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Traditional costing assigns manufacturing overhead based on the volume of a cost driver, such as the amount of direct labor hours needed to produce an item. A cost driver is a factor that causes cost to incur, such as machine hours, direct labor hours and direct material hours. Activity-based costing allocates the costs of manufacturing a product according to the activities needed to produce the item. Managers should understand the advantages and disadvantages of both systems to meet the needs of their business.
These are the two overhead allocation method to a product.
In traditional costing overhead are allocated on the basis of volume e.g. labor hours and machine hours are considered as the main couses for overhead genration and so these both or any one of these are using for overhead allocation to a products.
But as with the changing working envoirment there is many types of cost which is not driven by labor or machine hours so Activity Based Costing (ABC) is more suitable for overhead allocation.
Activity based costing is1st identifies all the activities which are performed for for production, allocating overhead to this activities and then allocating overhead to the products using suitable driver for each activity. so which product consume more driver will recieve more overhead.
In simple
ABC costing : If any activity is carried out in the production of product, then we will charge cost of activity to product.
Traditional Method: We charge an appropriate amount based on Direct labour hours, or Machine hours etc irrespective of how much Actual cost driver has been used in production of product.
Activity based costing is useful for a company with multiple products , Very useful for arriving at accurate cost , thus helping in arriving at the correct selling price .
However it is a time consuming activity and should not be carried out manually
There some Concepts at Activity Based Cost to distribute overhead cost (indirect cost) with more Justice Way we use to Cost pools which are groups of associated costs that all relate to a specific product or service in some manner. Many businesses as well as institutions of higher learning make use of the cost pool to track expenses related to a specific project or department. The idea behind the pool is to associate direct and indirect costs with a particular cost driver, making it much easier to determine the total amount of expenses involved with the operation of the department, or the completion of a given project.
In traditions cost ways we use rate to distribute overhead on cost centers most of time that rate or ratio doesn’t express the justice for distribution like (overheads/ # of machine work hours).
he activity based costing "ABC" care about the activity and give a cost for each activityand it need a lot of analysis and investigation and it cost more than the traditional methodsthe traditional method, depend on the item nature
