Costing And Activity Based Costing Accounting Essay

Published: Last Edited:

This essay has been submitted by a student. This is not an example of the work written by our professional essay writers.

This assignment are knowledgeable a lot of information approximately Traditional costing method and Activity based costing and also changes of management accounting. The discussion will be divided into two part, which are first part calculated traditional costing method and activity based costing from the information that given.

After that student need give definition, advantages, disadvantages and differences. of both traditional costing method and activity- based costing, Firstly discuss about of Scooter Driver based on the issues raised by each of the directors. The second part will be discuss the coursework student have to give the changes of management accounting over the past decades and also the impact of the changes in management accounting.

Current Method

Production Cost Per Unit



Total 4 180 000

2.0 Activity-Based Costing Method

2.1 Production Cost Per Unit


2.2 Profit


Total 4 180 000

Traditional costing method

To: Director of ScooterDriver

From: Management Accountant

RE: Evaluate the Absorption Costing and Activity- based costing

The traditional method refers to the allocation of manufacturing overhead costs to the products manufactured (Hansen, Mowen, 2006). The traditional method also known as the conventional method assigns or allocates the factory's indirect cost to the items manufactured on the basis of volume such as the number of units produced, the direct labour hours, or the production of machine hours (Huntzinger, 2007).

The traditional costing system only has one or a few indirect cost for each department or whole plant however the application of cost in the traditional costing system is normally based on an indirect cost driver cost applications are often financially (Drury, 2007). The traditional approach to costing of products fundamentally utilities a system whereby the total cost to produce a number of products are divided between the various products by making use of the traditional costing system, it thus means that all the cost incurred have to be allocated to one or other products (Coombs, Hobbs, Jenkins, 2005).

Besides, traditional costing system tend to use a smaller number of second stage allocation bases, typically direct labour or machine hours and frequently the traditional system assume that direct labourhave a significant influnces in the long term on the level of overhead expenditure (Drury, 2004). Traditional costing system also apply indirect cost to products based on a predetermined overhead rate, additionally the traditional costing is optimal when indirect cost are low compared to direct costs and there are several steps in the traditional costing process (Bhimani, 2006).

The problem with this approach is that for most overhead activities, the proportions of the activity actually consumed by a specific product, does not universal correspond with a single cost driver and this holds true for most modern companies where products are produced by a combination of manpower and technology (Horngren, 2007). The traditional cost accounting model employs a volume-based driver, such as a direct labour hours or machine hours for the assignment of all manufacturing overhead cost therefore the conventional cost accounting models ends up with a cost of goods sold based on absorption costing and includes only products costs are defined in financial accounting (Jiambalvo, 2009).

Activity Based Costing

ABC (Activity Based Costing) is a system that attempts to accurately trace indirect costs to products by allocating indirect costs to activities and then to products based on their usage of the activities (Drury 2004). ABC is optimal when accuracy is very important and when indirect costs comprise a large proportion of total costs compared to direct costs and ABC is also commonly used in the manufacturing sector (Finkler, 2003).

ABC is so useful for the manufacturing sector is fairly obvious, by allocating indirect costs to products based on usage, a company can more accurately see where the resources and energy is going in their company. (R. Hansen, M. Mowen, Guan, 2007). It will figuring out where the money and energy is going, efforts can be focused upon those products that are eating up the most time and energy and this eventually lead to a drop in cost, in theory, as efforts will be made to reduce the costs on the bulk of the products. (Hansen, M.Mowen, Guan, 2007).

Activity based costing system also used to determine product costs for special management reports (Weetman, 2006). This system is ordinarily used as a supplement to the company's usual costing system. Most organizations that use ABC systems have two costing systems are known as the official costing system that is used for preparing external financial reports and the activity based costing system that is used for internal decision making and for managing activities. (Drury, 2004).

