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

	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.