Traditional Costing Versus Activity-Based Costing Advantages and Disadvantages Essay Example

the factors such as Wages and salaries, employee benefits, supplies, traveling allowances, depreciations and other fixed charges, operating expenses and miscellaneous (Dury, 2008). Activity bases accounting system is based on evaluation of suppliers, purchase order, expedite deliveries and supplies, purchase orders, expenditure on internal process, maintaining check of item quality and deliveries, resolving the problems and internal administration.

From the above description on the factors that form base of accounting system, it can be stated that Traditional costing system operates in independent manner and Activity based costing system is an interdependent activity (Blocher, 2006). The main problems related to use of traditional costing system is limited economic focus. The benefits offered are intangible and remain unmeasured. These all the factors that might prove to be bottleneck for the company can be cleared by the help of activity management cost (Thomsett, 2002).

The traditional cost system follows the mentioned principles: •Traditional costing used cost allocation method. In cost allocation method, the costs are estimated based on the future. •This costing system does not take into consideration the factor of why and where cost goes. •This method does not give proper focus on the variances. •This method is not flexible, time oriented, and inaccurate. •The operational managers do not give any consideration to knowing the activities that are costly. •The focus is fiscal. •The cost of product and services are not associated with actual efforts improved.

Activity based costing system follows the mentioned principles •It measures the actual performance of the organization, taking into consideration every cost associated with activities. •With the help of this system the managers there is proper relation of consumption

and expenses is maintained. •In activity based costing cost of activities are calculated based on resources that are consumed. •This method helps the managers to draw proper insight of sources of cost and the impact that might happen on and due to decisions taken.

Activity based costing system enables manager to realize the performance breakouts and take action accordingly (Traditional Costing vs. Activity-Based Methods, Exac cost, 2010). The Traditional cost system depends largely on the volume variance. The volume variance is measured as the cost of labor and machines used for manufacturing the number of items. If number of item produced are less than the expected, then actual cost are likely to increase. This means the labor and the overheads used in manufacturing of products were not planned in proper manner.

On the contrary, activity based costing system provides impeccable focus on the manufacturing of product. According to Hall (2008) many companies in US and UK and China have adopted activity based costing system, with the help of this system the managers of account and other department should keep separate tracks of costs differently. This is required to manufacture individual units in such manner that product design is manufactured in batches and manufacturing facility operates in efficient manner.

Taking into consideration, the discussion activity based costing system is gives focus on overall organizational activities and traditional cost system focuses on individuals and machineries. Hence, use of activity cost system can be managed more efficiently than standard costing system (Daly, 2002). The main motive of activity and traditional cost system is increasing profits. Traditional cost system focuses on large volume production of products,

which is impossible if there is keeps on focusing on simple factors direct material, labor, and operational overheads.

However, if there is no focus given on variable elements such as supplies of major and minor parts, electricity and other power resources, the actual cost of product can not be calculated. It is obvious that there is not just work of labor and machinery in producing finished goods (Cokins, 2001). It is necessary to consider fixed as well as variable overheads. Activity based costing system considers variable and fixed overheads, which helps in knowing the right number of activities involved in producing finished good. This process is known as unitizing fixed cost.

Hence, the traditional cost system’s objective is to control cost, but activity based cost system plays more vital role of analyzing these factors to maintain the production in efficient manner (Anklesaria, 2008). In today’s uncertain business environment, it might become difficult to operate in rigid system that allocated cost to number of activities. Activity based costing system is not an improvement in the traditional standard accounting system, but an enabler for an establishment of the first time true management system.

It is necessary to have flexible system, as rigid allocations do not work for an organizations having decentralized management system (Baumol and Blinder, 2007). Thus, application of activity based cost system over the traditional cost system helps the management to know the factors that are immeasurable and identify circumstances wherein the objectives get out of line on spending decision. Hence, it can be said that traditional cost system has control emphasis on cost and activity cost system has it on activities

arried in the organization (Lee and Epstein, 2004).

The traditional costing system is generally estimates that the cost of whole organization is driven form the number of products and services are delivered. On the other hand, the activity based cost system allows non-linearity of costs in the organization by recognizing the fact that units of goods produced do not cause some costs (Grossman and Livingstone, 2009). This can be explained with the help of comparison chart of traditional and activity costing system drawn by a university.