Traditional and Activity Based Costing: A Comparative Analysis

This report provides an understanding of traditional and activity based costing methods and compares their usefulness in decision making. It explores the strengths and weaknesses of activity based costing and suggests that it is more accurate for future predictions of volume and prices. The study also discusses the life cycle of a table in both costing methods and highlights the importance of choosing the right costing method for Sweden.

REPORT

INTRODUCTION
Costing accounting is method used in management accounting which aims at capturing
total production cost by assessing variable cost of each cost of production and the fixed costs.
Cost accounting is for internal use by the management for proper allocation of costs. This is used
for assessing the cost of producing an item. There are not standards for cost accounting as it is
for the internal use. Activity based costing is used for identifying cost associated with each
activity. Present report will provide understanding about the statements used in Traditional and
ABC Method. It will also provide about the statement that is more useful in making decisions for
future production volumes and prices about the Sweden. Study will also suggest about other
methods that can be used to make future projections on prices and volume.
MAIN BODY
Concepts of costing
Traditional costing
It refers to making use of the overhead related to factory over goods and services that rely
upon consumption of production resources in quantitative terms. In this costing method
overheads are applied based over either machine hour used or the direct labour hour consumed.
Issue with this costing method is that the factory overheads are much more than allocation basis.
This results in small changes in amount of resources consumed will be triggering massive
changes in amount of the overheads applied (Abu, Nor and Rahman, 2018). The issue is common
in the high automated production environment, where factory overheads are quite larger & direct
labour is near to non existence.
Activity Based Costing
To overcome the problems related in traditional costing method, another method method
was developed known as Activity based costing. This costing uses much detailed analysis about
the relationship between the cost drivers and overhead costs. There are any cost drivers that
could be used for creating the well-founded overhead costs allocation. This is the method for
making use of the overheads costs which are being related to several activities. When the
expenses are being assigned to several activities. This type of method is basically used to work in
more critical environment. They make use of huge number of elements and factors which are
difficult to sort out. It is less beneficial in that environment which is stream lined. Analysis based
on absorption costing and ABC costing
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Businesses use absorption costing method for identifying the amount of spendings over
individual products and production processes. These figures are used as basis for the cost of
goods sold, that is important for calculating the net income. Requirements of accounting
standards could be met using absorption costing. ABC is based over labour and materials
directly contributing the product including variable and fixed overhead (Geiszler, Baker and
Lippitt, 2017). Variable costs of company affects the output and fixed cots are not varying with
the output.
Absorption costing has the main focus of measuring the cost of goods sold. Unlike the
ABC, absorption costing do not get into details of cost generated by each product. Absorption is
not helpful in making comparisons about the product line to drop.
In this costing when the products are not sold, fixed associated with product are not
reduced from the earnings. The assignment of little overheads to products in warehouse,
company an effectively keep the overhead costs out of income statements, that makes the
business to look more profitable.
ABC allows company to make comparisons. ABC method is more useful in management
decision-making. ABC assigns overhead and costs to specific products & processes, which gives
the management areas where expenses are required to be cut. Company can compare the cost of
activity with the industry norms. In case of big customer requiring additional costs like returns or
special care, ABC helps in assigning the expenses to customer and assessing the profitability of
customers (Labro, 2019). ABC provides for evaluating the overhead costs associated with every
channel for comparing the revenues.
Short term and Long term analysis
Activity based costing is beneficial for making long run and short run businesses. They
provide the relevant variable costs of product that are helpful in decision making. It provides
classification of short term and long term variable costs. Short term variables cost is allocated to
product basis of cost drivers related to volume like direct materials, direct labour and the
machine hours. Cost drivers related to volume cannot be used in ABC for allocation of long term
variables costs to the products. As they are driven by variety and complexity of the business
activities than volume. The bifurcation helps the management in making more informed
decisions for both the short-term and long term analysis of production and prices.
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Marginal costing and absorption costing
These are basically two different techniques used for valuing inventory of company. In this
type of costing cost related to variables incurred are applied by company to inventory and where
in costing related to absorption both the variable and fixed cost incurred by company is applied
