Critical analysis of activity based costing and traditional costing Assignment

Critical analysis of activity based costing and traditional costing system - Assignment Example In the efforts to implement the Strategic Management Accounting approach in organizations,modern business enterprises find Activity-Based Costing as an improved costing system by which the problem of large number of indirect costs and their allocation problem can be overcome It has been observed that ABC method is the most sought after innovation in the field of management accounting in the last two decades. The method was originated in the Unites States of America during the 1980s as an improved system to enable better cost allocation by means of classification of more costs as direct (Cooper and Kaplan, 1988). The advocates of ABC method argue that the firms would be able to enhance their efficiency and cost control without having affected the customers' value, if ABC is successfully implemented and followed. However, its acceptance rate is still overwhelming across industries and countries despite the strong recommendation by Robin Cooper and Robert S Kaplan, the proponents of the method. The main problem associated with the low implementation rate may be attributed to the difficulties and complexities of the system. This paper discusses and analyses the ABS system as an improved cost control technique. The paper takes comparative and analytical approach; in which comparison is made between ABC and Traditional Costing System (TCS). The paper discusses the various aspects of ABC as a superior technique of cost control by assuming hypothetical examples. Every attempt is made to analyse the important characteristic of ABC with that of TCS in a critical manner. 2. Activity Based Costing- Meaning and Significance ABC as the name signifies is a system of costing based on activities involved in transformation process. ABC is the process of simplifying and clarifying decisions required to be made by the management using activity costs. It analyzes the cost and the benefits of various operational and business activities. According to Computer Aided Manufacturing International (CAM-I), "Activity-based costing is a methodology that measures the cost and performance of activities, resources, and cost objects. Resources are assigned to activities, then activities are assigned to cost objects based on their use. Activity-based costing recognizes the casual relationship of cost drivers to activities" (CAM-I). ABC, which was basically developed as an alternative to traditional costing system enhances the scope of performance management as a measure. This system was propounded by Robin Cooper and Robert S Kaplan as a superior tool to overcome the limitations of TCS. The main inefficiency with TCS is that it fails to accurately measure the actual cost of production and hence decisions are made out of inaccurate data. Therefore, the main logic behind the emergence of ABC system revolves around supplying accurate information regarding the cost of production, cost allocation; which are vital for cost and profit analysis. The main argument in favour of the ABC system is that it is against the traditional system of cost allocation on a percentage basis. ABC system, instead takes into account the cost effect relationship for cost allocation on a subjective basis. Whenever a cost is incurred and identified in relation to an activity, the cost is allocated to the extent the product has used the acti vity. Supports of ABC system strongly believe that supplying accurate information is the most important benefit of this system. In addition, ABC is justified from the benefits such as cost control, cost reduction, more accurate allocation of indirect costs, improved insight into cost causation and identification of activity costs and improvement of operational efficiency (Kaplan and Anderson 2004). It has also been justified for being able to supply accurate cost information which is necessary for fair pricing and thereby adds value to customers.