Compare The Activity Based Costing Abc With Traditional Costing Accounting


The aim for this assignment is to compare the Activity-based costing (ABC) with traditional costing. Andrade, Filho, Maia and Qassim (1997) found out that Activity-based costing (ABC) is being widely implemented as a replacement to traditional costing. They mentioned the cost of operations in an organisation that are reflected by Activity-based costing (ABC) is more accurate and reliable comparison to traditional costing. Turney (1996) defines Activity-based costing (ABC) as a method of mensurating cost and public presentation of activities and cost objects.

It allocates overhead to multiple cost pools, and it so assigns the activity cost pools to merchandises and services based on cost driver.In contrast, the cost allotment in traditional costing is based on labour hours or machine hours which are difficult to reflect the existent cause and consequence relationship between indirect costs and single merchandises. (Maliah, Nik Nazli and Norhayati, 2004 ). Carsten (2002) besides pointed out that the attack of Activity-based costing (ABC) is seeking to apportion overhead costs to be objects more accurately than traditional cost systems or traditional costing.

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In short, Activity-based costing (ABC) and traditional bing represent two viing merchandise bing methods. Traditional attack usage merely unit-level drivers to delegate costs to merchandises. ABC varies from traditional costing where it uses more cost pools and more cost drivers (Shannon and Don, 2007) . By reading through the background research and literature reappraisal, we will explicate, explore and give more specific information about Activity-based costing (ABC) and the traditional costing.

Background Research

Base on Peter B.B. Turney (1998) and Jan Emblemsvag (2008), Activity-based costing (ABC) appeared in the mid-nineteen 1880ss due to the increasing of lower relevancy of traditional cost accounting methods.

Activity-based costing (ABC) method was foremost introduced in an organisation, which is called John Deere Company in United States.Many esteemed United States companies such as Hewlett-Packard, Procter & A ; Gamble, Tektronix and Caterpillar have adopted Activity-based Costing (ABC) . However, organisations in Japan prefer to implement traditional method at that clip. They prefer volume steps under traditional method like utilizing direct labour hours to apportion overhead cost to merchandises alternatively of using Activity-based costing (ABC) (March and Kaplan, 1987) .

On the other manus, Jan Emblemsvag (2008) besides claims that the traditional cost accounting methods were designed around 1870 – 1920 and in those yearss, industry was labour intensive because there was no mechanization. On other manus, the merchandise assortment was undistinguished and the operating expense costs in companies were by and large really low compared to this globalisation age where homo has achieved great success in the development of engineering.Besides that, Shannon, James, Mark Young (1892), N.S Ong, L. N Lim, K.T Yeo (1993), Gunasekaran and Sarhadi (1996) besides found out that the development and publicity of Activity- based costing (ABC) have been stimulated and mostly influenced by the work of Cooper and Kaplan (1987) particularly in fabricating sector.This method was subsequently explained in 1999 by Peter F. Drucker in the book Management Challenges of the twenty-first Century.

Though initial Activity-based Costing (ABC) execution emphasise chiefly on the fabrication or mill, today the ABC attack has spread to identify non-manufacturing maps such as selling, technology and research and development (Waeytens and Bruggeman,1994 ; Gunasekaran and Sarhadi,1996) .Based on Kingcott (1991), John and Mitchell (1995), David and Robert (1995 ), the benefits and advantages for the Acticity-based Costing (ABC), which is besides the new cost system are aiming cost decrease, public presentation measuring and different cost object. Besides that, Kingcott (1991), Evan and Ashworth (1995) besides find out that the disadvantages or restriction of the new cost system — -Activity-based costing (ABC) are ABC system can be expensive to utilize and some arbitrary allotments continue. More inside informations about the pros and cons of ABC will be luxuriant in Literature Review portion.

Literature Reappraisal

Harmonizing to Shannon and Don (2007), Activity-based costing (ABC) differs from traditional bing base on the figure of cost pools and the figure and type of cost drivers.The activity cost pool is the entire cost associated with an activity. In the interim, a cost driver is a factor that has direct influence on the cost and public presentation of the activities.

