Introduction
Cost is the amount of money an organisation spends in producing a unit of the product. There are various types of costs incurred in producing a unit of the final product. Some of these costs are fixed and some are variable. Some costs are distributed among various products being produced in an organisation. Accounting for all these costs to derive at final value of a product is known as cost accounting. The paper aims at contrasting the two main types of cost accounting systems, which are process cost accounting and activity based accounting system.
The paper is divided into three sections. The first section briefly defines process and activity based accounting systems. The second section contrasts the two methods of cost accounting. The third section concludes the paper.
Process and Activity Based Cost Accounting
Process Cost Accounting
Process cost accounting is a method of accounting cost involved in production to individual units of goods produced. It involves accounting of costs of factor of production on per unit basis, for instance, man hours and machine hours. Process cost accounting system is used when production process is well defined. In a standardised production process it is easy to establish the department wise inventory levels, opening, closing and work in progress. Thus, it is easy to determine cost in each department involved.
Activity Based Cost Account
According to Johnson (n.pag.), activity-based costing determines every activity associated with producing an item and allocates a cost to the activity. It adds manufacturing as well as non-manufacturing expenses to the goods produced.
Process Cost Accounting vs. Activity Based Cost Accounting
There are five major differences between process cost accounting and activity based accounting systems, which are discussed in this section.
First, unlike process cost accounting, activity based accounting also accounts for non-manufacturing expenses while deriving at cost of production of individual units. According to Johnson (n.pag.), traditional accounting fails to allocate nonmanufacturing costs that also are associated with the production of an item, such as administrative expenses.
Second, as activity based cost accounting accounts for non-manufacturing expenses as well, it is more precise in determining unit costs. It also shows a better picture of overall product cost structure. It helps better in creating benchmarks and deciding on profitability of individual products. This kind of comparison helps firms in deciding upon the more profitable projects, as resources available are limited. According to Johnson (n.pag.), process costing system of accounting can lead to bad management decisions because it excludes certain nonmanufacturing costs, like administrative expenses.
Third, though activity based costing is more accurate, it is more expensive than process based accounting system. Thus, companies may be reluctant to implement this method of cost accounting.
Fourth, number of cost parameters involved in activity based cost accounting is much higher than process based accounting. Hence, the former is more prone to misinterpretation than the latter.
Fifth, process based cost accounting is cheaper but can be used only in those companies where production processes are well defined. It would be difficult to determine units products are each level if processes are not streamlined in process cost accounting.
Conclusion
While process cost accounting has been traditionally used for allocating costs to individual units of goods produced, it has its own limitations. Activity based cost accounting removes the limitation of process based accounting by accounting for non-manufacturing expenses like administrative expenses as well. While the later gives a better picture of product cost, it is expensive and open to misinterpretation.
Works Cited
Johnson Rose. “Traditional Costing Vs. Acitivity Based Costing”. Smallbusiness.chron.com, 2014. Web. 29 Nov. 2014.
