During the production of any product, it is important to know the manufacturing cost of each product. Costing helps the company in strategical and profitable decision-making. It is an important component in determining the total production costs of the product. Activity-Based Costing and Traditional Costing are one of the ways of costing in accounting.
Activity-Based Costing vs Traditional Costing
The main difference Activity-Based Costing and Traditional Costing is that Activity-Based Costing is a method of costing that focuses on activities. In this type of costing, costs are initially traced to activities than to products. On the other hand, Traditional costing is used to allocate overhead costs based on the capacity of production used.
Activity-Based Costing is used to find production costs. It splits overhead costs between production-related activities. This type of costing can give a clearer picture of where money is going and which products are profitable because it gives a breakdown of specific production costs.
Traditional costing is one of the methods that is used to predict the future. This type of costing is beneficial to use when the overhead of any company or firm is not more than the direct value of money or costs of production. It gives exact cost figures when the production capacity of any business or firm is very high and changes in overhead cost do not make any major changes.
Comparison Table Between Activity-Based Costing and Traditional Costing
|Parameter of Comparison||Activity-Based Costing||Traditional Costing|
|Definition||Activity-based costing focuses on activities performed to produce products in the manufacturing industry.||Traditional costing is a method to fix the cost of manufactured products to make profits and is based on allocating overhead manufacturing costs.|
|Primary focus||Activity-based costing focuses on cost allocation, where cost drivers are determined for different activities, and the cost is allocated as per these cost drivers.||Traditional costing focuses on the appointment of overhead costs to the activities of production.|
|Scope||Activity-based costing is covering product costs only.||Traditional Costing can cover both products as well as period costs.|
|Application||Activity-based costing is difficult to implement and it takes time and efforts||Traditional Costing applies as a single cost driver which is set for all activities and is straightforward to implement.|
|Use||Activity-based costing value can be used in the financial statement.||Traditional costing reports cannot be used in reports of external reporting.|
What is Activity-Based Costing?
Activity-based costing is a costing system for dealing with the overhead value of money or costs and indirect costs. It is used in the manufacturing industry because it enhances cost data reliability. This will produce reliable costs, which are beneficial for better production of the company based on activities and determined goals.
The activity-based costing method also solves the problem of erroneousness that comes in a traditional approach. It helps to distinguish between profits that are profitable or profits that are not profitable.
ABC is the most accurate and difficult to implement that’s why it is best suited for a company or firm with high overhead costs compared to a small company that offers services. Companies that manufacture a large number of products with different varieties prefer ABC because it gives exact data of the costs of every product.
With ABC it is comfortable to know about areas where the actual expenses are used for nonyielding products. Every manager wants accurate cost that is the reason many choose activity-based costing. Even it is the costliest method but it provides information that gives edges to managers for taking a profitable decision in the company in the long-term process.
What is Traditional Costing?
Traditional costing is a costing system that adds the total sum of overhead value from the direct costs of manufacturing products. It is a method to determine the cost of production to make a profit for the company. This type of costing is based on allocating overheads to manufacturing goods. It is used to estimate overhead cost rates for specific cost drivers.
Traditional costing is beneficial when the overhead of the business or firm is not so much compared to the direct cost of production. Trading Costing generally gives exact costs figures when the product is very good in amount and change in overhead rate does not create major change while measuring the cost of production.
It is not expensive as activity-based costing to implement. It is used usually for external exports because it is easier and more understandable for outsiders. Traditional costing is a good method for those manufacturers who produce only make few different goods.
It does not give accurate figures to managers of the product cost. It is used for absorption of manufacturing overheads and can cover both products as well as period costs.
Main Difference Between Activity-Based Costing and Traditional Costing
- Activity-based costing uses multiple costs for different activities whereas Traditional costing identical costs for multiple activities.
- Activity-based costing is difficult to implement because it requires time and effort whereas traditional costing is easy to implement and straightforward.
- Activity-based costing gives accurate costs figures whereas traditional costing reasonably gives accurate costs figure.
- Activity-based costing is good for businesses that manufacture a large number of products whereas traditional costing is good for businesses that produce low and different products.
- Activity-based costing covers cost product only whereas traditional costs cover both products as well as period costs.
Costing is a necessity for businesses to take effective, profitable, and strategical decisions making. Traditional based costing method is easy to understand by the management of the company. It is a conventional method of costing suitable for business which has a low overhead cost.
When there is a medium and large overhead size company then activity-based costing is the preferable option. It is the most effective way to give accurate cost figures to managers. Both activity-based costing and traditional costing are effective in their respective area when it comes to accounting and chose by managers according to the need of the company.