The cost drivers give the ultimate account of why costs in an activity cost pool alteration over clip (Kennedy, 1996 ). Lere (2000) mentioned that in order to appreciate the possible power of Activity-based costing (ABC) cost informations in pricing, it is of import to understand how Activity-based costing (ABC) cost informations is different comparison to traditional method. The characteristic of Activity-based costing (ABC) is although a cost does non vary with volume, it may change with some other step of activity. Activity-based costing (ABC) recognizes that activities cause cost.

Harmonizing to Cooper (1990), the first group of activity, unit degree activities refer to activities that must be performed for each unit of a merchandise manufactured. The 2nd group of activity is batch degree activities. Batch degree activities refer to other activities that are performed for each batch of units. The cost of batch activities vary with the figure of batches and non the figure of units manufactured because batches can incorporate different figure of units.

The 3rd group of activity is product-level activities. Once product-level activities were performed, it will profit all units of a peculiar merchandise. Cost incurred to execute the groups of activity mentioned before this all vary in response to alterations in some step of the activity called the “ cost driver ” . This means cost of the 3 groups activities can all be changed by altering the sum of the activity ‘s cost driver.

Under Activity-based costing (ABC), some costs do non alter in the short-run because these costs are associated with supplying the capacity necessary to set about the fabrication operations, selling operations, or disposal. They include facility-level costs such as depreciation, belongings revenue enhancements and insurance on the installations. Facility-level costs are like fixed costs under traditional cost behavior categorization and will be treated the same manner. However, the sum of facility-level costs are smaller because they represent merely that part of the traditional fixed costs that does non vary with batch- or product-level activities (Cooper, 1990) .

If traditional cost behavior is applied, industrial sellers would non be competitory with non-manufacturing costs. This is because traditional cost behavior assumes that an order is typical of overall operations such that all activities are performed in proportion to the volume step with which variable costs vary. Activity-based costing (ABC) will bespeak a figure of activities, such as transportation and order processing, that may be modified in dialogues with a client to give a more competitory command and this is why Activity-based costing (ABC) allows industrial sellers to be more competitory with non-manufacturing costs (Lere, 2000) .The difference between traditional cost behaviour and Activity-based costing (ABC) is traditional cost behaviour divides cost into variable and fixed classs while Activity-based costing (ABC) divides the costs into those that vary with unit-level activities, batch-level activities and facility-level costs.

Activity-based costing (ABC) can be a powerful tool in 3 ways when the cost is recognized to be changing with something other than volume. First is it reflects important differences among merchandise specifications since Activity-based costing (ABC) influences cost estimations to utilize in pricing.The cost estimations under traditional cost behavior assume that overall company resource use is typical of resource use for each merchandise. Second, Activity-based costing (ABC) guides the industrial seller to find which merchandise specifications may be adjusted in dialogues to give of import cost decreases which may ensue in a more competitory monetary value.

Under traditional cost behavior estimations, a alteration in volume is the lone manner to cut down costs. Third, Activity-based costing (ABC) permits cost decreases that will let the company to fulfill client wants better by bespeaking countries for alteration in operations (Lere, 2000) .By and large, traditional systems tend to be simplistic, chiefly because they are cheap to run, do extended usage of arbitrary cost allotments, and have a low degree of truth, high costs of mistakes and so on. On contrast, Activity-based costing (ABC) systems tend to be more sophisticated, because they are expensive to run, do extended usage of cost and affect cost allotments, have a high degree of truth, low cost of mistakes and so on (Drury, 2000) .

In this epoch, there are a big figure of companies that have converted to the Activity-based Costing (ABC) system since as far back every bit 1980 as the system has shown its serviceability in the appropriate merchandise mix determination and overheads direction (Gunasekaran, 1999) .However, some companies still stick to implementing the same traditional costing system that was developed decennaries ago in this globalisation age (Cooper and Kaplan, 1991) . The inquiry that lingers in our encephalons is why those companies still implement traditional bing alternatively of Activity-based Costing (ABC) ? It is because the Activity-based Costing (ABC) has it pros and cons (John, Evans and Ashworth, 1995) .The first and most dominant benefit of an ABC system mentioned by John, Evans and Ashworth (1995) is aiming cost decrease.

