Traditional absorption costing vs. Activity Based Costing

ACC2-Management

AccountingAssignment 1

Essay -

Discuss

the relative advantages and

disadvantages of traditional

absorption costing techniques

(absorbing indirect costs on a

labour hour basis), and activity

based costing

ACC2-Management

Accounting

student

ID

:

09290124

Contents

1.

Introduction

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2.

Absorption costing

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2.1

Definition

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2

2.2

Background

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2.3

Approach

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3.

Activities based costing (ABC)

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3.1

Definition

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3.2

Background

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3.3

Approach

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4.

The different between traditional absorption costing and ABC

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4.1

Allocation, apportionment and absorptions rate

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4.2

Approach

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4.3

Methodology

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4.4

Legal validity

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4.5

Range

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4.6

Advantages of absorption costing

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4.7

Disadvantages of absorption costing

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4.8

Advantages of ABC

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4.9

Disadvantages of ABC

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5.

Conclusion

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6.

References

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7.

Bibliography

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ACC2-Management

Accounting

student

ID

:

09290124

1.

Introduction

No

matter

tradition

absorption

costing

or

Activities

based

costing,

they

both

are

important component for companies because these are the management methods for

accounting

to

calculate

the

costs,

which

can

let

the

companies

know

the

operating

costs of the business. Generally speaking, both of them are use to trace indirect cost to

cost object because not all overheads can be charged to cost object directly. This essay

is going to describe the advantages and disadvantages of traditional absorption costing

and activities basis costing (ABC). It will be separated three parts, the first part is the

information

about

traditional

absorption

costing

and

ABC,

which

included

the

definition,

background,

and

working

process.;

the

second

part

is

the

difference

between

traditional

absorption

costing

and

ABC,

which

shows

the

advantages

and

disadvantages

for

these

costing

technique,

compare

with

each

other,

and

give

the

reasons for how suitable for those companies; and the final part is conclusion of this

article.

2.

Absorption costing

2.1

Definition

Kilgour

(2005)

stated

that,

‘In

absorption

costing,

all

production

costs

are

absorbed into products and the unsold stock is valued at total cost of production.’

It

means

the

units

produced

absorbed

all

of

the

manufacturing

costs,

which

include direct materials, direct labour, and both variable and fixed manufacturing

overhead. In addition, the traditional costing system is charged indirect cost based

on labour hour. Therefore the company need to use them to analysis the costs and

give the information for guidance of management, which the usage of absorption

costing is for cost control purpose.

2.2

Background

Obviously since the early 1900s, traditional costing systems have been developed

which

was

charged

the

overhead

to

product

by

using

basic

apportionment

and

now

are

still

widely

used.

Although

some

accountants

say

ABC

is

better,

it

depends on the type of company.

2.3

Approach

The working process

of

Absorption costing, firstly, to

charge all manufacturing

overheard

to

production

and

service

cost

centre;

secondly,

to

reallocate

the

service

cost

centre

to

production

cost

centre;

thirdly,

to

calculate

the

overhead

rate for each production cost centre; At last, put the cost overhead to product.

2