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    Pros and Cons of traditional absorption costing techniques Essay

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    The intent of this study is to discourse the advantages and disadvantages of Traditional soaking up and Activity based costing. In add-on, analysis will be carried as to why a company needs either the Traditional based costing or the Activity based costing. Differences between both stairss will be looked into.

    Furthermore, this study will besides see, accounts of an allotment, an allotment, soaking up rates and suggestions will besides be made as to what method is suited.

    Executive sum-up

    This study has been put together to analyze the advantages and disadvantages of ABC and soaking up costing. Research have been exhaustively done to work out the job originating from the usage of soaking up costing, coupled some few illustration as to how ABC works.

    Why ABC was implemented.

    Activity based costing was implemented in the United provinces in the twelvemonth 1890, by Robert Kaplan and William Burns, who brought the constructs of ABC to existence. It was implemented to undertake jobs faced with traditional soaking up costing, which is unable to acknowledge exactly the factual cost of procedures for strong direction determinations. ( Naron, D.2009 ) . Originally, ABC ‘s country of specialization was the fabrication industry, where, technological development and productiveness betterments reduced the per centum of direct, labour and material costs. However, it caused an expansion in the per centum of indirect or operating expense costs ( CIMA planetary, November 2008 ) .

    “ An Activity based costing is said to be a type of system which allocates overhead to each chief activity in an administration, thereby ensuing to legion cost pools. It so allocates the cost of activity to the merchandise, services or other cost objects that caused the activity ” .

    On the other manus, “ Traditional soaking up costing technique is the type which at first allocates all operating expense to the production and service cost Centres section of an administration and so reallocates service section costs to the production sections, ” ( Drury,2006, p.349 )

    However, there are points to observe, in finding the most suited.

    Why does the company need either soaking up costing or ABC

    Why company demand Absorption Costing

    Absorption costing is indispensable for a company, because all cost are aimed to be recovered and identified into merchandise or service as to organize the footing for the rating of stock list and pricing. However, merely overheads that are straight connected to the production of stock list can be recovered. In a company, entire soaking up costing will retrieve all cost from each section that are involved in production, and industry. One of the major jobs that might happen is that all cost might non be identified until the terminal of the accounting period.

    Why companies need Activity Based Costing

    Activity based costing are needed, to bring forth a perfect cost for each merchandise. The apprehension behind this method is that, necessary computation is expected to be accurate in order to command cost. In other words, directors do non desire to take the hazard of holding to do determinations based on imprecise informations provided by the soaking up technique, as competition is increasing. Recently, soaking up costing has failed to carry through the outlook of the new fabrication industrial environment. However soaking up bing besides lacks edification, while allotment of direct cost has failed to reflect the original distribution of cost, so activity based costing is aimed to rectify this defect. Furthermore, ABC, has been brought into being to for better allotment of costs, for disbursals to be traced easy and straight to merchandises or services, and measuring for quality sweetening chances. ( Narong, D.2009 )

    What are the differences between Absorption bing and ABC

    Absorption bing makes usage of direct labor and machine hr to apportion their costs while ABC makes usage of cost pools and cost drivers as footing of allotment. Under ABC technique, “ cost pools are allocated to objects based on how much of the activity is consumed by the objects ” , ( Stratton, al.2009 ) while cost driver is any signifier of activity that drives cost. ( Drury, C.2006 )

    Furthermore soaking up bing uses a solitary accretion of cost, this cost are non identifiable straight, being portion of cost of labor or merchandise. Examples of this cost include, allotment of direction rewards, cost of care and disbursals and eventually depreciation. Activity based costing consume smaller targeted cost that increases based on activities. In service operations, such as Bank, Accountancy, Administration, Architecture and Insurance complex companies make usage of Activity based bing since their services are non of volume.

    3. What stairss would the company demand to take if it was to present an ABC system ( presently has soaking up bing ) ?

    A company needs to use five stairss in order to finish the purpose of cost recovering. Step 1 is to avoid maintaining separate record for fiscal accounting and direction accounting because many concerns have integrated fiscal accounting and direction accounting systems. A company can easy follow single merchandise or service towards direct cost such as direct stuff and direct labor.

    The 2nd measure is to sort all cost into certain groups and classs these costs before apportioning them into separate sections. An illustration involves the demand of ciphering entire cost for visible radiation and heat or rent.

    The 3rd measure is for a company to apportion indirect cost to sections. Furthermore, direct cost can be straight traced to goods and services. In the instance of operating expenses, the applicable procedure is indirect while the chief point is to happen the appropriate portion for allotment.

    The 4th measure is to reapportion all the cost to production sections because this cost must be recovered into specific merchandises which are merely made in merchandise section. At the 5th measure cost are absorb into concluding merchandise while a suited recovery rate is chosen. The nature of activity will be reflected by the chosen rate.

    Measure six is about using the soaking up cost into production.

    Stairss Required in ABC

    In ABC the three stairss are the same as traditional costing. Meanwhile the 3rd measure is to place those activities that determine the overhead cost such as production. Step four is to place all cost drivers, and appropriate allotment should be made to this cost drivers. In measure five all activity cost driver rate are calculated, this method involve, the division of figure of activity by the entire cost for a cost driver. Step six is to absorb both direct and indirect cost into a merchandise or service.

    Differences between an allotment, allotment and soaking up rate.

    Harmonizing to ( Drury, C 2006 ) , an allotment is said to be a process for delegating cost, when there is no being for a direct step for a measure of resources used up by a peculiar cost object. That is, cost that can non be traced straight, to a peculiar object will be assigned to a cost object. The assignment of indirect costs to a cost object with the aid of a peculiar base is known as an allotment base

    Harmonizing to ( Lucey, T.2009 ) an allotment, is when cost is been distributed under a figure of cost Centres.

    Harmonizing to ( Drury, C.2006 ) an soaking up rate is besides described as a cover overhead rate. An soaking up rate is a peculiar operating expense rate used by an full administration or company for bear downing their operating expenses or indirect cost to production, for an accounting period. As overhead soaking up is been calculated earlier than the accounting period, budgeted cost tends to be over or under absorbed. By over soaking up, we mean that operating expense absorbed in the cause of production is greater than the existent operating expense. On the other, under absorbed is when operating expense is lower than existent operating expenses.

    In decision to the all the above analysis, ABC is the most suited type of bing because:

    Research and study has proved that it is best method, adopted by most fabrication and service companies. It is every bit good utile for doing direction determinations such as planning, budgeting and to reexamine the public presentation of an administration.


    Drury, C. ( 2006 ) Cost and Management accounting. Sixth edition. Bedford Row, London: Thompson Learning.

    Jones, M. ( 2006 ) Management Accounting, Second Edition. British Library Cataloguing -in-Publication Data

    Proctor, R. ( 2009 ) . Managerial Accounting for Business Decisions, Fourth Edition. FT Prentice Hall. Pearson Education.

    Narong, D ( 2009 ) Activity-Based Costing and Management Solutions to Traditional Shortcomings of Cost Accounting. Cost Engineering.Morgantown.51 ( 8 ) August, pp.11-22.

    Stratton, Al ( 2009 ) Activity-Based Costing: Is It Still Relevant? Management Accounting Quarterly, 2009.Vol. 10, Iss.3, spring, p.A 31-40A

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