The elaborate analysis of activities and costs that are required for bing provide an enrich visibleness and a new position on allotment of operating expense costs (John, 1995) . It provides a profile for direction of what is being done with resources provided. This information has proved equal for testing against different standards associating to the value of each activity to the administration. Where the costs are high and the value of the merchandise is low, the activity becomes a mark for cost decrease and betterment.

Carolfi (1996) claimed that Activity-based costing (ABC) may let directors to extinguish costs related to non-value added activities and better the efficiencies of bing procedures since Activity-based costing (ABC) may supply greater visibleness into concern procedures and their cost drivers. When information visibleness is improved, it may besides enable the deployment of quality-related enterprises by placing activities that are associated with hapless merchandise quality, and their cost drivers (Ittner, 1999 ; Cooper, Kaplan, Maisel, Morrissey ; A ; Oehm, 1992) .Apart from that, another advantage of this system is public presentation measuring. Kingcott (1991) said that the information provided by Activity-based costing (ABC) on cost drivers and cost driver rates shows that they are potentially powerful affect on the title of staff and they are used as public presentation steps (Kingcott, 1991) .

Cost drivers provide volume steps on a different sort of operational public presentation which reflect the effectivity and truth of the activity concerned. So, they can assist in measuring the efficiency with which activities are carried out when it is linked to cost.Traditional bing systems use bases like direct labor and machine hours to apportion disbursals to merchandises and services (Banker et al., 2008) .

The bases are associated with indirect and support activities. The disbursals of indirect and support resources are segregated by activities under Activity-based costing (ABC), and so those disbursals are assigned based on the drivers of these activities (Cooper ; A ; Kaplan, 1991) . This is why Activity-based costing (ABC) provides works directors with a more structured attack to measure the disbursals associated with specific activities used to back up a merchandise.Different cost object is besides one of the advantages of Activity-based Costing (ABC) .

John and Mitchell (1991) have found out that the Activity-based costing (ABC) methodological analysis can be applied to be objects except for the merchandise. Indirectly, this allows client profitableness to be analysed and so provides direction with a market-oriented position of how returns have been earned. Activity-based costing (ABC) can besides be used as a tool for determination devising particularly for merchandise mix costing and pricing determinations (Kee, 2008) .Supporters of Activity-based costing (ABC) have argued that Activity-based costing (ABC) can assist to capture the economic sciences of production processes more closely and may supply more accurate costing informations than traditional cost-based systems (Cooper ; A ; Kaplan, 1991 ; Ittner, 1999) .

There is a suggestion from anterior research that Activity-based costing (ABC) should take to operational and strategic benefits within organisations (Anderson ; A ; Young, 1999 ; Cooper ; A ; Kaplan, 1991) .By placing all the work activities and their costs that go into fabricating a merchandise, presenting a service, or executing a procedure, Activity-based costing (ABC) helps to make full in the spreads of traditional method. A clear image of the entire cost of a procedure becomes transparent when the person costs are added. Activity-based costing (ABC) can even distinguish the cost of functioning the different section of clients (Shank, 1996) .

Advantage of Activity-based costing (ABC) harmonizing to Qian and Ben-Arieh (2008) is Activity-based costing (ABC) is a more accurate cost-estimation method. They argue that Activity-based costing (ABC) can assist directors to go cognizant of original parametric quantities that create demands on indirect and support resources which can place and take non-value adding activities. Ben-Arieh and Qian (2003) and Qian and Ben-Arieh (2008) think that Activity-based costing (ABC) attack has demonstrated to be accurate than the traditional cost appraisal.Singer and Donoso (2008) conducted trial on cogency of Activity-based costing (ABC) cost appraisal and they concluded that the truth of appraisal of costs made by Activity-based costing (ABC) was valid.

Activity-based costing (ABC) is a more accurate product-costing system than traditional volume-based bing systems particularly when organisations are confronting higher merchandise diverseness from the findings of Charles and Hansen (2008).Although Activity-based costing (ABC) frequently provide better merchandise cost than traditional volume-based systems, it still has the restrictions (Evans and Ashworth, 1995) . First and first, Activity-based costing (ABC) systems can be expensive to utilize. The addition cost of placing multiple activities and using big sum of cost drivers deter many administrations from utilizing Activity-based costing (ABC) .

