Difference Between Traditional and Abc Costing

dddDifference between Traditional and ABC Costing

ABC

• It is a superior allocation method for overhead costs, using multiple allocation bases. Of these allocation bases, some are often volume related and others are not

• ABC first categorise indirect costs according to discrete business activities that are responsible for consuming resources and then uses cost drivers to estimate the resources attributable to cost objects.

• ABC is a costing system in which organisational processes, e.g. productions, are analysed and broken down to activities. The techniques can be used to identify the costs available to activities which provide information on product costs or customer profitability.

Activity: an event which causes a cost to be incurred

Cost Drivers: the costs assigned to these activities are then allocated to products or services on the basis of cost drivers appropriate to these activities.

Traditional Costing

• It typically allocates overheads on the basis of direct labour or a measure of activity that is correlated with unit volume such as sales dollars or costs of goods sold.

• Problem: by adopting this approach, business units with the higher portion of sales or COGs are penalised.

• More comparison can be found in Deloitte Bible P213.

Assumptions when calculating ABC (can be used for advice for management)

• Depreciation: Note that all the above calculations have omitted any consideration of deprecation, because it was not supplied in the case. If it had been included, the customer profit would have decreased for all three stores. Depending on the nature of the deprecation, and in particular what it is related to (plant or trucks), the percentage decline in profitability could vary across the three stores.

• Allocation: if we are not sure the allocation basis, it would affect the degree of precision of the ABC calculation which would affect the profitability of customers.

Advantages of ABC (can be used for advice for management)

• Provide the firm with information for directing attention and guiding management action

• Provide advice to management about how activities might be more efficiently run in the future and aid in creating and maintain competitive advantage

• Support decision making and action

• Suggesting ways for improving production efficiency and product design

• Informing production and sales efforts

• Indentifying