Question

What are the primary differences between traditional and activity-based costing? And when is an activity-based costing system better than a traditional allocation system?

Answer 1

ANSWER:

Traditional Costing System   Activity-Based Costing System          
1   Under this method a single overhead rate is used for allocating the overhead cost, This rate is known as Plantwide Overhead Rate   Under this method overhead rate is calculated separately for separate activity which are known as ABC rate          
2   This method of cosing is simple to use as single overhead rate is involved and not much resources are used to identify this rate   This method is more complex than the other as it requires to calculate activity rate for each activity separately so every departments are involved in it's compuatation and hence it requires more resources          
3   This method can only be used to allocate the manufacturing overhead cost. In other words can only be used for Product cost   This method can only be used to allocate both manufacturing overhead cost and Selling costs. In other words can only be used for Product cost and Period costs also.          
4   It can be used for external reporting purpouse   It is only used for Internal Purpouse by the management          
Activity-Based costing is better when a unit has different and distinct costs and related activities which can be identified  
sepatrately. When a unit has diversified activities and operations then each activity needs to be assigned a unique activity rate
upon which allocation is based.