Difference between Traditional and Activity Based Costing

Answer 3
Under traditional method of costing, cost is absorbed based on a single factor
whereby the indirect cost of production of goods are allocated on the basis of a
single factor like labour hour, machine hour etc. The method ignores the other
critical factor which have a crucial impact on the costing of a product. Thus, the
result under the said method does not represent a true cost picture as the
method believes that cost can be allocated on the basis of a single factor.
On the other hand, under Activity Based Costing cost is allocated on the basis of
a number of cost driver which have influence on the costing of a product. This is
a modern system if costing where by the various indirect cost are categorise
under different head and the cost of these indirect cost are allocated on the
basis of cost drivers. Thu, the said method provides a more accurate cost
computation of product. Further, the method properly matches the indirect cost
incurred to the product.
In the present context, there are three model and cost of each model has been
computed under two system of costing i.e. Traditional System of Costing and
Activity Based Costing. There has been difference in cost under both the heads
on account of following reason:
(a) Difference in method of allocation of indirect cost under two methods;
(b) Activity based costing identifies true cost of product and allocates cost based
on different driver;
(c) Traditional Costing allocates cost based on a single factor and does not
properly matches cost.

Computation of cost under Activity Based Costing
There are three models that are produced in the company. The production of
units comprised 16000 units for Model 1, 15000 units for Model 2 and 4000 units
for Model 3. The production involves two runs for Model 1, 3 runs for model 2 and
5 runs for model 3.
The details provided w.r.t drivers for activity based costing has been described
here-in-below:
Particulars Model 1 Model 2 Model 3
Direct Material 50 60 70
Direct Labour (hr / Board) 2 3 4
Set up Time (Hr/ Board) 5 5 5
Machine Time (hr/ Board) 1 1.25 2
Engineering 40% 35% 25%
Facility 55% 30% 15%
Other costs 45% 38% 17%
Particulars Amount
Machinery Cost Pool 1600000
Set Up Cost Pool 25500
Engineering Cost Pool 836000
Facility Cost Pool 660500
Receiving/ Inspection Cost Pool 200000
Material-Handling Cost Pool 350000
Quality -Assurance Cost Pool 620000
Packaging/Shipping Cost Pool 544000
Overhead Costs 4836000
On the basis of drivers, the cost has been allocated in the following manner:
(a) Machinery Pool Cost has been allocated to the three models based on
Machine time per unit. Accordingly, the time taken for production of Model 1
is 16000 hours, Model 2 is 18750 hours and Model 3 is 8000 hours.
Accordingly, the allocation has been worked out on the basis of individual
hour to total hour.
(b) Set up Pool Cost has been allocated to the three models based on Machine
setup time. The set up time is depended on runs required for production.
Accordingly, the machine set up time for production of Model 1 is 10 hours,