Kingcott (1991) advised that if the costs of Activity-based costing (ABC) exceed the benefits, company should non use Activity-based costing (ABC) systems. If non, the capital outgo on the activity based system and its subsequent running costs can be a route block for houses.Although Activity-based costing (ABC) systems are largely more accurate comparison to traditional method, the restriction of Activity-based costing (ABC) is ABC may use estimations because existent costs can non be traced back. The costs of happening true costs may dominate the benefits of happening true costs (Stapleton et al., 2004) .Gering (1999) mentioned that Activity-based costing (ABC) will work best with a minimal sum of item and estimated cost figures. This means that Activity-based costing (ABC) interior decorator will necessitate to come out with more precise measuring tools if more accurate costs are needed.Evan and Ashworth (1995) claimed that although more overhead costs can be allocated directly to merchandises via ABC ‘s multiple activity cost pools, but, some overhead cost remain to be assigned with the aid of some arbitrary volume-based cost driver like machine or labour hours.

The disadvantage of Activity-based costing (ABC) is it may increase the frequence of mistakes in merchandise cost measuring through increasing in figure of cost pools and betterment in specification of cost bases (Datar and Gupta, 1994) . Another disadvantage mentioned by Noreen (1991) is Activity-based costing (ABC) execution may supply good consequences merely under specific conditions. Some surveies conducted by McGowan and Klammer (1997) suggested that many Activity-based costing (ABC) adoptive parents have abandoned their executions and this raised concerns on the possible impact of Activity-based costing (ABC) on public presentation.The disadvantage of traditional bing systems is they do non supply non-financial information about Small and Medium Enterprises (SMEs) .

The traditional costing systems provide small information about the factors that matter to the clients like quality and service. Traditional bing systems study merely fiscal information while non-financial information like defect rates and throughput rates in each activity is beyond the range of traditional bing systems (Gunasekaran, Marri and Grieve, 1999) . At first, directors viewed Activity-based costing (ABC) attack as a more accurate manner of ciphering merchandise costs. However, Activity-based costing (ABC) has emerged as a enormously utile usher to direction action that can interpret straight into higher net incomes (Cooper and Kaplan, 1991) .

Harmonizing to Dickinson and Lere (2003), one of the most important failings of traditional method is the cost of a gross revenues representative ‘s engaging in nonstandard merchandising activities is frequently excluded from his/her public presentation reappraisal. This is a job because most people tend to maximise whatever standard is established as a public presentation criterion. For illustration, when a gross revenues representative is evaluated based on remarkable end products such as gross revenues volume or gross net income, they may prosecute in activities to accomplish the terminal consequence without sing the existent cost of those activities and the ensuing eroding of profitableness to the house.Traditional costing systems are non relevant in such dynamically altering environments since traditional costing systems are based on premises of long production tallies of a standard merchandise with inactive specifications.

Advocates of Activity-based costing (ABC) argued that Activity-based costing (ABC) may supply more accurate information on the activities and minutess that impact merchandise costs in fabricating environments characterized by production of smaller batch sizes, high wide mix, and frequent conversions (Krumwiede, 1998) .Presents, a precise and accurate costing is necessary because a larger figure of merchandises are produced and competition among companies is increasing. However, traditional methods are still utile and accurate when an organisation made a few merchandises and indirect fabrication costs are negligible comparative to direct fabrication cost. (Kaplan, 1989 ; L.

Angote, Andrate, Espozel, Maia and Qassim 1996) .Supporting TheoryThere are many types of bing systems available for concerns to utilize such as Activity-based costing (ABC), Just-in-Time (JIT) Processing, Job Order Costing and Process Costing. Most of these bing systems are designed to delegate costs to merchandises. (Gerhard Plenert,1999 )Mohamed (2003) stated that Just-in-Time (JIT) is a processing system dedicated to holding the right sum of stuffs, parts, or merchandises arrive as they are needed in order to cut down the sum of stock list.

