Management Accounting - Assignment PDF

ACCOUNTING AND FINANCE- Management Accounting
Executive Summary
The report seeks to explore that traditional method of allocation of cost over products and services are
outdated and no longer serve the needs in the fast changing world. Further, the report highlights how
Activity Based Costing overcomes those deficiencies.
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ContentsExecutive Summary...............................................................................................................................1
Table of Content....................................................................................................................................2
Introduction...........................................................................................................................................3
History...................................................................................................................................................3
Traditional Costing System- Cost Allocation..........................................................................................3
Advantages........................................................................................................................................4
Disadvantages....................................................................................................................................4
Allocation of Cost under Modern Costing System.................................................................................4
Advantages........................................................................................................................................4
Disadvantages....................................................................................................................................4
Traditional Cost System Vs Modern Costing System.............................................................................4
Conclusion.............................................................................................................................................7
References.............................................................................................................................................7
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Introduction
The term costing shall be defined as allocation of cost to objects based on parameters which vary from
enterprise to enterprise. The term has its origination back dated 20 th Century where in traditional
costing was coined on account of surging demand for allocation of cost based on parameter like
labour hour, material cost. The method held its importance till end of 20th Century where in need was
felt for greater accuracy on account of technological updation and need for true cost computation was
felt.
Further, with the changing market scenario, the market became competitive and driven by consumers.
Thus, changing price of product became difficult and the only way to earn profit was estimating the
true cost of product and minimising the same. The surge for ascertaining the true cost of production
gave birth to modern costing which is popularly known as Activity based costing.[ CITATION Gow11 \
l 1033 ]
Further, in today world the most common traditional costing method is absorption costing where in
the indirect cost of production are absorbed over different products.
Traditional Costing System- Cost Allocation
Traditional Costing System is slowly losing out its relevance in today’s market on advent of change in
technology and need for greater accuracy. The traditional costing system allocates cost of products
on the basis of direct and indirect cost wherein the direct cost is allocated based on true marching
where in the cost incurred for that is truely matched with that product. However, indirect cost are
allocated based on arbitrary manner on the basis of parameters like labour, wage rate etc.
[ CITATION Dav02 \l 1033 ]
Generally, under this method the allocation of indirect cost is not properly matched with the product
displaying incorrect result and profits. Further, the rate of allocation is determined based on an
Overhead Allocation rate which is computed in the following manner:
OAR= Total Indirect Manufacturing Cost/ Cost Allocation Base.
Advantages
The advantage are that it is in legal requirement of GAAP and User friendly and widely known along
with easy to use
Disadvantages
The main disadvantage are unbalanced inventory as stock shall be counted as asset, Revenue report
shall be inaccurate and Poor management and forecasting shall be inaccurate.
Allocation of Cost under Modern Costing System
Under the modern system of costing, the deficiencies identified under traditional system of costing
where overcome by means of allocation of indirect cost of production over different products through
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