Traditional Costing Method

Discuss about the Activity Based Costing In Farm Management System.

The main purpose of this assignment is to analyze the basis cost concepts and methods which are used by business such as traditional method and Activity based Costing (ABC) method. The assessment also focuses on the selection of the most appropriate method out of the two. Costing is regarded as an important part of the management of the business wherein the cost which are incurred by the business are evaluated (Hilton & Platt, 2013). The estimation and identification of costs are important as the same are used for the computation of profits which are earned by the business (Fullerton, Kennedy & Widener, 2013).

The concept of traditional costing may be defined as the techniques which allocates indirect expenses which are related to the business to the items which are produced by the business on the basis of volume. Some of the common units which are considered for the purpose of cost allocations are number of units produced, total labour hours used in the production process and even total machine hours used in the production process (Parker & Fleischman, 2017). The main objective of traditional costing technique is to effectively ascertain the costs of the business and also predict the profits which the business is going to earn (Thomas & Gilbert, 2014). On the other hand, ABC model of costing can be defined as the accounting method that is used by business for the identification of the activities which a business is engaged in and on the basis of such assign the indirect costs or overhead costs to the products (Tsai et al., 2013). Under this method certain costs which are difficult to assign can be done easily such as depreciation cost on the machineries.

The traditional method of costing even though is used by a majority of firms in Australia faces criticism as such techniques are inaccurate and outdated considering the developing business environment. The external users of such cost records demand nowadays a more accurate results for the purpose of cost allocations (Öker & Ad?güzel, 2016). As per Bendrey et al (2003), activity-based costing considers the product’s complexity, cost charges to the products and relate the same to production circumstances. Therefore, it can be said that ABC model nowadays play a vital role in the measurement of the costs and profitability of the product. As per the view point of Drury (2013), Absorption costing is the legal requirement for the for external financial reporting of the business and the mechanism is a sound one which can ensure that all costs whether fixed or variable are covered (DRURY, 2013).

Activity-Based Costing (ABC) Model

Absorption costing is one of the most methods which is a part of traditional costing system. It is a system in which both fixed and variable costs of the business are considered for bring out the costs which are associated with the product. Both fixed and variable costs are allocated on the basis of the cost unit and considered to be a part of the products manufacturing costs. The system of traditional costing is based on the consideration of volume metrics and is allocated usually using cost drivers such as number of units of the products produced, labour hours used. In many researches it is shown that traditional costing model is applied by businesses due to the simplicity and understandability of the reports which are shown in this method of cost allocation. In other cases, the method is used due to the governmental regulations on business to use the method so as the financial reports which are generated are easily to understand.

The primary thing to understand is that the method allocates indirect costs which are associated with the business on basis of volume metrics and segregated universally over the products which are produced by the business.

The major advantages which traditional model of costing are discussed below in point form:

• The major reasons for applying such method in businesses is that the method is known to be user friendly. The method promotes understandability of the costs structure of the business and the users of such reports are easily able to identify what are the indirect costs which are related to the business and how are the same allocated in the business
• The method is easy to implement in the business and is regarded to be attractive to most of the costs accountants due to the simplicity which the method promotes and also due to the fact that the method better matches the costs which are incurred by the business with the revenues which are earned by the business.
• In a business where the production is carried out in large volumes and the overhead costs are low, the method is regarded as the best method which can portray the costs associated with the production of the product to be accurate. In such a business such method of costing is considered to be favorable.

• The traditional method of costing uses machine hour rate, labour hour rate which are favorable when valuing the closing stock of the business but are not at all useful in the decision-making process. Hence the method is of no help in decision and strategy formulation for an extended period.
• The cost which are associated with the products are segregated into fixed and variable costs which in circumstances are considered to be unrealistic in nature (Weygandt, Kimmel & Kieso, 2015). The method has been criticized for portraying inaccurate costs of the products as the allocation of indirect costs of the business are considered to be inaccurate under this method.
• With the changing environment of business and development of new costing techniques such as ABC model of costing, the external users of the cost reports demand for a more accurate presentation and traditional costing techniques are unable to deliver the same. In addition to this, the method is considered to be outdated in nature.
• The method is considered to be unfavorable for a business which is engaged in production of more than one product and also has a high overhead cost which is needed to be accurately allocated over the different products.

