ACTIVITY BASED COSTING VS TRADITIONAL COSTING

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Meaning:

Activity-Based Costing (ABC) is a costing method that identifies activities in an organization and assigns the cost of each activity to products and services according to the actual consumption by each in order to arrive at the actual cost of products and services.

In Activity based costing costs of all organisation's resources are assigned to the products and services that the organization manufacture/render.The main intention behind the assignment of resource cost to the product/services is to find out the cost of the product and the resultant profitability.

Purpose:

The main purpose of Activity Bases costing is the elimination of unprofitable activities in the organization. Further, to identify the over priced activities in order to lower the prices of those activities. It is generally used as a tool for understanding product and customer cost and profitability. As such, ABC has predominantly been used to support strategic decisions such as pricing, outsourcing and identification and measurement of process improvement initiatives.

How does ABC costing differ from traditional allocation methods?

Traditional costing system VS Activity based costing system

In Traditional costing system , indirect expenses are allocated on the basis of the direct expenses.However, this method of allocating the indirect expenses is purely arbitrary in nature and it wont give the accurate result.This can be explained with the simple example.

One product might take more time in one expensive machine than another product and assuming the amount of direct labor and materials are same, the indirect cost is allocated on the basis of direct labor/material.Therefore, the additional cost for the use of the machine is not recognized ie., one machine is more expensive than another machine and the additional usage of time is not recognized in the traditional method of ...