ABC Costing: A Comparison of Traditional and Activity Based Costing Methods

ABC costing
ABC costing
Traditional costing and ABC costing ABC costing

Table of Contents
INTRODUCTION......................................................................................................................2
TRADITIONAL: ABSORPTION COSTING METHOD.........................................................2
ACTIVITY BASED COSTING METHOD..............................................................................2
NUMERICAL EXAMPLE........................................................................................................3
FINDINGS.................................................................................................................................6
WHETHER OR NOT TO USE ABC METHOD FOR DECISION MAKING........................6
CONCLUSION..........................................................................................................................7
REFERENCES...........................................................................................................................8

INTRODUCTION
Management accounting systems have become an integral part of any organisation
nowadays and are an important area that helps in computing and controlling costs. These
systems have evolved over the years. But there are certain organisations that still use the
traditional methods of cost allocation even after new and better areas are devised. The
coming sections shall provide a comparison on the difference in the approach followed by the
traditional absorption costing method and the modern activity based costing method with the
help of relevant numerical examples.
TRADITIONAL: ABSORPTION COSTING METHOD
The traditional absorption costing method helps in allocating costa by using an
estimated overhead costing rate for cost allocation. The allocation is done on the basis of the
budgeted hours of production (Law, 2016). The allocation in this system ignores the use of
resources by the different products and just focuses on the hours of production that too
budgeted. The biggest disadvantage is no importance given to the level at which the activity
is undertaken by each product (Noreen, Brewer, and Garrison, 2014).
ACTIVITY BASED COSTING METHOD
Activity based costing method helps in more precise cost allocation by using the cost
drivers that pull cost overheads. As a result the cost that gets allocated is done on the basis of
the criterion that is the base motive behind occurrence of the cost. E.g. if the inspection
overhead is to be divided then the same is to be done on the basis of the number of inspection
checks. There is no relevance of the production hours, but the drivers behind the overhead
expense are relevant. They can be the number of machine setups, quality checks, inspection
run, production run, number of soldering, and etc. The example of using the traditional
costing method and the activity based costing method is listed in the next section (Dale, and
Plunkett, 2017).
JUDGEMENT REQUIRED
The behaviour pattern of each kind of overhead is to be analysed in order to decide
upon the accurate cost driver behind the occurrence of any kind of cost. Further, the
organisation needs to classify all the production overhead costs into several overheads.