Question

Briefly discuss some of the indicators of an outdated costing system (Word limit: 200 words) b) Despite the obvious advantages of ABC, many firms are still reluctant to implement it. What are the reasons for this reluctance? (Word limit: 150 words)

Answer 1

the following are indicators of an outdated costing system

i. Products which are difficult to make have high profit margins.

ii. Competitors prices appear unrealistically low.

iii. Customers are not deterred by price increases

.v. A lot of time is spent on special product cost projects. Costing

Traditional costing adds an average overhead rate to the direct costs of manufacturing products. The overhead rate gets applied on the basis of a cost driver, such as number of labor hours required to make a product.

Pros and Cons of Traditional Costing

Traditional costing is best used when the overhead of a company is low compared to the direct costs of production. It gives reasonably accurate cost figures when the production volume is large, and changes in overhead costs do not create a substantial difference when calculating the costs of production. Traditional costing methods are inexpensive to implompanies usually use traditional costing for external reports, because it is simpler and easier for outsiders to understand. However, it does not give managers an accurate picture of product costs because the application of overhead burden rates is arbitrary and applied equally to the cost of all products. Overhead costs are not allocated to the products that actually consume the overhead activities.

The traditional costing method is best used for manufacturers that only make a few different products.

Activity-Based Costing

Activity-based costing identifies all of the specific overhead operations related to the manufacture of each product. Not all products require the support of all overhead costs, so it is not reasonable to apply the same overhead costs to all products.

Accountants created the ABC method to solve the problems of inaccuracy that result from the traditional costing approach. Managers needed more accurate costing methods to determine which profits were actually profitable and which were not.

A fundamental difference between traditional costing and ABC costing is that ABC methods expand the number of indirect cost pools that can be allocated to specific products. The traditional method takes one pool of a company's total overhead costs to allocate universally to all products.

Pros and Cons of Activity-Based Costing

Activity-based costing is the most accurate, but it is also the most difficult and costly to implement. It is more suited to businesses with high overhead costs that manufacture products, rather than companies that offer services. Companies that manufacture a large number of different products prefer an activity-based system because it gives more accurate costs of each product. With activity-based allocation of overhead costs, it is easier to identify areas where expenses are being wasted on unprofitable products.

Deciding between traditional or activity-based costing is not easy. Your choice should depend on the purpose of the reporting and who will see the information. Managers need accurate product costs and prefer to use an activity-based accounting system. Even though this system is more costly, it provides better information that will enable managers to make more profitable decisions in the long-term.

For external reporting, companies still use the traditional costing system, but it is becoming obsolete as outsiders demand more accurate information about businesses.

The Advantage of Ab Costing is Activity-based costing provides a more accurate method of product/service costing, leading to more accurate pricing decisions. It increases understanding of overheads and cost drivers; and makes costly and non-value adding activities more visible, allowing managers to reduce or eliminate them.