed by the organization, General Motors. The organization used this system to calculate the total manufacturing cost that is sum of all the costs related to individual operations. However, the cost that matters the most to organization is profitability, which is required for improving the competitiveness. This cost estimation is done by activity based costing. The basic preface of activity based cost system is that the organization is an integrated process and operates when there is proper supply of parts and raw materials at respective plants. It continues until the final good reaches the customer (Drury, 2008). The traditional cost accounting system is based on the factors such as Wages and salaries, employee benefits, supplies, traveling allowances, depreciations and other fixed charges, operating expenses and miscellaneous (Dury, 2008). Activity bases accounting system is based on evaluation of suppliers, purchase order, expedite deliveries and supplies, purchase orders, expenditure on internal process, maintaining check of item quality and deliveries, resolving the problems and internal administration. From the above description on the factors that form base of accounting system, it can be stated that Traditional costing system operates in independent manner and Activity based costing system is an interdependent activity (Blocher, 2006). The main problems related to use of traditional costing system is limited economic focus. The benefits offered are intangible and remain unmeasured. These all the factors that might prove to be bottleneck for the company can be cleared by the help of activity management cost (Thomsett, 2002).

The traditional cost system follows the mentioned principles: •Traditional costing used cost allocation method. In cost allocation method, the costs are estimated based on the future. •This costing system does not take into consideration the factor of why and where cost goes. •This method does not give proper focus on the variances. •This method is not flexible, time oriented, and inaccurate. •The operational managers do not give any consideration to knowing the activities that are costly. •The focus is fiscal.

The cost of product and services are not associated with actual efforts improved.

Activity based costing system follows the mentioned principles •It measures the actual performance of the organization, taking into consideration every cost associated with activities. •With the help of this system the managers there is proper relation of consumption and expenses is maintained. •In activity based costing cost of activities are calculated based on resources that are consumed. •This method helps the managers to draw proper insight of sources of cost and the impact that might happen on and due to decisions taken. •Activity based costing system enables manager to realize the performance...

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