ABC systems differ from traditional system by having a greater number of centers in the first stage and a greater number, and variety, of cost drivers or allocation bases in the second stage (Drury, 2004). Activity based costing (ABC) was developed to overcome the shortcomings of the traditional method. Instead of just one cost driver such as machine hours, ABC will use many cost drivers to allocate a manufacturer's indirect costs. ( Weerman, 2006).

Differences between ABC and traditional costing method

Traditional cost accounting system and ABC have some similarities, for instance both have two stages whereby resources costs are pooled before being assigned to cost objects. The first stage pools indirect costs in production cost centers (in convention system) or in activity centers in (ABC system) (Narayanaswamy, 2008). The second stage allocates overheads to cost objects using volume realated bases direct labour hours, direct labour cost or machine hours or a mixture of both volume and non-volume related bases in ABC system (Narayanawamy, 2008).

However, despite these similarities several features differentiate the two system, first in traditional costing system only manufacturing overheads normally allocated to cost objects, whereas manufacturing and non-manufacturing overheads are assigned in ABC system (Bierman Jr,2010).

Another, an ABC system usually has considerably more cost pools (based on activity centers) than a traditional system (based on production departments) (Banjerjee,2007). Moreover ABC uses more sophisticated and complex allocation bases, particularly during the second stage of tracing costs to products.

ABC advocates argue that these differences make ABC system superior as the provide managers with more reliable information about product costs (Bierman, Jr.,2010). Traditional cost accounting practice are accused of frequently overestimating the cost of high volume products and underestimating those of low volume ones, epically when overhead are less related to volume (innes and Mitchell, 1998).

In contrast to traditional cost accounting system, ABC system are not inherently constrained by the tenets of financial reporting requirement rather, ABC system have the inherent flexibility to provide special reports to facilitate management decision regarding the cost of activities undertaken to design, produce, sell, and deliver a company's products or services (Patra, 2006). This flexibility is the fact that ABC system focus on accumulating costs via several key activities, whereas traditional cost allocation focuses on accumulating costs via organizational units (Needles, Powers,Crosson, 2006). By focusing on specific activities, ABC systems provide superior cost allocation information, non-volume-based cost drivers cause epically when cost. Even so, traditional cost accounting system will continue to be used to satisfy conventional financial reporting requirement, ABC system will continue supplement, rather than replace, traditional cost accounting system (Ramchandran 2007).

Finally, traditional coasting and ABC can differences by costs associated with a product can be categorized as a direct costs and indirect costs (Drury,2007). Direct cost, is the cost which can be identified with the product, while indirect cost are not directly accountable to a cost object for example cost of materials, direct labour cost such as wages and salaries are example of direct cost (Ryan,2004). Administrative costs and depreciation are some of the examples of indirect cost the reason to identifying total cost of a product are very important to determine the selling priceof that product (Stolowy, 2006).

Implication of activity-based costing for ScooterDriver

The comment by the finance director is disagreeing because Fireball is making profitable with the existing system but unprofitable with the ABC system. The two systems can have major impact on overall profits. The purpose for the differences in product profit is that Fireball has the lower volume but it makes the higher relative demand on the three activities identified by the ABC system, because Fireball uses a lower proportion of direct labour hours than the other products and the existing system allocates a lower share of overheads to Fireball.

The marketing director argues that incremental costs are required for the pricing decision. Consequently disagree with this because, its important to distinguish between short term and long-term incremental costs. ABC seeks to report long-term incremental cost opportunities will be lost to reduce capacity and the long-term incremental costs will remain unchanged. ABC distinguishes that longer term incremental costs can be reduced by making decision that ensure that activities should be undertaken only where incremental revenues exceed long term incremental costs. It is important that facility-sustaining costs are omitted from the costs reported by the ABC system since they are neither short-term nor long-term incremental costs.

