During the production of any product, it is important to know the manufacturing cost of each product. Costing helps the company in strategic and profitable decision-making. It is an important component in determining the total production costs of the product. Activity-Based Costing and Traditional Costing are one of the ways of costing in accounting.
Activity-Based Costing vs Traditional Costing
The main difference between Activity-Based Costing and Traditional Costing is that Activity-Based Costing is a costing method that focuses on activities. In this type of costing, costs are initially traced to activities rather than products. On the other hand, Traditional costing is used to allocate overhead costs based on the capacity of production used.
Activity-Based Costing is used to find production costs. It splits overhead costs between production-related activities. This type of costing can give a clearer picture of where money is going and which products are profitable because it gives a breakdown of specific production costs.
Traditional costing is one of the methods that is used to predict the future. This type of costing is beneficial when the overhead of any company or firm is not more than the direct value of money or production costs. It gives exact cost figures when the production capacity of any business or firm is very high, and changes in overhead cost do not make any major changes.
Comparison Table Between Activity-Based Costing and Traditional Costing
| Parameter of Comparison | Activity-Based Costing | Traditional Costing |
| Definition | Activity-based costing focuses on activities performed to produce products in the manufacturing industry. | Traditional costing is a method to fix the cost of manufactured products to make profits and is based on allocating overhead manufacturing costs. |
| Primary focus | Traditional Costing applies as a single cost driver, which is set for all activities and is straightforward to implement. | Activity-based costing covers product costs only. |
| Scope | Activity-based costing focuses on cost allocation, where cost drivers are determined for different activities, and the cost is allocated per these cost drivers. | Traditional Costing can cover both products as well as period costs. |
| Application | Activity-based costing focuses on cost allocation, where cost drivers are determined for different activities, and the cost is allocated per these drivers. | Activity-based costing is difficult to implement, and it takes time and efforts |
| Use | Activity-based costing value can be used in the financial statement. | Traditional costing reports cannot be used in reports of external reporting. |
What is Activity-Based Costing?
Activity-based costing is a costing system for dealing with the overhead value of money or costs and indirect costs. It is used in the manufacturing industry because it enhances cost data reliability. This will produce reliable costs, benefitting company production based on activities and determined goals.
The activity-based costing method also solves the problem of erroneousness in a traditional approach. It helps to distinguish between profitable profits and those that are not.
ABC is the most accurate and difficult to implement, that’s why it is best suited for a company or firm with high overhead costs compared to a small company that offers services. Companies that manufacture many products with different varieties prefer ABC because it gives exact data on the costs of every product.
With ABC, knowing where the actual expenses are used for nonyielding products is comfortable. Every manager wants accurate costs; that is the reason many choose activity-based costing. Even though it is the costliest method, it provides information that gives edges to managers for making a profitable decision in the company in the long-term process.
What is Traditional Costing?
Traditional costing is a costing system that adds the total sum of overhead value from the direct costs of manufacturing products. It is a method to determine the cost of production to make a profit for the company. This type of costing is based on allocating overheads to manufacturing goods. It is used to estimate overhead cost rates for specific cost drivers.
Traditional costing is beneficial when the overhead of the business or firm is not so much compared to the direct cost of production. Trading Costing gives exact cost figures when the product is very good in amount, and a change in overhead rate does not create a major change while measuring the cost of production.
It is not as expensive as activity-based costing to implement. It is used for external exports because it is easier and more understandable for outsiders. Traditional costing is a good method for those manufacturers who produce only a few different goods.
It does not give accurate figures to managers of the product cost. It is used for absorption of manufacturing overheads and can cover both products and period costs.
Main Difference Between Activity-Based Costing and Traditional Costing
- Activity-based costing uses multiple costs for different activities, whereas Traditional costing uses identical costs for multiple activities.
- Activity-based costing is difficult to implement because it requires time and effort, whereas traditional costing is easy to implement and straightforward.
- Activity-based costing gives accurate cost figures, whereas traditional costing reasonably gives accurate ones.
- Activity-based costing is good for businesses that manufacture many products, whereas traditional costing is good for businesses that produce low and different products.
- Activity-based costing covers the cost of the product only, whereas traditional costs cover products and period costs.
Conclusion
Costing is necessary for businesses to make effective, profitable, and strategic decisions. Traditional-based costing method is easy to understand by the management of the company. It is a conventional costing method suitable for business, with a low overhead cost.
When there is a medium and large overhead size company, activity-based costing is preferable. It is the most effective way to give accurate cost figures to managers. Both activity-based and traditional costing are effective in their respective area of accounting and are chosen by managers according to the company’s needs.
References
- https://link.springer.com/content/pdf/10.1007/978-1-4899-6828-9_11.pdf
- https://onlinelibrary.wiley.com/doi/abs/10.1111/1475-679X.00031
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