Traditional Costing vs Activity Based Costing: Which is More Accurate?

FINANCE
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POST 1
Traditional costing measures refer to the costing techniques whereby the overhead cost are
allocated between the various products based on the direct cost usually machine hours or
direct labour costs. A key question thereby arises with regards to whether traditional costing
measures provide a true reflection of the costs. While the direct cost allocation across various
costing techniques essentially remains the same, the key difference amongst traditional
costing and modern costing methods such as ABC (Activity Based Costing) is with regards to
allocation of overhead costs across the various products (Damodaran, 2015). In this context,
it has been witnessed that ABC tends to allocate the overhead costs based on the underlying
activities that constitute the overhead costs and the usage of these overhead activities by the
various products. As a result, ABC is able to capture the overhead cost associated with
different products much more accurately then traditional costing. Traditional costing
essentially leads to over-allocation and under-allocation of overhead costs across the products
and thereby facilitates poor decision making in scenarios where multiple products are
manufactured (Drury, 2016).
An appropriate alternative to traditional costing can be in the form of activity based costing
(ABC). The primary difference between ABC and traditional costing methods is that activity
based costing tends to rely on the actual costs that are incurred with regards to overhead costs
related to a given product. In this regards, the cost driver is identified and then based on the
driver value, cost allocation takes place (Bhimani et. al., 2017). This is quite unlike the
traditional costing where the cost allocation is done on basis of a particular direct cost
without much reference to the individual activities involved in overhead and the exact
consumption of these by the respective products. Thus, where more accuracy is desired with
regards to costing, it would be preferable to use ABC approach instead of traditional costing
approach. It is noteworthy that ABC approach tends to be significantly more complex in
compared to traditional approach and requires dedicated resources in terms of manpower,
time and money to make the shift (Parrino and Kidwell, 2014).
Post 2
It is apparent that cost need to apportioned correctly across products. This is pivotal since if
the costs in one products are under allocated, then the same would be over allocated on the
other products. Considering the intimate link between cost and price, the product whose cost
is underestimated would also be underpriced and therefore might attract huge sales but at