Traditional CostingOverhead Costs of Operating Departments
Overhead Costs of Service DepartmentsApply to inventory using a
single cost driver for all Overhead Costs Allocate to Operating
Departments and apply to inventory using the cost driver for the
Operating Department
ActivityBased CostingApply to inventory using different cost
driver Apply directly to inventory using cost drivers for each type
of Overhead Cost
The Traditional Cost System that many companies use does not
trace indirect costs, such as supervisors salaries and utilities,
directly to the product. Instead, using a traditional cost system,
companies allocate indirect costs to the product using an
allocation base such as direct labor hours or machine hours. The
advantage of traditional cost system is its simplicity. However,
the saying you get what you pay for, is appropriate here. The
resulting cost data are typically not as those more complex and
expensive cost systems provide.
Activity-based costing is commonly used approach to improve a
traditional costing system. Activity-based costing is a costing
method that first assigns costs to activities and then to goods and
services based on how much each good or services uses the
activities.
Regardless of the number of different overhead cost pools, and
allocation bases used, traditional costing systems are
characterized by their exclusive use of volume-related, or
unit-level, measures as base for allocating overhead to output. For
this reason, traditional systems are also called Unit-Based System.
Notice that any ABC system necessarily uses multiple overhead cost
pools, but not every multiple-pool system is an ABC system. For
example, a florist shop might cost its floral arrangements by
separately calculating the perminute costs of cutting, arranging
and decorating, the costing system is a unit-based system, not
ABC.
Other distinctions usually exist between traditional and ABC
systems. The number of overhead costs pools & allocation bases
tends to be higher in ABC systems, but this is largely because many
traditional system use a single cost pool or a single base for all
cost pools. This distinction is not universal. A system can use
very large numbers of overhead cost pools and allocation bases, but
if all the bases are at the unit level, the system is a
traditional, unit-based system. A general distinction between ABC
and Traditional systems is in the homogeneity of costs within s
cost pool. ABC requires both calculating on activity cost pool and
identifying an activity driver for each significant costly
activity. As a result, more care often least is taken in forming at
least some costs pools in ABC than in traditional costing.
The usual result is that all the costs within an activity cost
pool are very much alike in their logical relationship to the
activity driver, while the some cannot be said of most traditional
systems. Another distinction between ABC and traditional systems is
that all ABC Systems are two-stage systems, while traditional
systems may be one-ortwo stage. In the first stage of AB, activity
cost pools are formed under resource costs are allocated to
activities based on resource drivers. In the second stage, costs of
activities are allocated from activity cost pools to products or
other final cost objects. In contrast, traditional system uses two
stages only if departments or other cost centers are created.
Resource costs are all allocated to cost centers in the first
stage and are then allocated from the cost centers to products in
the second stage. Some traditional systems are single-stage because
they do not use separate cost centers, but there is no such thing
as a single-stage ABC system.
