Traditional Costing Methods vs Activity Based Costing (ABC)

Traditional Costing Methods vs Activity ground Costing ( alphabet)In this herald I exit tone-beginning to discover whether it is feasible as a company to modify the Traditional modes of monetary valueing we currently use to the more than modern Activity Based Costing methods, enumerateing at the benefits and drawbacks of changing and whether it is worth implementing these new be methods to our company as a whole. grounding / BackgroundAs a sm whole local engineering science sign of the zodiac we currently use the Traditional representing method where we apportion ingathering command processing overhead times on the basis of direct tote hours. Does this give a comely and complete representation of the true cost of outgo distributively product consumes or should we as a company convert to the Activity Based Costing system or ABC as I will refer to it from here in, where we first assigns be to the activities that be the real act of the overhead and thusly assi gn the cost of those activities only to the products that ar real demanding the activities. Would this give a fair and more realistic look at the direction we cost jobs. In this report I will look at both methods and rig whether we as a company should change the focusing we cost our jobs and if we do change to the ABC method of costing, what the conditions atomic number 18 of implementing this to us.Traditional Costing MethodsCurrently we adopt the more traditional way of apportioning our production overheads which involves the overhead rate macrocosm calcu latishd victimisation direct labour hours, machine hours, or units, in our case victimization direct labour hours. The advantages of using this system areSimplicity the computing of overhead rates is relatively straightforwardThey are widely still in businessThey are not expensive to operateUntil the late 1980s they were seen as fairly dead-on(prenominal)They are still being use after many decades.The weaknesses of t raditional costing systems areTheir trustingness on arbitrary rather than bring-and-effect any(prenominal)ocation of overheadsTheir inability to give accurate product costs in multiproduct companiesTheir failure to analyze non-manufacturing costs.(Traditional costing system. A Dictionary of Business and Management. 2006. Encyclopedia.com. 19 Nov. 2010 . )Currently using the traditional method of cost accounting we are allocating the factorys indirect costs to the items manufactured on the basis of direct labour hours, By using only labour hours to share the manufacturing overhead to products, we are implying that the labour hours are the underlying cause of the factory overhead. Traditionally, that may study been sufficient for the companys external financial statements. However, in recent decades the manufacturing overhead has been caused by many other factors. For example, some customers are likely to demand additional manufacturing operations for their products. Other cust omers simply essential great quantities of product.If we want to know the true cost to produce limited products for detail customers, the traditional method of cost accounting is inadequate. ABC was positive to overcome the shortcomings of the traditional method. Instead of just one costing such(prenominal) as labour hours, ABC will use many costings to allocate our indirect costs. A few of the costings that would be used under ABC include the number of machine setups, the pounds of material purchased or used, the number of engineering change orders, the number of machine hours, and so on.So do we progress to use this system because it is simple to use and has been used for decades or do we want a more accurate analysis and breakdown of the way we allocate costs.Activity Based Costing (ABC)Activity-Based Costing (ABC) is an Information constitution developed in the 1980s to overcome some of the limitations of traditional cost accounting and to enhance its usefulness to strateg ic decision-making.ABC systems are intentional and implemented on the premise that products consume activities, activities consume resources and resources consume costs (Sprow, 1992). ABC systems assign costs to activities based on their consumption of resources, and because activity costs are assigned to products or services in proportion to a selected measure of their individual workloads (Anderson, 1993 p. 7). ABC systems examine all processes (or activities) that are actually relevant to the production of a product and attempt to determine exactly what portion of apiece resource is consumed i.e. which activity a particular product uses.(M. Gupta, K. Galloway / Technovation 23 (2003) 131-138)Why the need for ABC, you may gather upNowadays managers are facing global competition and increased productiveness in new manufacturing environments. Companies attempt to become customer focused and narrow on quality products at competitive prices. Under these circumstances, many firms are interested in find out various costs more accurately with the objective to integrate manufacturing and marketing strategies. Various costing systems are used to provide an increased accuracy about product costs, product mix, determine and other investment decision- makings. Some experiences reveal that the distortion in describe product costs and, in turn, product pricing could be minify by using activity-based costing (ABC)(A. Gunasekaran, M. Sarhadil Int. J. Production Economics 56-57 (1998) 231-242)What are the benefits then of this new and modern way of costing, is it really the way forward for us.It substance abuse eliminate costs but it will give us detailed information about the way we are consuming them, thus destiny us to isolate problem areas with the view to rectifying why the costs are so broad(prenominal) in these areas.ABC costing is a reliable tool where variant customers require different needs.Its an unwritten rule prise by many in the business world t hat you generally contend your best customers the best. The problem is, do you really know who your best customers are, or do you think you know? The majority of business people have the false perception that the best customer is the one that accounts for the largest portion of your income all year. This is not always the case for the simple reason that the same customer may be responsible for the biggest part of your expenses also. Studies have shown that 20% of all customers virtually provide all the profits of a company. Another 60% break even and the remaining 20% only reduce the roll in the hay line. Wouldnt it be nice if you had the names of that 20% of headache-inducing customers that are literally more trouble than theyre worth? To determine how much a customer is costing you, you mustiness first identify the activities that relate to each customer and determine the total cost absorbed by those activities. These activities or cost drivers should be considered then to mea sure the level of activity absorbed by each customer. The ultimate purpose of implementing ABC is to separate these activities into individual cost drivers. Then, all you have to do is measure each customers participation in the specific cost.(The ABC Portal is 2002 Offtech Computing Pty Ltd.)So with our customers needs being different in terms of specific shelters and designs we could cost jobs more accurately to each customer.Looking at the draw backs to the ABC costing system, we would have to watch into account the data collection process for this new system could conjure up to be very time consuming along with the capital expenditure on this new system and its subsequent running costs. Employee resistance must also be taken into account. This is a major obstacle in implementation of an ABC system. Such resistance is natural as the around common objective is to give a reduction in overhead costs, and in almost all circumstances this could result in a reduction in personnel.S o to break it down the advantages and disadvantages of ABC areThe main advantagesAssesses costs of individual activities, based on their use of resourcesEnables accurate costing of all activities to be obtained throughout an organisation.Easy to identify where high (and low) costs are being incurred and the cause.A valuable tool for both business and process improvementHelps with future product planning e.g. the cost of all activities associated with a product or service can be accurately determined before it is launched. This can then help with determining pricing, and any associated expenditure.Disadvantages includeIt may be difficult to set up and establish, particularly if an organisation is using more traditional accounting methodologies. (barriers to change) stern be time consuming if all activities are to be costedwhitethorn provide too much detail obscuring the bigger picture.Can choose to employee and possible management disharmony.