Your employer is contemplating changing the existing traditional costing systems

Question

Your employer is contemplating changing the existing traditional costing systems used in the business to adopt activity based costing (ABC).
Prepare a business report comparing the traditional costing system with ABC and evaluate arguments for and against ABC.

Use the Internet as a resource and academic journal articles (about 500 words excluding references).

Kindly explain as much as possible, there already isa samequestion posted by someone last year and has also been answered but its short.

Thanks

Explanation / Answer

I will explain the core differences between the traditional methods and ABC costing. You can build on this answer to get to your final submission.

First, let us understand why costing is important. Suppose you are a manager of a production line in a car factory. You are responsible for the production line that manufactures engines and then fixes them onto the cars made. Now, if you are responsible for 50 activities which are being performed daily, you as a manager would like to know which activities are profitable and which are loss making.

This is where costing comes in - it is a technique in finance where the costs associated with every activity is listed down for the respective set of activities.

Traditional Costing: Traditional costing is the technique which has been used widely so far due to its simplicity. What does it do? It simply takes an average overhead cost and adds it to the cost associated with the activity. What is overhead costs, you might ask? Overhead costs are the indirect costs which are associated with manufacturing a certain product: For example, the cost of labour for the operator who is running your forklifts, the cost of people who maintain your machines, the cost of the cleaners of the factory floor - these all are not raw materials which go into the making of the product, but they are all indirectly involved in the manufacturing of the product.

The issue with traditional costing is that it assigns an average overhead to all activities, irrespective of whether the activity has consumed all the overheads involved or not. The advantage is that it is easy and simple to implement, the disadvantage is that it is inaccurate

ABC Costing: This is a more modern method wherein each overhead is exactly assigned the value it is to be assigned. For example, if the cost of all labour associated with your line is $20 per activity, and the cost associated with all labour in your peer's line is $30, that is exactly how it will be allocated here. However, note that in the traditional method, they might simply take an average of the two and allocate $25 as the overhead costs. The clear advantage here is that it is accurate, and most managers prefer this method as this gives them a clear idea of which activities are profitable and which ones are not. The disadvantage is that it is very complicated and difficult to implement

What to implement when simply depends on the organization and how much it is willing to invest!

Related Questions

Navigate

• Browse (All)
• Browse Y
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.