Analysis: Traditional Costing vs. Activity Based Costing

This report provides a comprehensive analysis of traditional and activity-based costing (ABC) methods. It begins by outlining the limitations of traditional costing and introduces ABC as a more advanced technique for cost reduction and strategic decision-making. The report includes a detailed example of cost allocation using the ABC method, comparing it with traditional approaches to illustrate the differences in per-unit cost calculations. It then explores the advantages and disadvantages of ABC, emphasizing its ability to provide more accurate cost information and facilitate process improvement. The report further examines the implications of adopting each costing approach, including their impact on pricing policies and overall business performance. The conclusion highlights the superiority of ABC for reducing production costs and enhancing firm operations. References to relevant books, journals, and online resources are included.

The Implications of Adopting
Traditional Costing Approaches and
Activity Based Costing Approach

TABLE OF CONTENTS
INTRODUCTION...........................................................................................................................1
TASK 2............................................................................................................................................1
CONCLUSION................................................................................................................................4
REFERENCES................................................................................................................................5

INTRODUCTION
Many tools are there which are used in lowering a product’s cost. But, in order to lower
the costs, management accountant needs to opt appropriate methods in order to lower the cost in
a proper manner (Franco-Santos, Lucianetti and Bourne, 2012). Basically, in the ancient times,
traditional methods were used in the business in order to make operations viable and effective.
But such methods were entirely related to cost of production. Nowadays, management
accountant uses advanced technique which is only helpful for lowering the costs but also help in
framing strategy for the firm.
TASK 2
In the previous time, company uses traditional method for calculating product’s price
which was not so cost efficient. Later, various methods emerged in order to reduce the cost
effectually (Kumar, Teichman and Timpernagel, 2012). This has been seen that the management
accountant uses activity based costing technique for lowering the cost of production in the most
proficient manner. Here, under the given circumstances, cited company's management
accountant uses ABC methodology in order lower the price of product to a great extent. Under
ABC, production overheads are allocated into per unit cost in an effective manner than
traditional method. This is known as two step approach where overhead costs are allocated to the
concerned activities recognised as cost pool and after that, those allocated costs are assigned to
the product. Various costs will be assigned for goods which have been demanded for the similar
activity (Sekaran and Bougie, 2016). ABC mainly concentrates on the production activities. The
operations of the firm cover various activities which includes complete overhead costs. Hence,
this is anticipated to acquire a logical per unit cost at the end.
Allocation of cost to two products:
Activity Activity cost General cost Basic Advance
Machine setup 200000 1000 50000 150000
Material receiving 120000 1.5 45000 75000
Inspection 160000 100 70000 90000
Machinery related 840000 14 280000 560000
Engineering 280000 40 120000 160000
Total overhead 1600000 1155.5 565000 1035000
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costs for each
product
Cost as per ABC :
Particulars Basic Advance
Total cost 565000 1035000
No. of products 1000 1000
Cost per unit as per ABC 565 1035
Calculation cost per unit:
Basic Advance
Cost according to
traditional approach
Plant wide 2200 3000
Departmental 2080 3120
Cost according to
ABC approach
565 1030
Henceforth, this is observed that ABC method is much better as compared to traditional
costing approach as this considers the exercise of each of task by goods instead of going for a
common basis. This is the reason, company needs to opt ABC system in order to have the
business operations in an effective manner. However, there are various advantages and
disadvantages of ABC method.
Most appropriate cost information leads to better decisions: The costs information
rendered by ABC costing method is normally considered as the most appropriate. So,
information provided by traditional costing methods enable administration to frame effective
decisions in the domain like product pricing and product mix decisions.
Enhanced knowledge of production related activities leads to process enhancement
and limit costs: This method needs to identify the tasks covered in manufacturing process and
assigning costs to these. Such methods provide administration with an improved view of the
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detailed activities covered and the cost of each activity. Administrators most probably
concentrate on enhanced efficiency so that the cost of product can be reduced to minimum.
There are major concerns which are faced by company at the time of opting ABC
technique. Some of them are:
It is costly to implement: ABC system needs to have team work throughout the firm
(Cawley and Meyerhoefer, 2012). That is why, company requires employees to frame their
routine activities in order to assist in the ABC process. The cost assigning process takes time, as
this determine and find out the cost drivers, and also assigning costs to the products.
Using fixed costs could be misleading: Product costing covers allocating costs in
activity centres to goods and measuring product cost per unit. The issue with such approach is
that fixed costs are usually a broad part of overheads which are being allotted.
Implications of considering traditional costing approach and ABC costing methods:
Manufacturing organisations earn some effective results. The firms which use ABC
method have great amount of overhead costs than those which use traditional costing. The
companies which are using ABC methods also have a great level of automation. The complexity
of manufacturing procedures and goods related to be higher for those implementing ABC
method and these firms runs at a great extent (Tan and et. al., 2012). The major differences
between firms using ABC methods and those which use traditional methods are covered in the
areas like overheads costs, complicated procedures and frequency of capacity that were relatively
small. Although, users of ABC costing reflected their system.
Impact of ABC costing and traditional costing in firm pricing polices:
Both the methods are determined as overhead costs which are related with the production
and then assign with cost of products. The major accuracy and simplicity of the two methods
which are used by the company (Activity-Based vs Traditional Costing, 2016). It is because,
traditional costing is simpler and less accurate as compared to ABC costing.
Traditional costing systems are applied mostly on indirect costs to goods that are based
on present overhead rates. It is at the highest stage when indirect costs are low as compared to
direct cost. Under this costing, costs are balance and company need to analysed its opportunities
which are valuable for the company in order to control the price which are set by the firms.
ABC costing are more balance costing methods which company need to balance
according to position of the investor available with the firms. The pricing of product is more
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precise because of breakdown of indirect costs (Emblemsvåg and Bras, 2012). It is more costly
to implement in an organisation. Pricing under this costing method is more effective as products
are categorised into various stages on the basis of their durability and quality. It will be more
helpful for company to get competitive advantages and to generate its profitability in the coming
scenario.
CONCLUSION
From the above report, it can be concluded that ABC framework is much essential than
traditional costing approach. As, this aides the firm to reduce the total cost of production for the
firm. On the other hand, ABC costing methods are used in this report to categorise various costs
which impose a huge impact on company’s growth and performance. Overall, this has been
concluded that ABC method is more effective for the firm operations..
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REFERENCES
Books and Journals:
Emblemsvåg, J. and Bras, B., 2012. Activity-based cost and environmental management: a
different approach to ISO 14000 compliance. Springer Science & Business Media.
Tan, S.S. and et. al., 2012. Update of the Dutch manual for costing in economic evaluations.
International journal of technology assessment in health care. 28(2). pp.152-158.
Cawley, J. and Meyerhoefer, C., 2012. The medical care costs of obesity: an instrumental
variables approach. Journal of health economics. 31(1). pp.219-230.
Sekaran, U. and Bougie, R., 2016. Research methods for business: A skill building approach.
John Wiley & Sons.
Kumar, S., Teichman, S. and Timpernagel, T., 2012. A green supply chain is a requirement for
profitability. International Journal of Production Research. 50(5). pp.1278-1296.
Franco-Santos, M., Lucianetti, L. and Bourne, M., 2012. Contemporary performance
measurement systems: A review of their consequences and a framework for research.
Management accounting research. 23(2) pp.79-119.
Online
Activity-Based vs Traditional Costing, 2016. [Online]. Available through:
<http://www.economist.com/node/13933812>. [Accessed on 8th September 2017]
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