Is Activity-Based Costing (ABC) superior to traditional costing in which only one overhead pool?
Traditional costing in which only single overhead pool is used is inferior to Activity-Based Costing since it can not be used to make effective running decisions which can be relied by a firm. This is because it was well designed for firms which had single production and huge costs as compared to indirect outlay of ABC (Holmen, 1995). Also, it provides limited information to aid in running control of prices at merchandise level or less. ABC is best suited to oblique costs than the latter and offers no alterations the way the material and labor accredited to processed goods. This is achieved via simplifying the indirect information of activities into meaningful pools. Thus enabling them to be keyed in the processes which will reflect the expenses incurred.
Traditional costing has limited ability to assemble data on illogical application of operating costs which assist in reconciling attained information to have accurate pricing (Holmen, 1995). This mostly exposes company to high risks of losing rather than making profit. This means that it has little knowledge on cost of goods and it is rendered inefficient in making both present and future decisions to place the firm at a competitive edge above other same-line operating companies. Conversely, ABC gives almost all the necessary required costs which include labor, resources, facilities to be used and machineries (Holmen, 1995). This helps the management to make sound decisions early in advance for well organization of firm and ensure that future challenges are catered for.
In some instances, resources can consume other resources like a worker utilizing space he is working on. This will not be featured by traditional costing since it applies two-stage process thus rendering it ineffective. With ABC, it considers the relationship of diverse costs and its application with evaluating of their rate of efficiency (Holmen, 1995). Costs are accredited with regard to material consumption and then assigned to price objects. This helps in tracing how the materials and workforce are relating and giving the correct information at stipulated time for better comparison. While traditional pricing assigns their costs by functions or divisions of a company and then assigned to products via one activity to evaluate.
Traditional cost accounting gives no guidelines to the top officer on the impact of sales, selling, supplies and customer prices trends on a given product (Tarr, 2004). Also it does not depict the line of profitability so as to make advance adjustments required in the market. ABC though has some minimal assumptions in its evaluation, it tries to give far almost close to accurate approximation and its benefits can be compared to the latter. ABC allows accurate allocation of costs when fixed costs are not encountered at the same case as with straight labor expenses.
Today’s enterprises’ activities are becoming more complex as with figures and diverse transactions which can not be handled properly with traditional costing methods. This renders the latter method almost outdated though it has its few application areas and its advantages (Tarr, 2004). This has seen immense application of computers to capture all the data needed which the ABC is well versed with for efficient running and making quality executive decisions. In ABC the costs are from the initial making of the product to the final stage of goods in the market catering all the expenses. That is to say from setting up of the production facilities, labor involved and resources required (Tarr, 2004). This still ensures that, suppose one area has a high demand of the product, can be catered adequately since the resources are well catered and can be traced. In traditional costing this is not the case and only small view outlook is shown leaving other complicated processes out. Thus ABC is better than traditional cost both in aiding in decision structuring and well organization of a firm.
Reference
Holmen, J. S. (1995). Activity Based Costing vs. Theory of Constraints: Its a matter of time.
Management Accounting. Retrieved on 22, April 2011 from
http://maaw.info/ArticleSummaries/ArtSumHolmen95.htm
Tarr, D. J. (2004). Activity Based Costing in the Information Age. Retrieved on 22, April 2011
from http://www.theacagroup.com/activitybasedcosting.htm
