Question

Your company has been using traditional costing and is considering moving to Activity Based Costings for a number of product lines. Explain what is meant by Activity Based Costings, how it differs from traditional costing, and how it may be advantageous

Guidelines:

A clear explanation of Activity Based Costings contrasting with the traditional costing.

List at least two clear advantages to the company

Answer 1

Activity Based Costing In activity based costing cost is allocated of overhead costs. A different cost allocated for different activity on the basis of which is more suitable for each activity.

Traditional Costing In traditional costing cost is allocate overhead costs based on a single cost driver according to the consumption of a volume of production.

Difference between activity based costing & traditional costing 1. Primary Focus - In activity based costing it uses different cost drivers for different activities. They allocate cost according to these cost drivers. In traditional costing it uses same cost drivers for different activities.

2. Application - The application of activity based costing is difficult. Because in this costing it uses different heads for different activities. Choosing suitable heads for each activity is a difficult task. It is time consuming. In traditional costing its application is very easy. Because it choose only one cost driver for different activities. The overheads are simply divided into fixed and variable overheads.

3. Scope - In activity based costing, it can effectively be used for allocating both manufacturing and non manufacturing overheads like selling, administration etc. It cover product cost only. In traditional costing it alloates only manufacturing overheads.. It can coer both product and period costs.

4. Management Use - Activity base costing can only be used for management purposes. It can be used by the management of a company to make better allocation of costs more accurately. The values can be used in external financial statements. Traditional costing it inculcates only product costs for the statement of profit or loss. The values cannot be used i reports of external reporting.

5. Effectiveness of Operation - Activity based costing improves business processes in long term. . It enhances management knowledge about activities related to production process and the management want to investigate deeply. Traditional costing doesnot requires this much of time. It does not provide opportunity to identify any specific reasons for costs incurred.

Advantages of Activity Based Costing 1. Accurate product cost - It will brings accurate, correct and reliable cost for products by focusing on cause and effect relationship in the cost incurrence.

2.Better decision making - it will help the manager of a company to take correct decision because they can use reliable product cost data.

3. Cost management - It provides cost drivers rate and information about transaction volume. It will help them to manage the cost of the products.

4. Information about cost behaviour - it will identify real nature of cost behaviour and help in reducing costs and identifying activities which donot add value to the product.