Analysis of Traditional and Activity Based Costing Systems (MA620)

This report provides a comparative analysis of traditional and activity-based costing (ABC) systems within the context of advanced management accounting. It begins with an executive summary highlighting the importance of cost segmentation and the limitations of traditional costing, particularly in accurately allocating overhead costs. The report then delves into a literature review, exploring the advantages and disadvantages of traditional costing, which often relies on volume-based allocation methods, and the issues that arise from its inherent inaccuracies. It then introduces ABC as a solution, detailing its methodology of assigning costs based on activities and consumption, thus leading to more accurate product costing and better management decisions. The report further discusses the cost of implementing ABC, including organizational changes and resource requirements. Finally, it presents case studies illustrating the application of both traditional and ABC systems, demonstrating how ABC can provide more precise cost allocation and improve strategic decision-making, particularly in the Australian business context. The report concludes by summarizing the key findings and emphasizing the benefits of ABC in achieving competitiveness.

Advance management accounting
School Business
Course Name Master of Professional Accounting
Unit Code MA620
Unit Title Advanced Management Accounting
Trimester Trimester 1, 2018
Assessment
Author
Dr Dimuthu Ekanayake
Assessment
Type
Report
Assessment
Title
Assessment Task 4 – Assignment [Group]

EXECUTIVE SUMMARY
In costing system the division of known and fixed costs is critical while segmentation of costs
is also important. It is significant, as known fixed costs are eligible for segments while the
general fixed costs are booked in conventional costing system model. There are guidelines in
place for the use of conventional approach is to make use of the same in wider context,
general guidelines in identifying whether the cost is traceable or not. Present study shows that
approach of traditional costing has inborn inaccuracies. The conventional costing system
model merely have one or more than one pooling of indirect costs for each segment. To
resolve the issues with traditional costing system, Activity based costing system can used by
businesses operating in Australia. Analysis in the present study shows that the management
can make better and quality decision by knowing the perceptive the nature of each activity.
The ABC costing system aid the management on considering the variables on value-added
activities while alleviating the non-value added activities (Pazarceviren & Celayir,
2014).Further the precise yet appropriate allocation of costs is necessary to make effective
pricing decisions on multiple products thereby leading to sound pricing policy. Thus, ABC
system comes with accuracy and relevancy in the determination of costs of in product by
providing consideration on causes and impacts related with the incurred costs (CPIM & Paul,
2016).

TABLE OF CONTENTS
Introduction................................................................................................................................4
Literature review........................................................................................................................4
Advantage of traditional costing system................................................................................4
Issues with traditional costing system....................................................................................5
Activity based costing system................................................................................................5
Adoption of Activity based costing system to resolve costing issues....................................6
Cost of implementing activity based costing system.............................................................6
Case study analysis....................................................................................................................6
Case study of company using traditional costing...................................................................6
Case study of company using activity based costing.............................................................7
Conclusion..............................................................................................................................8
References..................................................................................................................................9

INTRODUCTION
Costing systems are said to be information systems, requiring a particular type of information
like direct labour hours and production of units, to be valued. It is systematic accounting
procedure that starts from the input data that generates costs and other related information,
which are identified as per the specified costing system based on defined methodology.
Further, the outcomes will be based on the use of costing system, as the similar input data can
be used in various ways (Strumickas and Valanciene, 2015). A costing system offer
information that can assist in minimizing wastage. This indicates that the resources needed to
develop, adopt and manage a costing system must be lower than the derived advantages from
the implementation of system. In this situation, there are two systems which are; traditional
costing system and activity based costing (Fullerton, Kennedyand Widener, 2013).
Previously; majority of companies in Australia were making use of traditional costing system
however with the improvement in accounting and costing principles this trend has been
modified (Haroun, 2015). Present study has been based on evaluation of statement given by
Langfield-Smith, Thorne & Hilton regarding traditional and activity based costing system by
considering relevant literature.
LITERATURE REVIEW
Traditional Costing System
Traditional costing system means the allocation of the industry-related overhead to products
on the basis of production volume of the consumption of production resources. According to
this method, overhead is generally applicable on the direct labour working hours amount of
on the usage of machine hours(Halinen and Jokela, 2016). It assigns the indirect costs of
factory to the produced based on volume like the number of units generated etc. Traditional
system of costing implements indirect costs to commodities on the basis of a fixed overhead
rate. Traditional costing system allots the overhead costs to the facts of productivity based on
their comparative use of direct labour (Weygandt, Kimmel & Kieso, 2015).

