Question

6. Differentiate between functional based costing and activity based costing. Comment on cost distortions commonly observed in traditional costing systems.

Answer 1

1) Activity based costing allocate expense based on activity performed.

Functional costs are made up of the total costs of all activities performed by a functional unit.

2) The ABC system pegs overhead costs directly to specific activities based on the actual amount of each fixed expense they incur.

Functional-based costing considers total expenses incurred at the departmental, business-unit, work-group or individual level.

3) If an activity requires 10 hours of electricity, for example, accountants can easily determine an exact amount of electric utility expense incurred by the activity.

In functional-based costing, accountants assign fixed costs such as manufacturing overhead to output on a per-unit basis.

4) Activity-based costing can be advantageous when analyzing the profitability or income contribution of different activities in an organization.

Functional-based costing can be better-suited to providing big-picture overviews of company expenses.

5) Activity-based costing can be more time-consuming and prone to human error than functional-based costing

Functional-based costing cannot provide the type of insights that ABC can reveal for internal decision-making.

Costt distortion observed in traditional system.

It is often difficult to allocate expense to particular activity or product.

In most cases this type of costing system assigns the overhead costs to products on the basis of their relative usage of direct labor

For this reason traditional cost systems often report inaccurate product costs.