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Why activity based costing is better than the traditional system of costing?

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2017-12-10 17:00:48
2017-12-10 17:00:48

ABC....why? The problem with Traditional costing is that it can easily over-allocate overhead to cost objectives. Traditional costing is production volume driven so its would be easy but yet inaccurate to assign a Skittles production with more overhead than say a the division within the same company that makes custom pies. Activity based costing accounts for the multiple costs that go into making a product or service thus making allocation of overhead more efficient and allowing managers to make better business decisions. Derek Coleman

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Over costing and under costing occurs because overhead cost is applied first using some ratio to find out the cost of product before the process of production done and actual cost found.

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assigning manufacturing overhead costs for each activity cost pool to products

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needs of product costing system

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Activity-based costing is a more accurate cost management system than TCA. One would use the ABC method when overhead is high, products are diverse, cost of errors high and competition is stiff. Traditional Cost Accounting is unable to calculate the 'true' cost of the product. TCA arbitrarily allocates overhead to the costs of objects. Total company's overhead is allocated to the products based on volume based measure e.g. labor hours, machine hours.

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Job order costing is more appropriate than process costing when the product being produced is a custom product

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The Traditional costing system used to allocate/assign overhead costs to products by using only volume based cost drivers. In fact, these traditional systems were designed decades ago when most companies manufactured a narrow range of products, and direct labour and materials were the dominant factory costs. Overheads costs were relatively small and the distortions arising from inappropriate overhead allocations were not significant. Danish Ayub

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* More accurate costing of products/services, customers, SKUs, distribution channels * Better understanding overhead* Easier to understand for everyone * Utilizes unit cost rather than just total cost * Integrates well with Six Sigma and other continuous improvement programs * Makes visible waste and non-value added * Supports performance management and scorecards * Enables costing of processes, supply chains, and value streams * Activity Based Costing mirrors way work is done * Facilitates benchmarking * More time consuming to collect data * Cost of buying, implementing and maintaining activity based system * Makes waste visible which some executives and managers don't want their boss to see

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In Target costing system, comapnies tries to achieve target prices by reducing those parts of activity which are not increasing the value of product. Life cycle costing is a concept in which companies tries to read the overall process of development of product life cycle and tries to minimise the cost at area where it is not required or not increase the value of product.


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