to inventory.
Marginal Costing
Marginal cost refers to cost of every single additional output in units. Marginal costing
can be termed as that method of costing related to costs are charged against the cost which are
related to fixed and units are written off completely against contribution (Aleem, Khan and
Hamad, 2016). It is helpful in making decision for carrying on any product or service further and
to ascertain adequate level of activities by break even analysis. Profitability of product is
determined on the basis of contribution margin.
Absorption Costing
This is also known as costing which is full. In this type of method all production costs ,
including fixed and variable are considered as product cost. Fixed costs in production are not
considered as period costs in this costing method. Period costs in this method include selling,
distribution, administration and general cost that are not added to cost of product but is expensed
at period incurred. This costing method is accepted by the accounting standard. It is helpful in
estimating job costs and profits over job by absorbing the overhead into product costs.
Life cycle of the table
Life cycle in traditional costing provides various deviations from real product life cycle.
It focuses over cost of labour, materials and lower proportion of overhead apportioned using
absorption rate over the product. Where life cycle in ABC costing is much accurate as it has
emerged as an innovative and accurate costing method. BC is based over principle that the
product or consume activities & activities consume the resources that generates cost. ABC focus
over calculating cost incurred on performance of activities for manufacturing product. Life cycle
of the given table is shorter in traditional costing and where it is more in activity based costing
(Labro, 2019). Life cycle will be longer as Sweden is profitable in ABC where running in loss in
case of traditional method. Company do not like to move with product line having negative
profits. Also it is essential to identify that loss is not represented due to the method of costing
chosen.
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Strength and Weakness of Activity based costing
Strength:
 In an assessment of cost system ABC could be used for convincing management for
taking steps for becoming more competitive. With this they can strive for improving
quality with focuses on cost reduction.
 Continuous improvement of activities by analysis, enables ABC in eliminating or taking
connective actions against the less efficient or non value adding activities.
 Products costs that are realistic, mainly in the high tech industries where the overhead
costs are significant proportions of total cost.
 More factory overheads could be traced over the products. In manufacturing modem,
there are various non factory activities growing. ABC costing paying attention over all
activities, so non factory overheads could be traced (Chouhan, Soral and Chandra, 2017).
 ABC costing recognises that activities causing costs are not the product, and it is the
product which consumes activity.
 ABC costing recognises complexity of diversity of the production modems with use of
multiple drivers of cost, in which many of them are just transaction instead of volume
based product.
Weakness
 In this costing for assigning the costs effectively, pools of individual costs are required.
System becomes complex with the increased cost pools.
 It is difficult to implement ABC costing in large organisation that makes it very
expensive.
 In ABC input is required from the multiple departments and they may have different
priority sector.
 There may be difference and accuracy problems in the data gathered for labour hours
(Shea and et.al., 2018).
 Unlike the absorption costing ABC requires database of it own rather drawing data from
general ledger.
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CONCLUSION
The above research helps in analysing that both traditional and ABC costing systems
have disadvantages. This should be used by Sweden where the utilization is a important factor a
it is unique. ABC costing is much accurate as important factors are taken into account prior to
assigning costs to product. This takes time and is bit complicated process. The decision
regarding future predictions for volume and prices are best taken using the activity based
costing.
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REFERENCES
Books and Journals
Abu, M.Y., Nor, E.M. and Rahman, M.A., 2018, April. Costing improvement of
remanufacturing crankshaft by integrating Mahalanobis-Taguchi system and activity
based costing. In IOP Conference Series: Materials Science and Engineering (Vol. 342,
No. 1, p. 012006). IOP Publishing.
Chouhan, V., Soral, G. and Chandra, B., 2017. Activity based costing model for inventory
valuation. Management Science Letters. 7(3). pp.135-144.
Aleem, M., Khan, A.H. and Hamad, W., 2016. A comparative study of the different costing
techniques and their application in the pharmaceutical companies. The Audit Financiar
journal.12(143). pp.1253-1253.
Geiszler, M., Baker, K. and Lippitt, J., 2017. Variable Activity‐Based Costing and Decision
Making. Journal of Corporate Accounting & Finance.28(5). pp.45-52.
Shea, V.J. and et.al., 2018. ERROR RATE IMPACTS ON DECISION EFFICACY:
ACTIVITY-BASED COSTING SYSTEMS IN SMALL BUSINESS. QRBD. p.59.
Labro, E., 2019. Costing systems. Foundations and Trends® in Accounting.13(3-4). pp.267-404.
Agrawal, R.K., 2018. Principle of Management Accounting. Educreation Publishing.
Online
Activity Based Costing. 2019. [Online]. Available through :
<https://quickbooks.intuit.com/r/pricing-strategy/activity-based-vs-traditional-costing/>.
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