Agree with the managing director decision that the cost per activity should not remain constant over the long term. Efforts should be made to reduce the costs of activities and improve the efficiency. Therefore ABC reported costs should be made evaluated and adjusted at periodic intervals. There are also some costs such as facility sustaining costs do not change with activity and are not variable with any activities measure. For example it could be costs excluded from the reported separately as facility sustaining costs.

The chairman is true about the profitability analysis based on maintaining the same product mix will yield the same total profits. However, different profits or loses are reported by products and making future decisions on the basis of ABC information compared with the existing system. Therefore have an impact on total future profits such as, assuming that the costs reported by the ABC system are all based on cause and effect relationship then a decision may be made to discontinue production of Fireball. This will not apparent in existing method but still, it is an important that decision should not be based solely on financial factors and non-financial factors should also be taken into account.

Question 2

Changes and impact information technology

There a lot changes information technology (IT) make in our daily business environments. Most of them can be filed under the broad heading of technology such as the changes that occurred in industrial harnessing of electricity. Not only did plants and factories running off the recent power develop, entire town infrastructures were changed to accommodate. Moreover the available hours also makes changes and some companies began operating all 24 hours each day with third-shift workers.

Besides, power lines became global throughout the country, as did telephone lines. Even today, these are considered essential pieces when outfitting a proper office building and most business innovations in the 20th century involved plugging devices into walls electrical or telephone outlets but the 21st century has seen reflective emphasis on wireless capabilities.

During the past decades the use of information technology (IT) to support business activities has increased dramatically and development of electronic business communication technologies known as e-business, e-commerce or Internet commerce have had a major impact. For example, consumers who have access to the Internet are able to compare the relative merits of different product and are more discerning in their purchases. E-commerce such as bar coding has allowed considerable cost saving made by streamlining business process and has generated extra revenues from the adept use of online sales facilities. The skillful use of e-commerce has given companies a competitive advantage.

Changing and impact of competitive environment

In order to compact in today competitive environment company have had to become more customer driven and make customer satisfaction and on over reading priory. Customers are demanding every improving level of service in cost, quality, reliability, delivery, and choice of innovative new products. Identify cost efficiency, quality, time and innovation as the key success factors. In addition to concentrating on this factor organization are adopting new management approach in their quest to achieve customer satisfaction.

Excellence in manufacturing can provide a competitive weapon to compete in sophistic worldwide market. In order to compete effective companies must be capable of manufacturing innovative product if high quality at low cost and also provide a first class customer services.

Organization as those operating in the airline and financial services industry were either government owned monopolies or operated in highly regulated protected and non-competitive environment. These organizations were not subject to any greater pressure to improve the quality and efficiency of their operation or tom improve profitability by element services or product that were making losses.

Compare to the increasing competition as also made decision error due to poor cost information more probably and more costly. If the cost system resulted in destroy product cost begin reported, than the overhead cost product willed to higher bid price in business and business loss to those competitor to be able to quote lower price poorly because the cost system produce more accurate cost information. Alternatively there is a danger that under coasted products will resulted in acceptances of unprofitability business.

The changing and impact of globalization

In the globalization, international corporations have to deal with difficulty and risk facing the business. There are many differences in political system, accounting system of external report, legal system and culture and custom in different countries (Pettersen, 2001). In order to run successful business abroad, it is significant for managers to understand these differences and the income taxes system difference is another key factor.

Management accountants must give careful consideration to local tax law and tax rate, which may be different from domestic legal. Lastly, for the different monetary system, managers of multinational companies must be monitoring the foreign exchange fluctuation continuously. So the world economy is influenced by many factors, and exchange rates fluctuate frequently and widely. When the corporations go abroad to establish contracts, make commodity transactions and run businesses, there are much more similar problem they have to face. For management accounting, it has to overcome significant barriers and difficulties in the globalization.