Activity based costing is an extension of traditional costing, however the method rectifies the flaws which are present in traditional costing. The method allocates the indirect costs of the products on the basis of the activity which the business engages in and thereby allocates the cost of the overhead to specific products. The method is known to provide the business with an accurate assessment of the costs which are associated with the product which is manufactured by the business. As per Larry (2010) ABC model of costing focuses on overcoming the deficiencies which traditional costing method has and requires the business to discard the traditional costing method which is considered to be outdated and apply ABC Model of costing. ABC model of costing provides a linkage between activity which the business engages in, the cost which the business incurs in the manufacture of the products and the nature of the products which are produced by the business. In addition to this, ABC model as per many experts brings out the most accurate data of costs of the business and is the most reliable method when considering the cost data for decision making process.

Advantages and Limitations of Traditional Costing

The advantages which are associated with the application of activity-based costing model are given below:

• The most basic advantage which Activity based costing provides is that the method promotes accuracy of the cost data presentation which can be effectively used for decision-making process (Monroy, Nasiri & Peláez, 2014).
• The system can also be used for process of understanding the cost structure of the business and also allocation of the costs which are based on the cost drivers and activities which are undertaken by the business.
• The system is considered to be very useful in case of companies which are engaged in manufacturing process of products which are more than one. The system provides an accurate measure for the costs of the products under such a circumstance.
• ABC model of costing is very useful in strategic management process of benchmarking which forms an integral part of the quality management process of the business. In addition to this, the method is considered to be effective in quality improvement and upgradation programs which are followed by the business (Carli & Canavari, 2013).

• The most basic limitation which the business faces while setting up ABC model of costing is that the method is vert costly to implement and maintain. The costing method is also regarded to be difficult when the implementation of the same is to be done.
• Another major disadvantage which ABC model of costing faces is related to the difficulty and complexity of the method. In many cases business opt for traditional method of costing instead of ABC model of costing is due to the complexity of the process and the reports which are generated under this system are a bit difficult to interpret by the users of the reports for cost (Huynh, Gong & Nguyen, 2013).
• Moreover, the use of ABC model of costing in a business which has a small operation is considered to be unfavorable and therefore the method is not universally applicable.

As per the discussion which is provided in the above paragraphs, it can be said that ABC costing model is more effective for business than traditional costing model which is becoming outdated as time passes and the market further develops traditional costing will not be used by the business. ABC costly model also has advantages with respect to accuracy of cost data which is presented. It is to be noted that ABC model of Costing not only considers the functions and features which are present in traditional costing method but also considered the additional factors which are associated with the production which can facilitate the business to consider the activities of the business for which inputs are to be considered. Thus, it is recommended that business should implement ABC model of costing for the purpose of better presentation of the financial data of costs and also generate reports which are accurate in nature in terms of cost presentation.

Reference

Carli, G., & Canavari, M. (2013). Introducing direct costing and activity based costing in a farm management system: A conceptual model. Procedia Technology, 8, 397-405.

DRURY, C. M. (2013). Management and cost accounting. Springer.

Fullerton, R. R., Kennedy, F. A., & Widener, S. K. (2013). Management accounting and control practices in a lean manufacturing environment. Accounting, Organizations and Society, 38(1), 50-71.

Hilton, R. W., & Platt, D. E. (2013). Managerial accounting: creating value in a dynamic business environment. McGraw-Hill Education.

Huynh, T., Gong, G., & Nguyen, A. (2013). Integrating activity-based costing with economic value added. Journal of investment and management, 2(3), 34-40.

Monroy, C. R., Nasiri, A., & Peláez, M. Á. (2014). Activity Based Costing, Time-Driven Activity Based Costing and Lean Accounting: Differences among three accounting systems’ approach to manufacturing. In Annals of Industrial Engineering 2012 (pp. 11-17). Springer, London.

Öker, F., & Ad?güzel, H. (2016). Time?driven activity?based costing: An implementation in a manufacturing company. Journal of Corporate Accounting & Finance, 27(3), 39-56.

Parker, L. D., & Fleischman, R. K. (2017). What is Past is Prologue: Cost Accounting in the British Industrial Revolution, 1760-1850. Routledge.

Thomas, D. S., & Gilbert, S. W. (2014). Costs and cost effectiveness of additive manufacturing. NIST Special Publication, 1176, 12.

Tsai, W. H., Chen, H. C., Leu, J. D., Chang, Y. C., & Lin, T. W. (2013). A product-mix decision model using green manufacturing technologies under activity-based costing. Journal of cleaner production, 57, 178-187.

Weygandt, J. J., Kimmel, P. D., & Kieso, D. E. (2015). Financial & managerial accounting. John Wiley & Sons.