The upcoming discussion will update you about the difference between Traditional Costing System and Activity-based Costing System (ABC).
Difference # Traditional Costing System:
1. Single or limited number of cost pools or cost centres exist.
2. Overhead costs are first related to the various production and service departments and then to products.
3. Overhead costs are charged to products on a production volume-related basis such as direct labour hours, machine hours etc. As a result, traditional system leads to over- cost high volume products and under-cost low volume products.
4. Since the overhead costs are related to the cost centres or departments a realistic picture of the cost behaviour is not portrayed.
5. It assumes simple labour-based production norm and overhead costs are in small proportion because support or servicing functions are less.
6. Only two levels of activity i.e., facility level and unit level are identified.
7. It is simple and inexpensive.
Difference # Activity-based Costing System (ABC):
1. Many activity-based cost pools or cost centres are created to reflect different activities.
2. Overhead costs are first related to activities or grouped into cost pools. This costing system assumes that activities are responsible for the incurrence of costs and products create demands for activities.
3. It recognizes that volume is one of many cost drivers and uses multiple cost drivers to assign overhead costs to products. This system improves the accuracy of product cost.
4. It portrays more realistic cost behaviour since the overhead costs are related to cost drivers.
5. It assumes production is automated and computerized and overhead costs constitute a very high proportion of total costs as compare to labour. Overhead costs are more affected by range and complexity of products manufactured.
6. All levels of activities in the manufacturing cost hierarchy i.e., unit level, batch level, product level and facility level are identified.
7. It is a more accurate and reliable system of determination of product costs. It helps to identify non-value-added activity so that they may be weeded out.