Advantages of traditional costing system
Traditional costing can provide benefits when the company’s overhead is comparatively less
than the direct cost of production. It is helpful when there is less time or when accuracy will
not be impacted by the production activities, it most effective for the times when the
overhead is running low. Conventional costing method is also relatively cost-effective and
inexpensive to use. Generally, companies use traditional costing for the outer reports, it is
because it is easy for externals to interpret and implement (Simatupang, Piboonrungroj and
Williams, 2017). Moreover, this method is a key determinant of the cost products, as it is
solely based on allotting general overhead rates Along with this, there is high capability of
conventional costing system to distort, and for the companies having large-scale production
of few products; this methodology can offer better insight of production costs (Mitra, 2016).
Issues with traditional costing system
Contemporary business, on the other hand have turned out to be less based on the utilization
of labour while not keeping their machine operations running every time in order to cater the
most appropriate outcomes. Rather than this, a business might resort towards technical
advancement, while concentrating on rapid stock turnover and best-quality customer service
to stimulate business progress, along with proper maintenance of pre-determined use in
machine and labour(Simatupang, Piboonrungroj and Williams, 2017). By considering these
changes in business environment might result in issues for conventional practices on
accounting. In a situation where an accounting process has insufficient measures and actions
to successfully trace the performance of new business or even lack of accurate measure
required to fix wrong areas (Christopher, 2016).
The issue with this approach is that for a lot of overhead activities, the extent of the activity
used by a particular product, does not generally match up with singular cost driver. This
grasp true findings for a lot contemporary corporations wherein production of products in
done by integrating workforce and technology. Further, accounting model based on the
traditional cost uses an approach based on volume like direct labour working hours and
machine hours for the allotment of producing overhead costs (Almeida and Cunha, 2017).
This model ends with costing of products sold on the basis of absorption costs and inclusive
of only good costs as described in financial accounting. Essentially, conventional costing

system attempts to allot cost directly to goods, instead of activities and then to the units of
products. This cost report offers information on the spending and the reason of spending.
Activity based costing system
Activity based costing refers to a costing method that determined activities within an
organization and allots the cost of every determined activity along with resources to all goods
and services as per the consumption on actual basis by each. This method realizes and
understands the connection amongst products, costs and activities and by considering this
connection it allots indirect costs to the products with low arbitrarily (Bouten and Hoozée,
2013). This method clearly and carefully assigns overheads to the items which actually makes
use of it. It helps improving the efficiency and accuracy in costing, while uncovering the real
costs along with profitability of activities and products.
Adoption of Activity based costing system to resolve costing issues
ABC differs from conventional costing in its treatment of non-volume related overhead costs.
Many significant overheads are related to specific activities which are relatively independent
of production volume.
The ABC system allows companies across the world in free market to determine the real
costs of procedures and products while making optimal decisions regarding the expenditure
and profitability of the produced products, and the efficiency of production and business
procedures (Mitra, 2016). Further ABC allows companies to attain and manage a competitive
edge in the international market of 21st century(Cho, Michelon and Patten, 2012). In the
large-scale, the adoption of ABC is done successfully and findings are conducted by
researches that ABC is the key to achieve competitiveness in SME’s.
Activity-based costing is a method for assigning overhead in an appropriate manner to the
items which makes use of the same. The ABC terminology depicts tracking of consumption
of resources and ultimate outputs of costing. Resources are assigned to activities and further
activities are assigned to objects of costs (Bouten and Hoozée, 2013). ABC makes sense in
complex situations, in which the approach is expected to offer some types of advantages
which are accuracy in products and services costing methods, precise pricing decisions,
offering accurate information to interpret drivers of costs and products overheads. ABC refers