Under JIT processing, an administration such as Dell receive natural stuff merely in clip for usage in production and they complete finished goods merely in clip to be sold.The chief benefit of JIT is to cut down apparatus clip. Hirano, Hiroyuki and Makota, Furuya (2006) claimed that cutting setup clip allow the organisation to cut down or extinguish stock list for “ conversion ” clip. Overall, Just-in-time (JIT) is an stock list scheme that tries to better a concern ‘s return on investing by cut downing in-process stock list and associated carrying costs.

( Ohno, 1988) .Job order costing is a cost accounting system in which cost is allocated to each occupation or batch, while ; Process Costing is an accounting system usage to use costs to similar merchandises that are mass-produced in a uninterrupted manner. In other words, companies allocate costs to specific cost system in a occupation order cost system. Companies allocate costs via a series of relevant fabrication processes or sections, instead than by single occupations in a procedure cost system. (Hansen and Maryanne M. Mowen, 2006) .

Therefore, Process Costing works expeditiously for the companies that are known to bring forth a individual type of merchandise.In a nutshell, the costing system is one of the most of import information systems in any concern. It is the key to direction ‘s appraisal of the company ‘s attempts to carry through the end and generate net income. Since it is so of import, the costing system must be carefully designed and decently maintained (H. James Williams, 1985) .Activity-based costing (ABC) is often applied together with other direction constructs or techniques.

Examples are entire choice direction (Carlson and Young, 1993), game theory (Charles and Hansen, 2008) and stock list control systems (Berling, 2008) .Activity-based costing (ABC) can besides be applied to assorted fabricating systems (Dhavale, 1993 ; Zhuang and Burns, 1992), including the fabrication system for joint merchandises (Tsai, 1996) . Procedures are the base usage to find the merchandise cost of joint merchandises.Goldratt (1990) mentioned that many of the premises implicit in traditional cost-based accounting systems are no longer valid and that these systems are taking many companies to catastrophe.

He developed Theory of Constraints (TOC) as a procedure of uninterrupted betterment. The precedences of Theory of Constraints (TOC) are factors that constrain the procedure of supplying goods and/or services to clients. Both Activity-based costing (ABC) and Theory of Constraints (TOC) are popular managerial tools for measuring merchandise mix determinations (Tsai et al., 2008) .


After reading through old subdivisions, more can be learned about both Activity-based costing (ABC) and traditional costing. First of wholly, we learn that Activity-based Costing is being widely implemented as a replacement to traditional costing from Andrade, Filho, Maia and Qassim (1997) . This means that nowadays most organisations use Activity-based costing method which is besides the new cost system.

Harmonizing to Turney (1996), Activity-based costing (ABC) is a method of mensurating cost and public presentation of activities and cost objects. Both Activity-based costing and traditional are viing merchandise bing methods.From background research, it can be concluded that most companies use Activity-based costing base on Turney (1998) and Emblemsvag (2008) . However, there are still some companies that prefer to utilize traditional costing.

Work done by Cooper and Kaplan (1987) has mostly influenced Activity-based costing (ABC) .There are many advantages and disadvantages of Activity-based costing (ABC) mentioned in the literature reappraisal subdivision. The chief advantages of Activity-based costing (ABC) mentioned antecedently are aiming cost decrease (John, Evans and Ashworth, 1995), public presentation measuring (Kingcott, 1991), tool for determination devising particularly for merchandise mix costing and pricing determinations (Kee, 2008) and supply more accurate costing informations (Cooper & A ; Kaplan, 1991 ; Ittner, 1999) .The chief disadvantages or restrictions of Activity-based costing (ABC) are expensive to utilize (Evans and Ashworth, 1995), increase the frequence of mistakes in merchandise cost measuring (Datar and Gupta, 1994) and may supply good consequences merely under specific conditions (Noreen, 1991) .

It can be concluded that although many companies have converted to the Activity-based Costing (ABC) system (Gunasekaran, 1999), there are still some companies that continue to utilize the same traditional costing system that was developed decennaries ago in this globalisation age (Cooper and Kaplan, 1991) .This is chiefly because no affair what bing methods, all of them do hold their pros and cons. It ‘s of import for the organisations to cognize clearly what they need before make up one’s minding on which bing method to utilize. The organisations need to analyze the pros and cons of each bing method to cognize which is more suited for their organisations.

There is no such thing as the best costing method ; there is merely the most suited bing method to utilize.

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