Traditional Costing Methods vs Activity Based Costing Essay

In this study I will try to detect whether it is executable as a company to alter the Traditional methods of bing we presently use to the more modern Activity Based Costing methods, looking at the benefits and drawbacks of altering and whether it is deserving implementing these new bing methods to our company as a whole. As a little local technology house we presently use the Traditional costing method where we apportion Production operating expenses on the footing of direct labor hours.

Does this give a just and accurate representation of the true cost of outgo each merchandise consumes or should we as a company convert to the Activity Based Costing system or ABC as I will mention to it from here in, where we foremost assigns costs to the activities that are the existent cause of the operating expense and so delegate the cost of those activities merely to the merchandises that are really demanding the activities. Would this give a just and more realistic expression at the manner we cost occupations.

In this study I will look at both methods and find whether we as a company should alter the manner we cost our occupations and if we do alter to the ABC method of costing, what the conditions are of implementing this to us. Traditional Costing Methods Presently we adopt the more traditional manner of allocating our production operating expenses which involves the overhead rate being calculated utilizing direct labor hours, machine hours, or units, in our instance utilizing direct labor hours.

Presently utilizing the traditional method of cost accounting we are apportioning the mill ‘s indirect costs to the points manufactured on the footing of direct labor hours, By utilizing merely labour hours to apportion the fabricating operating expense to merchandises, we are connoting that the labor hours are the implicit in cause of the mill operating expense. Traditionally, that may hold been sufficient for the company ‘s external fiscal statements.

However, in recent decennaries the fabricating operating expense has been caused by many other factors. For illustration, some clients are likely to demand extra fabrication operations for their merchandises. Other clients merely want great measures of merchandise. If we want to cognize the true cost to bring forth specific merchandises for specific clients, the traditional method of cost accounting is unequal. ABC was developed to get the better of the defects of the traditional method.

Alternatively of merely one bing such as labour hours, ABC will utilize many costings to apportion our indirect costs. A few of the costings that would be used under ABC include the figure of machine apparatuss, the lbs of stuff purchased or used, the figure of technology alteration orders, the figure of machine hours, and so on. So do we go on to utilize this system because it is simple to utilize and has been used for decennaries or do we desire a more accurate analysis and dislocation of the manner we allocate costs. Activity Based Costing ( ABC )

Activity-Based Costing ( ABC ) is an Information System developed in the 1980s to get the better of some of the restrictions of traditional cost accounting and to heighten its utility to strategic decision-making. ABC systems are designed and implemented on the premiss that merchandises consume activities, activities consume resources and resources consume costs ( Sprow, 1992 ) . ABC systems assign costs to activities based on their ingestion of resources, and so activity costs are assigned to merchandises or services in proportion to a selected step of their single work loads ( Anderson, 1993 ; p. ) .

ABC systems examine all procedures ( or activities ) that are really relevant to the production of a merchandise and effort to find precisely what part of each resource is consumed i. e. which activity a peculiar merchandise utilizations. Why the demand for ABC, you may inquire ; Nowadays directors are confronting planetary competition and increased productiveness in new fabrication environments. Companies attempt to go client focussed and concentrate on quality merchandises at competitory monetary values.

Under these fortunes, many houses are interested in finding assorted costs more accurately with the aim to incorporate fabrication and selling schemes. Assorted bing systems are used to supply an increased truth about merchandise costs, merchandise mix, pricing and other investing decision- devisings. Some experiences reveal that the deformation in reported merchandise costs and, in bend, merchandise pricing could be reduced by utilizing activity-based costing ( ABC ) What are the benefits so of this new and modern manner of costing, is it truly the manner forward for us.

It wo n’t extinguish costs but it will give us elaborate information about the manner we are devouring them, therefore assisting us to insulate job countries with the position to rectifying why the costs are so high in these countries. ABC costing is a good tool where different clients require different demands. It ‘s an unwritten regulation respected by many in the concern universe that you by and large handle your best clients the best. The job is, do you truly cognize who your best clients are, or do you believe you cognize?

The bulk of concern people have the false perceptual experience that the best client is the 1 that accounts for the largest part of your income every twelvemonth. This is non ever the instance for the simple ground that the same client may be responsible for the biggest portion of your disbursals besides. Surveies have shown that 20 % of all clients virtually provide all the net incomes of a company. Another 60 % interruption even and the staying 20 % merely cut down the bottom line.

Would n’t it be nice if you had the names of that 20 % of headache-inducing clients that are literally more problem than they ‘re deserving? To find how much a client is bing you, you must first place the activities that relate to each client and find the entire cost absorbed by those activities. These activities or “ cost drivers ” should be considered so to mensurate the degree of activity absorbed by each client. The ultimate intent of implementing ABC is to divide these activities into single cost drivers. Then, all you have to make is mensurate each client ‘s engagement in the specific cost.

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