Competition Bikes Inc.

Competition Bikes Inc.

Activity based costing versus traditional costing

Mostly it is impossible for a business to identify the accurate cost of product or service. However, for effective decision making, businesses try to attain more accurate costing tools or procedures. The accurate cost of product or service can be calculated when the cost is identifiable in relation with produced product or service. However, some cost are easy to identify such as direct material and direct labor has a direct relation with the product produced, but there are some indirect costs which are commonly difficult to related with product. Indirect cost such overhead is commonly difficult to relate with product and cannot be directly identified in relation with the company. Companies identify estimates for assigning cost to service or product as an alternative for accurate cost identification (Weygandt et. al, 2009).

Traditional costing system

In traditional costing system, it is noted that overhead cost is associated with units produced irrespective of product type and time required for product. Therefore, it can be said that there is fixed cost of batch level, facility level and product level activities. This means cost does not changes with production volume, and variable overhead is associated with base of units produced. However, association of cost based on number produced does not directly reflect the actual cost of the product based on activity of overhead on the product. Traditional costing characteristics are; there is one or a limited number of cost pools in traditional costing, the rate applied for overhead based on volumes, traditional costing is mostly used and suitable for labor intensive business, and traditional costing is inexpensive in nature (Kimmel et. al, 2010).

Activity based costing (ABC costing)

Generally, activity based costing is a tool for identifying and allocating overhead costs. In addition to this, in activity based costing overhead cost is allocated to various cost pools, and the cost pool associate cost to the product or service based on their cost drivers. In easier words, activity based costing refers to an activity or an event, transaction, action or sequence of work that affects the cost of the product or service. An activity cost pool refers to the association of cost to a specific type of activity such as storing, ordering or transporting. In the end, a cost driver refers to the direct cause effect relationship of consumed resources with any factor. There are certain advantages of ABC costing; ...