Question

Discuss the advantages and disadvantages of traditional costing system?

What is the process of traditional costing system?

Answer 1

Traditional Costing: Traditional costing system is a costing method where the overheads or other related costs are allocated, assigned or distributed to the product using a single cost driver (Example: Direct Labor hours).

Advantage :

Simple : Traditional Costing is simple and easy to understand.

Cost effective : Compared to other costing method this is cost effective .

Widely used for small business : Because of simplicity and less cost involved this is used in most of small business

Disadvantage :

Accuracy : Traditional Costing is less accurate compared to Activity Based Costing.

Usage of Cost Driver: Traditional Costing uses single cost driver to allocate cost.

Decision making : Traditional Costing is not that helpful in decision making, since it uses only one cost drive which may not say the exact cause for change in costs.

Process : can be explained with one example :

Total labor hours for Ceiling fan 200,000 and Table Fan 100,000, Material Handling Cost $600,000, Production Order cost $100,000, Design $500,000, and Plant utilities $1,800,000. Material handled in Ceiling Fan is 30,000kgs and 10,000kgs in Table Fan, Number orders in Ceiling Fan is 100 and 150 in Table Fan, Design change in Ceiling fan is 20 and 80 in Table Fan, Plant utilities 100,000 hours in Ceiling fan and 80,000 hours in Table Fan. In a period there were 100,000 units of Ceiling fans and 50,000 units of Table fans were produced.

Solution:

Allocation of overhead costs using Traditional Costing System.

Total Direct labor hours = 200,000+100,000 = 300,000

Overhead application rate = Total overhead/Total number of direct labor hours

Overhead application rate = 3,000,000/300,000

Overhead application rate per unit = $10

Total overhead allocated to each fan using direct labor hours = Direct labor hours*Overhead rate per unit