The objective of management accounting is changing. Before the globalization, most corporations are small and mainly relay on home operations. With the deepening of globalization, enterprise scales are increasing and go abroad to service their clients. The traditional accounting is always focusing on the domestic rather than the international market. These multinational corporations, facing the trend and requirement of globalization, have to redesign their accounting systems to satisfy the new global objectives. The objectives and goals of management accounting are not only domestic information, which is based on the historical data, but also the global information, which help managers reduce complexity and risk in business. So the management accounting should get the more exact and suitable information of working capital and operation cost. Keeping a tight hand on this information, international business can regain their competitive edge.

Excellent management accounting can provide useful information to help a corporation achieve its goals and objectives. First of all, it can give the scorekeeping of the business, which accumulates and classifies the data. Based on the scorecard, internal managers can evaluate the performance of the business. Second, the manager accounting supplies significant problem, which should be looked into the attention directing. Attention directing regards to giving the manager detail and direct information, which makes them realize the problem, opportunities and challenges of the company. To solve problems, management accounting often make a study to find out the possible methods and the most appropriate alternative.

The changing and impact Organizational structure

In contemporary competitive settings, organizations are increasingly concentrating on factors that provide value to the customer. This customer-focus is triggering a flattening of organizational structures. According to the term "horizontal organization" has evolved to reflect practices applied in companies that integrate activities across the value-chain to support a customer-focus strategy Chenhall (2008).

According to adopting new technologies may require changes in organizational structures and work processes to better suit the capabilities of improved technology. Khandwalla (1974), Thus, for better success, there is a need for a change to organizational structure fostered by advanced technology applications. Organizational design and structure represents the patterns and relationships that exist among organization or work unit elements in organizational structure (Macy & Arunachalam, 1995). A change in structure can be in the form of new organization structural, departmentalization, centralization, decentralization and emphasis that "organization structures are the product not only of coordinative demands imposed by complex technologies, but also of rationalized norms legitimizing adoption of appropriate structural models.

The organizational structure variable draws heavily on the seminal works of Bruns and Waterhouse (1975), who identified several organizational characteristics that were strongly related to the choice of accounting-control strategy. In summary, they found that as organizations and departments grow and become more complex, they tend to decentralize and implement a more administratively oriented control strategy, which involves a higher degree of behavior formalization and an increasing use of formal patterns of communication. In line with expectations, they also found that the MASs in these organizations ''matched'' the overall control strategy insofar as they tended to use ''a more highly developed and formal budgeting system, with greater standardization of information flows and greater operating manager involvement in budgeting'' (Merchant, 1984, p. 291). In contrast, smaller, more homogeneous and centralized firms tended to rely more highly on informal, personally oriented control mechanisms such as direct supervision and face-to-face communication. Accordingly, firms were less reliant on formal use of the budget when using this interpersonal control strategy.

The impact and changing economic growth (government)

The major economic environment backgrounds, such as great depression, governments make adjustments through policy changes that they hope will succeed in stabilizing the economy. Governments believe that the success of these adjustments is necessary to maintain stability and continue growth. This economic management is achieved through two types of strategies. In a recession, governments stimulate the economy with deficit spending expenditure exceeds revenue. The revenue taxation and spending policy designed to counter economic growth such as in order
to achieve lower unemployment, achieve low or no inflation, and achieve sustained but controllable economic growth.

Therefore business, now a day is vitally affected by the economic, social, legal, technological and political factors. These factors collectively form business environment. Business environment, as such, is the total of all external forces, which affect the organization and operations of business. The environment of an organization has got internal, operational and general lives managers must be aware of these three environmental levels and their relationship and importance. The term 'business environment implies those external forces, factors and institutions that are beyond the control of individual business organizations and their management and affect the business enterprise. It implies all external forces within which a business enterprise operates.

Business environment influence the functioning of the business system. Thus, business environment may be defined as all those conditions and forces, which are external to the business and are beyond the individual business unit, but it operates within it. These forces are customer, creditors, competitors, government, socio-cultural organizations, political parties national and international organizations. Some of those forces affect the business directly which some others have indirect effect on the business