Activity Based Costing vs. Traditional Methods

This assignment explores the limitations of traditional costing systems when applied to complex defense contract manufacturing processes, highlighting their potential for inaccurate cost allocation. It proposes Activity Based Costing (ABC) as a superior alternative, emphasizing its ability to accurately allocate overhead costs based on actual usage and facilitate targeted cost reduction strategies. The document delves into the steps involved in implementing ABC, contrasting it with traditional methods and discussing its benefits for organizations dealing with intricate product structures.

Running head: OVERHEAD MANGEMENT AND DEFENSE CONTRACTS
Overhead Management and Defense Contracts
Name of the Student:
Name of the University:
Author Note

1
OVERHEAD MANGEMENT AND DEFENSE CONTRACTS
Problem Statement
The issue that has been presented in the question is that the development of a problem
statement has been asked to be identified in regards to the process of the activity based costing.
Before developing a problem statement, the meaning of the problem statement must be
understood. A problem statement refers to a clarified description of the issues that are essentially
needed to be addressed by a problem solving team. The primary purpose of developing a
problem statement is that the issues faced in regards to the problem should be addressed
accordingly so that the proper solution is obtained.
The problem statement that should be developed in regards to the case provided is that
the costs when allocated on the basis of traditional costing systems often leads to the inaccurate
computation of costs in regards to the complex manufacturing processes and products. Often the
results are facilitated by the under-costing or over-costing of the activities. In case of the
traditional costing systems, the problem lies in the fact that the complex products have not been
allocated an amount of overhead costs. Moreover, the in case of the traditional costing system
the simple products are allocated with too much of the costs (Öker & Adıgüzel, 2016).
The traditional systems of costing apply indirect costs to products on the basis of a
predetermined overhead rate. The traditional costing systems treat the overhead costs on the
basis of a single pool of indirect costs (Weygandt, Kimmel & Kieso, 2015). Moreover,
traditional costing involves a huge number of procedures. These essentially include the
following:
 identification of the indirect costs;
 indirect cost estimation;

2
OVERHEAD MANGEMENT AND DEFENSE CONTRACTS
 selecting a particular cost driver that has been linked with the costs with a causal link
(machine or labor hours);
 estimation of the amount in relation to the cost driver for the appropriate period;
 computation of the rate of predetermined overhead;
 the application of the predetermined overhead rate for applying overhead to the products.
This is evident enough to show that the traditional based costing is not a competent form
of costing for organizations or manufacturing firms that deal in complicated structures
(Edmonds, 2016). Moreover, the traditional based costing system deals in a single cost pool,
which makes the process more complicated in nature. The traditional based costing system is
also a time consuming process that also leads to inaccurate development of cost drivers (Alles,
2015).
Therefore, the problem lies in the fact that when the traditional based costing system lead
to a number of issues like the ones that has been stated before, what type of costing method
should be used in order to mitigate these issue?
Potential solution
The only solution that is applicable in such a case is the activity based costing. Activity
based costing facilitates the allocation of the overhead costs to the items that actually utilize it.
The system can also be used for the targeted reduction in the costs of the overhead. The activity
based costing also deals in a multiple number of costing pools making the cost allocation
technique simple and accurate.

3
OVERHEAD MANGEMENT AND DEFENSE CONTRACTS
References
Alles, M. G. (2015). Drivers of the Use and Facilitators and Obstacles of the Evolution of Big
Data by the Audit Profession. Accounting Horizons, 29(2), 439-449.
Edmonds, T. P., Edmonds, C. D., Tsay, B. Y., & Olds, P. R. (2016). Fundamental managerial
accounting concepts. McGraw-Hill Education.
Öker, F., & Adıgüzel, H. (2016). Time‐driven activity‐based costing: An implementation in a
manufacturing company. Journal of Corporate Accounting & Finance, 27(3), 39-56.
Weygandt, J. J., Kimmel, P. D., & Kieso, D. E. (2015). Financial & Managerial Accounting.
John Wiley & Sons.