Managerial Accounting: Traditional vs ABC Costing Method

MANAGERIAL ACCOUNTING 1
MANAGERIAL
ACCOUNTING

MANAGERIAL ACCOUNTING 2
Contents
Introduction:...............................................................................................................................3
Calculation per unit using Traditional costing method:.............................................................3
Calculation per unit using ABC costing method:......................................................................4
Profit and Loss statement under Traditional costing method:...................................................6
Profit and Loss statement under ABC costing method:.............................................................6
Over and under absorption costs:...............................................................................................8
Ways of treating the over or under absorption:..........................................................................8
Treatment of over or under applied overheads:.........................................................................9
Conclusion:...............................................................................................................................9
References:...............................................................................................................................11

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Introduction:
In the field of accounting, there are mainly 2 methods of calculating the costs, the traditional
costing method being the first and the activity based costing method being the second. These
are the methods of the allocation of the indirect costs.
Both of these methods are used for the purposes of estimation of the overhead costs which are
related with production and then these are the costs that are assigned to the products using
some rate of the cost driver. The difference between these 2 methods is the accuracy and the
complexity which is employed when employing these methods. The traditional method of
costing is the method which is way simpler and is also considered to be less accurate when
compared with the activity based costing method. This is the method which assigns in these
costs of the overheads to the products and is based upon the arbitrary average rate. The
method of ABC is more complex and is also more accurate when compared with the
traditional method of costing. The first method is the one which assigns all of the indirect
costs to the various different activities and then goes on to assign in the costs to the products
which is based upon the usage of the various different activities of each one of the product.
The traditional costing method is the system wherein all of the indirect costs are applied to
the products which is based upon a pre-determined overhead rate. The method of ABC and
the traditional costing system helps in treating the overhead costs in one single pool of
indirect costs. The traditional costing method acts accurately when the indirect costs are
much low when compared with the direct costs. The following are the steps that are applied
when it comes to the allocation of the costs under the traditional costing method:
1. Identification of all of the indirect costs
2. Estimation of all of the indirect costs suing some appropriate period, usually a year,
quarter or a month

MANAGERIAL ACCOUNTING 4
3. Selecting the cost driver with one casual link to the cost such as the labour or the
machine hours
4. Estimation of the different amounts of the cost drivers for an appropriate period using
the labour hours for each quarter
5. Computation of the overhead rate
6. Application of these overheads to the products using a predetermined overhead rate.
The activity based costing system is much more accurate when compared with the traditional
costing system. This is due to the fact that this method provides a more precise breakdown of
all of the indirect costs. The activity based costing system is also complex and more costly
when it comes to implementation. The change from the traditional costing method to the
activity based costing method is very difficult (Wilkinson, 2019).
Calculation per unit using Traditional costing method:
The following table shows the calculation of cost per unit using the Traditional costing
method:
Particulars Basic Advanced
Units
1,700.0
0
1,600.0
0
Direct material
350.0
0
580.0
0
Direct labour
175.0
0
280.0
0