Costing is essential for every organization, as every manufacturing and other department has to be assigned accurate budget for proper operation (Hansen, Mowen and Guan, 2006). The costing system provides information that is useful to managers for minimizing wastage and allocating resources to different departments.
The traditional costing system is a costing system which calculates a single overhead rate and applies it to each job or department. This system has several flaws which make it outdated and ineffective in today’s business environment. One of the most important drawbacks of the traditional costing system is that it tends to over-emphasize on meeting standards such as price and efficiency without considering other important factors like quality, on-time delivery, and customer satisfaction because of which the products of other companies form better alternatives and pose a tough competition to the organization. It also stunts any scope for improvement or innovation as it is too focused on sticking to the set benchmarks. This often leads to poor overall performance of the organization in the long run which in turn affects the going concern of the business.
Secondly, it utilizes a single, volume-based cost driver which leads to the distortion of the cost of products. It traces overheads to products or services usin...
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...osts and where to apply efforts to curb inflationary costs. This can be of particular value in tracking new products or customers and also solves the cross-subsidies problem linked to traditional costing system by separating overhead costs into different cost categories or cost pools. Further, it helps in cost reduction as by allocating indirect costs to products based on usage, a company can precisely identify the area in which the maximum energy and resources get consumed and the focus is then shifted to these areas. This will eventually lead to a reduction in cost as efforts will be made to purchase in bulk benefitting from economies of scale.
The ABC system may be time consuming and expensive to implement and maintain, but its large number of benefits far outbalance the disadvantages of the traditional costing system; thus, creating a need for the ABC system.
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