Activity-Based Costing: A Solution to Inaccurate Costing in Modern Firms

Executive Summary
The report investigated the costing system. It began by highlighting the loopholes left by the
use traditional costing system to the modern firms. In this case inaccurate costing have been
highlighted as the major challenge. To solve this ABC costing have been recommended for
modern firms as it allocates costs based on activity hence allowing a more accurate estimate
of costs.

Contents
Introduction............................................................................................................................. 1
Body......................................................................................................................................... 1
Problems associated with the traditional costing system.....................................................1
Benefits of the Activity-based costing..................................................................................2
Limitations of the Activity based costing..............................................................................2
Conclusion and Recommendations..........................................................................................2
References................................................................................................................................4

Introduction
Due to the divergence of the business environment the costing system is shifting as
technological advancements sets in. In this report will evaluate the limitations of the
traditional costing system and ways through which implementing the ABC costing system
can assist modern manufacturing firms improve their decision making as well as the entire
business operations (Clinton & White, 2012).
Body
Problems associated with the traditional costing system
In the traditional costing system, the overheads are assigned using a single factor like
machine hours as the basis. This simply indicates that the traditional costing system imply
that there is only one driver of the overheads which is the machine hours.
This is simply not the case in the modern manufacturing sector. The use of technology has
brought with it capital intensive methods of operations that have led to the rise in several
drivers like special inspections, special storage, machine set ups and so on (Hicks, 2006). As
the product and consumer demand diversity increases the more complex it becomes to
allocate the costs accurately using a single base. The traditional costing system contains all
the overheads in one cost pool and then divide by the number of machine hours consumed,
this produces one average rate for all products regardless of the number of activities
involved. The diversion of activities in the modern production set up have made them
independent of the machine hours hence the resulting allocation will be misleading (Cokins
& Hicks, 2007).
Benefits of the Activity-based costing
The activity-based costing is a system that assigns the costs based on activities that an item
consumes during the production phase. The system is favourable for manufacturing sectors
which are characterised by massive use of technology which leads to immergence of diverse
activities. These activities have little correlation with the machine hours with the direct
labour cost and hence can only be allocated efficiently using several cost drivers. This
enables more accurate allocation of costs (Burns & Baldvinsdottir, 2005).