Question

What are the key reasons for product cost differences between traditional costing systems and Activity-Based Costing ABC systems?

Answer 1

Key Difference between ABC and traditional costing system are:

Activity Based Costing is accurate and preferred over the TCA cost management system. The ABC method of cost management system is adopted when the overheads of the company are high and there are large numbers of miscellaneous products. Inaccuracy or errors are most unwanted and undesirable because of the competitive rates set by the competitors in the market. Due to this heavy and stiff competition, a highly reliable and accurate method is required for the cost management.

TCA or Traditional Cost Accounting uses a single overhead pool and is not able to calculate the true cost. The costs of the objects are allocated randomly based upon the labor or machine hours etc. ABC costing includes identifiable products parts or labor whereas TCA arbitrarily accumulates expenses, salaries, depreciations etc.

Smaller targeted costs that are built upon activities are calculated with the help of the ABC system. The ABC system is advantageous since it helps in simplifying the decision making process and it makes management concepts become clear and target -oriented. It also helps in evaluating performances and sets standards which can help the manager to use this information for comparison purposes.

In the Traditional Cost Accounting System, the company determines the cost of production after the products have been produced whereas in the target or Activity Based Accounting System, the value or cost of the product is determined on the basis of customer feedback and pocket range. The ABC system helps the company to determine whether to lower or raise the activities cost to grab the consumers. The ABC system also helps in keeping up with the competitors without sacrificing the quality and the quantity of the products.

Activity-based costing is more accurate because it takes important factors into account before assigning a cost to a product. However, for this same reason, it is a bit more complicated and time-consuming. It’s also more thorough and considers nonmanufacturing expenses as well, such as administrative and managerial costs.

Traditional costing is a much easier way of determining the cost of a product, since it relies solely on assigning average overhead rates. This also means it won’t always be as accurate, because it doesn’t factor in nonmanufacturing expenses or determine which overhead costs actually affect specific products.

A simple example of these costing methods can be demonstrated with the costs of living in an apartment with roommates. Two roommates in an apartment will typically split the costs of rent, utilities and groceries, and they have a couple of options for doing so. They could simply total the cost of all of the bills and divide it exactly in two. This would be similar to traditional costing