to a managerial system of accounting that assumes the products and services costs by
allotting overhead costs to direct costs (Dale & Plunkett, 2017) .
Cost of implementing activity based costing system
ABC system requires an organizational change in terms of culture, learning knowledge and
available resources (Francis and et al. 2015). The main rationale for the demise of any main
project are insufficient flow of communication with management levels, weak planning or
lack of process and managerial commitment.
Implementation of Activity based accounting requires considerable resources in financial
terms. ABC system maintenance is also costly after the implementation too. Establishing an
ABC system is costly yet time consuming. Since the activities of business are analyses and
are required to be classified into each individual elements of activity. This overall procedure
can demand valuable resources as data collection, measurement and entering in a new system
needs substantial cost (Öker and Adıgüzel, 2016). Furthermore, business might also need aid
of advisors specialized in the ABC system implementation and offer training on the same.
Further expenditure can be created by using software to the application.
CASE STUDY ANALYSIS
Case study of company using traditional costing
An old manufacturing company (Hypothetical) may look at two products –in this case one
takes one labour hour to complete whereas the another takes two hours of labour to finish.
Further all the indirect costs are taken into account and added. Once, the determination on
spending are done, then the cost is divided with the metric amount in order to search for an
indirect cost each hour that can be applied to the particular product.
Take an assumption that creates widgets create a net 1 million each year. To do so, it needs
five working employees on full time bases, each on 2,000 hours along with three key
supporters on the same duration. With procedure of creating widgets, $1 million was been
spent. The rate of overhead would be caused by the dividing the $1 million by the 10,000
direct labour hours. This works out to overhead cost of $100 per hour.
The issue with conventional costing is that it makes use of flat rate in order o allocate the cost
For example, if an industry creates two products, and a line manager is capable to make

reduction in the cost of production hen the cost savings will be allocated throughput the
production of products and diminishing of the effect of the success of manger. ABC system
integrates further granularity levels, facilitating in more accurate allocation of costs.
It is a renowned fact that this system makes use of a singular, cost-driver based on labour
cost. This is the main rationale why the traditional costs system misrepresents the prices of
products, due to which Australian business must cease traditional costing system (Gond et al.
2012). By considering this rationale, traditional costs system generally report wrong product
cost. The main issue is the fundamental traditional costing methodology, the company to the
estimation that products results into cost (Mahal and Hossain, 2015). When a product is
product, it is expected that there is incurrence of cost. This estimation works with some direct
costs. IT doesn’t not makes sense with activities that are not yet conducted directly on the
units of products.
Case study of company using activity based costing
ABC allots costs to materials more precisely and reliably, plus assisting the users in
interpreting and analyzing the utilization of resources throughout the value of firm while
serving strategic results. A company operating in Australia namely Melco has made use of
ABC costing, by this implementation the company has derived several benefits including
accurate derivation of information and product pricing and thereby competitive edge in the
market(Banker and Byzalov, 2014). By the application company entitled to identify suitable
benchmarks which resulted helpful in staying top of competition. With this, better
information has allowed with the outsourcing of the same on various products turning them
into effective.
The effect of ABS on implementation is also studied the implementation of world-class
manufacturing activities and plant progress. They look out for WTM exercises which entirely
mediate the affirmative effect of ABC on plant progress and thereby enhance manufacturing
skills and capabilities representing the crucial missing like in interpreting the entire effect of
ABC (Weygandt, Kimmel and Kieso, 2015). According to the study, ABC implementation
by itself does not make improvement in plant progress, further the aim of the study is to
establish an extent that effectively targets the perspective of practitioners related with ABC,
plus the superiority of the same extent will also be considered (Figg and Hahn, 2013). The

variable evaluates four key dimensions which are; entire performance, effectiveness,
enhanced efficiency and strategic method of cost allocation.
The study aids in finding the ways of making improvement in financial health and
performance that is related with the implementation of ABC and the terms related to the
improvement of same. Indeed, an affirmative relation amongst ABC and ROI improvement
while ABC is implemented alongside with four key conditions which are strategic moves,
implementation in complex yet diversified firms. When the approach is implemented
environment wherein costs are comparatively significant and there are several restrictions of
transactions based on intra-company (Öker and Adıgüzel, 2016). Also, the relationship
between cost system, beliefs of manager regarding the reliability and usefulness of cost
information and real financial performance are considered. The outcomes of this study
suggests that system can offer better details on costs, greater classification of costs in
accordance with the conduct, while reporting cost information on frequent basis.
Conclusion
The present study shows that ABC costing system improvises the overall costing
methodology in order to assist management in making optimum utilisation of available
resources. Therefore, Australian companies must cease to make use of traditional costing
method for better assessment of their expenses and departmental profitability. Study shows
that ABC makes sense on activities and by considering that cost are allocated which
categorise expenses as per value-added activities as well as non-value added activities.
However cessation of traditional costing system is not viable for small companies having
single product as it is cost consuming procedure and small medium enterprise is not feasible
approach. Although; they can apply mix of activity based and traditional costing system to
generate accurate results and keep cost accounting comparatively convenient.

