While the universe ‘s attending is focused on the battle to increase productiveness and develop new engineerings, fabrication directors – particularly those in the electronics and mechanical equipment ( machinery ) industries – are softly engaging a different conflict: the conflict to suppress overhead costs ( Miller and Vollman,1985, p. 142 )” The intent of this essay is to compare and contrast the grounds for the usage of traditional and activity based costing in modern administration.
Traditional costing ( TC ) is a merchandise bing system in which direct stuff and labor are tracked down to merchandises and fabrication operating expenses are allocated to merchandises based on volume based cost driver ( Langfeild Smith, Helen, ; A ; Ronald, 2003 ) . Activity based costing ( ABC ) means delegating overhead costs to specific activities performed in a fabrication procedure with direct stuff and labor assigned to merchandises in the same manner as TC. The first subdivision of the essay trades with account and basic difference between of ABC and TC.
Staying subdivisions explain the demand and grounds for following each type of these bing methods ( ABC ; A ; TC ) in modern administrations. These subdivisions besides emphasis on transmutation from traditional bing method to ABC over the period. Since the beginning of Traditional cost accounting ( Johnson and Kaplan 1987 ) , it has been picked apart for its drawbacks such as cost deformation and non demoing present organisational worlds ( Kim ; A ; Glenn, 2001 ) .
Harmonizing to Miller, traditional costing studies what money is spent on and by whom, but fails to describe the cost of activities and procedures ( Miller 1996 ) . As a solution, a new costing method called Activity Based Costing ( ABC ) was formulated and has been encouraged as a mean for brushing over the drawbacks of Traditional Costing to convey relevancy back to Managerial Accounting ( Kim ; A ; Glenn, 2001 ) . In the traditional costing method, direct costs are related to each merchandise and overhead costs are allocated to each merchandise utilizing volume based cost drivers.
If the choice of allotment base is non right so consequence will be an imprecise merchandise cost. Many costs related to automated merchandise line, diverse merchandises, downstream costs etc are non driven wholly by volume based cost drivers. Comparing to TC, in ABC the operating expense cost are allocated to specific activities performed so costs are traced more accurately to merchandises or cost objects. The Following illustration about a workshop will exemplify the differences between the two types of bing methods.
See material handling as an activity so cost of equipments used, such as conveyor belts, forklift etc can be traced down to pool of activity. While utilizing TC in analyzing the cost of workshop, a larger cost pool will be used and overhead cost will be allocated based on volume of merchandises produced instead than complexness or clip taken for each merchandises. If the workshop produces unvarying merchandises with each utilizing same composing of stuffs and same clip for production, there will non be much difference between bing system based on TC and ABC.
Traditional costing methods are quiet equal when the industries are non to the full technologically advanced ( with non much merchandise distinction ) and major part of entire cost consist of direct cost constituent with indirect cost have no much consequence on entire cost. Traditional costing methods used for general intents when the disbursal of finding the indirect cost is higher than direct cost ( M C, Filho, Espozel, ; A ; Qassim, 1999 ) . This essay besides uses information collected in a study surveies carried out in Australia.
Conducted among 200 houses in 1997 the study consequences proposing that merely 14 % of houses use ABC and another 11 % have program to utilize it in close hereafter ( Askarany, 2007 ) . Reasons for the go oning usage of TC are ( 1 ) simple and easy apprehensible, ( 2 ) less dearly-won, ( 3 ) still running good for certain houses for long period. So even with the debut of ABC system, there are rather a figure of houses utilizing TC in the modern concern environment. Out of 231 companies surveyed in the Britain, 91 % of them use standard bing for cost control intents ( stated by David Lyall and Carol Graham ) .
In U. K. , out of 303 comptrollers ‘s 76 % of them and ’73 % of 85 finance and accounting specializers in New Zealand use standard costing ‘ . ( Marie, Attiea, & A ; Rao, 2009 ) . Study by Marie, Attiea and Anand Rao found that 39 % of service sector houses and 75 % of industrial houses use standard costing in Dubai ( Marie, Attiea, & A ; Rao, 2009 ) Non-financial information about Small and medium endeavor ( defect rate, through put rate ) is non obtained while utilizing traditional costing methods.
In add-on, factors like quality, service and information that matters to the consumers are out of the range for traditional costing system. These disadvantages associating to traditional bing systems will forestall administrations from going competitory and universe category in the modern economic system ( Gunasekaren, Marri, & A ; Grieve, 1999 ) . This has prompt SME ‘s from cut downing their dependence on traditional costing system and now they moved into ABC that resulted in improved net incomes for the administration and helped directors in accessing more information for better public presentation.
The chief unfavorable judgment for traditional costing system is that usage of simple volume based allotment system will non reflect the existent cost of a complex fabrication system in a modern administration. Use of traditional costing in a modern computing machine fabrication house is evaluated in this paragraph See the instance if computing machine maker who uses automated mechanism like robotic weaponries for fabrication merchandises.
If there is, no system to happen figure of hours robotic arm work on each type of computing machine, so fixed operating expense cost has to be allocated equally to all merchandises irrespective of the figure of hours machine works. This will ensue in complex merchandises with more fabrication clip holding understated costs and merchandises with simple fabricating process with exaggerated costs. The end consequence of all this being trouble Activity Based Costing has given rise to radical alterations in cost direction systems.
It is non a method of costing, but instead a technique for better organisational direction. The chief intent of activity based costing is to show cost deformation. Traditional based costing immixes all indirect costs into a individual 1. On the other manus, Activity Based Cost adopts multiple activity costs and cost drivers and therefore prevent Cost deformation. Second, Activity Based Costing provides procedure position by cut downing waste or unwanted activities. ( Kim ; A ; Glenn, 2001 ) .
ABC bring forth cardinal displacement in accent from traditional bing to activities, which requires resources. Therefore, commanding activities, which is associated to the resource, allows the administration to command costs at their beginning. Activity Based Costing allows the directors to section clients and adapt procedure and pricing schemes to run the administration more productively while Traditional accounting wholly hides this sort of informations. ( The Chartered Institute of Management Accountants, 2001 )
Activity based costing is disposed for administrations with a assortment of merchandises and services and are unable to cognize which merchandises are profitable. Actually, the companies that are large plenty and willing to follow Activity based costing can profit much out of it. This is because it can recognize high operating expense costs occurred and supply solutions for conveying down the costs. It puzzles out any inaccurate allotment of costs and calculates profitableness with faultless truth than traditional costing that uses direct labor hours as the lone cost driver.
One of the chief grounds modern organisations implement activity based bing method is that it could convey away drastic progresss in the quality of overhead cost allotment. Furthermore, assign cost units to each single activity such as wadding, designing, and quality control at the get downing phase of activities. ( Popesko2, 2010 ) As modern concern is become more complex and competitory, an accurate costing system is more than indispensable for helping the directors for better determination devising.
Over the past two decennaries, some radical occurring in concern environment has prompted directors to take an appropriate costing system, which suits the administration ‘s production system and merchandise line. In our determination, certain administrations that follow a labour-based production system and have merely limited merchandise scope adopt traditional costing system. While on the other manus, administrations with fabrication operating expenses, which are non based on volume-based cost drivers, travel for activity, based costing system.
It suits for those administrations that have legion merchandises attached to their merchandise line. Furthermore, it helps in determine which merchandises are profitable. To reason, in most instances, companies cost accounting system, both traditional and activity based costing, efficaciously measures the direct costs of merchandises and services, such as labor and stuff. However, it is up to the direction to make up one’s mind and take which is the most appropriate costing system based on their production system and merchandise scope.