While activity-based costing focuses attention on activities in allocating overhead costs to products, activity-based management focuses on managing activities to reduce costs. Under this method, overhead is usually applied based on either the amount of hours consumed or machine hours used. Setting standards require detailed study of various operations so that they may be made efficient. There are several steps in the traditional costing process, including the following: 1. Cost Control Budgets are prepared and standards are fixed under cost accounting system.
This may then create a chain reaction where efficiencies are also affected. Under new manufacturing technology, there is a need of the degree of completion of work with accurate indirect costs incurred. This is because it can be very costly to implement activity based costing into a business. Under this technique of costing, cost is made up of direct costs plus overhead costs absorbed on some suitable basis. 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.
Meaning of Absorption Costing 2. This is required to manufacture individual units in such manner that product design is manufactured in batches and manufacturing facility operates in efficient manner. It determines the costs of the various sources of indirect costs and allocates these expenses to the specific activities that use them. Apart from that, stable product and mass production are no longer valid for today manufacturing system. Therefore, top management should be give full support with clear understanding of goals and objectives of the whole organisation to the employees. Moreover, the management at the maximum should accept the advises given by the cost accounting system. Pros and Cons of Traditional Costing Traditional costing is best used when the overhead of a company is low compared to the direct costs of production.
In cost accounting, costs are absorbed on pre-determined rate. Activity-based costing cannot be accurately used for external reports because of the multiple activity rates involved. This can be especially important for a company that ramps up production well in advance of an anticipated seasonal increase in sales. Traditional Costing Traditional costing adds an average overhead rate to the direct costs of manufacturing products. There should be goal congruence between the personnel goals and the organisational goal. However, since traditional costing system is volume-based, inaccurate information will be generated which lead to company make wrong decision Gunasekaran et al. The traditional costing system in accounting is the allocation of factory overhead to products which is based on the volume of consumed production resources.
This allows for a faster response time to potentially troubling issues so cash can be saved. The indirect costs are allocated and reallocated at product level only after manufacturing of a product. Both methods estimate overhead related to and then assign these to based on a rate. Non-value added activities can be eliminated with the implementation of strategies such as total quality management, just in time and business process re-engineering. There should be appropriate participation of managers in preparation of budgets. Machine hours, worker hours, and unit costs would calculate costing. For example, under the traditional costing system, a small business might determine that, in general, overhead is related to direct labor hours and use direct labor hours to calculate the company's overhead rate.
Traditional costing systems use a plant-wide overhead rate to assign overhead to products based on the annual estimated overhead and an allocation base. It avoids the separation of costs into fixed and variable elements which cannot be done easily and accurately. Such allocation helps in Strategic decision making, such as Pricing. Management often focuses on unfavorable variances while ignoring favorable variances. Take a look at the production figures for the Hasty Rabbit Corporation. Apply to using the predetermined rate.
. On the other hand, if the standard set is very low it will be easily achieved without putting any extra effort. The trouble with traditional costing is that factory overhead may be much higher than the , so that a small change in the volume of resources consumed triggers a massive change in the amount of overhead applied. When costs fall significantly outside the standards, managers are alerted that there may be problems requiring attention. Difficulty in Comparison and Control of Cost: Absorption costing is dependent on level of output; so different unit costs are obtained for different levels of output.
It may cost an organization more to manufacture goods or provide services after the first projections are made, and there is no way for this accounting system to take that into account. Service organizations have almost no direct costs, most of the costs are overheads and they do not hold stocks of service as the service is consumed when it is produced. Then you take the average rate of labor or machine use costs per hour, multiplying it by the length of time necessary to create saleable goods and services. Many companies are transitioning away from this accounting option because its accuracy is dependent upon direct costs being high and indirect costs being low. Even if a company chooses to use variable costing for its accounting purposes, it still has to calculate absorption costing to file taxes and issue other official reports. I have compared between traditional method and activity-based costing method and I can say that its of much benefit to use action-based costing method.
Financial character expenses are not included for cost calculation. Therefore, in manufacturing environment, it is necessary for organisation to minimize non-value adding activities to reduce the cost of their products to compete in the market. Companies that manufacture a large number of different products prefer an activity-based system because it gives more accurate costs of each product. Workers who succeed in hiding variances diminish the effectiveness of budgeting. So sometimes inaccurate and out of date standards are set which do more harm than any benefit as they provide wrong yardsticks. If management only investigates unusual variances, workers may not report negative exceptions to the budget or may try to minimize these exceptions to conceal inefficiency. The expenses are not permitted beyond the budget amount.