REFERENCES
Pazarceviren, S. Y., & Celayir, D. (2014). Target costing based on the activity-based costing
method and a model proposal. European Scientific Journal, ESJ, 9(10).
CPIM, G. C., & Paul, D. D. (2016). Time-driven or driver rate-based ABC: how do
you choose?. Strategic Finance, 97(8), 20.
Almeida, A. & Cunha, J., (2017). The implementation of an Activity-Based Costing (ABC)
system in a manufacturing company. Procedia Manufacturing, 13, pp.932-939.
Banker, R.D. & Byzalov, D., (2014). Symmetric cost behavior. Journal of Management
Accounting Research, 26(2), pp.43-79.
Weygandt, J. J., Kimmel, P. D., & Kieso, D. E. (2015). Financial & managerial accounting.
John Wiley & Sons.
Mitra, A. (2016). Fundamentals of quality control and improvement. John Wiley & Sons.
Christopher, M. (2016). Logistics & supply chain management. Pearson UK.
Dale, B. G., & Plunkett, J. J. (2017). Quality costing. Routledge.
Bouten, L., & Hoozée, S. (2013). On the interplay between environmental reporting and
management accounting change. Management Accounting Research, 24(4), 333-348.
Cho, C. H., Michelon, G., & Patten, D. M. (2012). Impression management in sustainability
reports: An empirical investigation of the use of graphs. Accounting and the Public
Interest, 12(1), 16-37.
Figge, F., & Hahn, T. (2013). Value drivers of corporate eco-efficiency: Management
accounting information for the efficient use of environmental resources. Management
Accounting Research, 24(4), 387-400.
Francis, M., Fisher, R., Thomas, A. & Rowlands, H., (2014). The meaning of ‘value’in
purchasing, logistics and operations management. International Journal of Production
Research, 52(22), pp.6576-6589.
Fullerton, R.R., Kennedy, F.A. &Widener, S.K., (2013). Management accounting and control
practices in a lean manufacturing environment. Accounting, Organizations and
Society, 38(1).Pp.50-71.
Gond, J. P., Grubnic, S., Herzig, C., & Moon, J. (2012). Configuring management control
systems: Theorizing the integration of strategy and sustainability. Management
Accounting Research, 23(3), 205-223.

Halinen, A. & Jokela, P., (2016). Exploring Ethics in Business Networks: Propositions for
Future Research. In Extending the Business Network Approach (pp. 333-356).
Palgrave Macmillan, London.
Mahal, I. & Hossain, A., (2015). Activity-Based Costing (ABC)–An Effective Tool for Better
Management. Research Journal of Finance and Accounting, 6(4), pp.66-74.
Mitra, A., (2016). Fundamentals of quality control and improvement. John Wiley & Sons.
Öker, F. & Adıgüzel, H., (2016). Time‐driven activity‐based costing: An implementation in
a manufacturing company. Journal of Corporate Accounting & Finance, 27(3), pp.39-
56.
Haroun, A. E. (2015). Maintenance cost estimation: application of activity-based costing as a
fair estimate method. Journal of Quality in Maintenance Engineering, 21(3), 258-270.
Öker, F. & Adıgüzel, H., (2016). Time‐driven activity‐based costing: An implementation in a
manufacturing company. Journal of Corporate Accounting & Finance, 27(3), pp.39-
56.
Simatupang, T.M., Piboonrungroj, P. & Williams, S.J., (2017). The emergence of value chain
thinking. International Journal of Value Chain Management, 8(1), pp.40-57.
Strumickas, M. & Valanciene, L., (2015). Development of Modern Management Accounting
System. Engineering Economics. 21(4).