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The Significance of Accurate Costing
Accurate Costing is essential to every business as it helps to make sound financial decision to keep the business successful and competitive. In an every changing business environment with high competition, the need for accurate costing cannot be overstated. In this section, some of the importance of Accurate Costing System (ABC) will be discussed below.
According to Atrill & McLaney (2015), one of the significance of Accurate Costing System, it allows managers of organizations to monitor profit and to make the best decisions for the company's future. A company's gross margin may be measured with the use of an accurate costing system (Atrill & McLaney, 2015). Johnson (2014) maintained that for an organization to be as competitive and successful in its operation, there is need to know how much money the company spends. The organization will be able to create competitive sales prices that will increase profit and attract customers in this manner. Therefore, Accurate Costing is significance in this regard (Johnson, 2014).
Narong (2009) posited that inaccurate data about company's spending might severely limit the ability to start and run a profitable business. However, managers can assess profit using accurate costing data, allowing them to make the best decisions and predication for the company's future (Narong, 2009).
Another importance of accurate Costing is to determine a company's indirect costs, with the aim of supporting managers in making costing and profitability decisions that benefit the company. Only one overhead rate is used to display this. Machine hours or labor expenses are frequently used since they are closely related to the number of units produced (Hansen & Mowen, 2006). As stated by Hilton (2006), identifying cost drivers is a critical component of a successful ABC system, since it allows for more accurate and fully reflecting expenses inside a company. Furthermore, for businesses that just have one product or service, accurate costing provides for a rapid and painless adoption. This is due to the fact that the overall volume allocation basis will only cover the volume for a single product over the whole manufacturing line of the company (Hansen & Mowen, 2006).
Comparison of traditional costing system vs Activity Based Costing System
When comparing Traditional Cost to Activity Based Costing, there are a few things to keep in mind which will be discussed in details below:
Traditional costing technique apportions indirect costs based easy to identify elements such as direct labuor hours. This technique of allocating has been seen to be ineffective due to the fact that it has no significant correlation between the cost pool and the cost driver (Akyol, Tuncel & Bayhan, 2007). Consequently, this can result to making e indirect costs allocation not to be accurate.
On the other hand, ABC is intended to allocate costs to activities which allows for better accurate cost information (Jones & Dugdale, 2002). Furthermore, Activity Based Costing technique is generally suitable and applicable across the spectrum of organization functions and not just in the factory. ABC reveals the association between performing specific activities and the demands those activities make on company’s resources, thus giving managers a holistic view of how products, customers, facilities among others generate income and consume resources (Najjar, Strickland & Kaplan, 2017).
In several sectors, various authors have compared between traditional costing technique and Activity Based Costing technique. For instance, Lu et al., (2017) investigated a bicycle components manufacturer and discovered that using a traditional costing system with a single cost driver results in skewed cost allocation. In comparison, Activity Based Costing system allows for the accounting of resource use by each bicycle component, resulting in more precise allocation cost (Lu et al., 2017).
According to Kaplan & Andersen (2007), in spite of the immense benefits of ABC technique over the traditional costing system, several organizations are yet to implement Activity Based Costing system owing to the fact that implementation costs associated with data collecting in the initial level allocation is high.
Akyol, Tuncel & Bayhan (2007) conducted a study on a sanitary products company's cost allocation and price choice. In their study, they compared both costing system and discovered that while some goods were expensive and others were underpriced, the overall effect was nearly the same. As a result of the significant implementation expenses, they came to the conclusion that Activity Based Costing system implementation was not beneficial.
The ABC technique entails estimation of cost of every activity's resources and attributing that cost to the goods that employ those resources (Narong, 2009). ABC helps managers to make better informed decisions that can boost profitability by disclosing the real economic cost of company activities. Traditional overhead allocation apportions overhead based on a single overhead rate. On the other hand, ABC apportions overhead based on several cost pools and cost-driving activities.
Apportioning of factory overhead to goods based on the volume of production resources utilized is known as traditional costing. ABC is a costing technique that focuses on the activities that are performed in the production of products (Jinga et al., 2010). ABC costing is a method of costing in which expenses are traced first to activities, then to goods. Costs are accumulated into facility- or department-specific cost pools in a traditional costing system. Each cost pool's expenses are heterogeneous; they are costs from a variety of main processes and are seldom produced by a single element. Costs are accumulated in activity cost pools using the ABC scheme (Jinga et al., 2010). These are made to relate to significant company operations or processes. Costs in each cost pool are generally generated by a single factor the cost driver by design.
Traditional costing methods distribute expenses to items based on volume: units, direct labor input, machine hours, income, and so on. The ABC system allocates costs from activity cost pools to goods, services, and other cost items using allocation bases that correspond to the cost drivers of activity costs (Baum, 2013). Traditional costing focuses on calculating the cost of a single cost object, such as a product or service unit. ABC focuses on cost estimation for a wide range of cost objects, including units, batches, product lines, business processes, customers, and suppliers, to mention a few. It is less expensive to implement and maintain a traditional costing approach. The ABC system is both expensive to install and maintain (Garrison, Noreen & Brewer, 2018). Traditional costing is appropriate for labor-intensive businesses with little overhead. Capital-intensive, product-diverse, broadly diversified collection of operating activities, variable in number of production runs, and high-overhead enterprises benefit from an activity-based costing system.
Summing up, ABC is an accounting methodology that allocates costs to products or services based on the activities and resources that make up the overhead of manufacturing a product or providing a service (Lu et al, 2017). Traditional costing, on the other hand, allocates production expenses based on specific elements such as labor, materials, marketing, and other sources of overhead (Ben-Arie & Qian, 2003). Because overhead expenses are not uniformly distributed across all goods, activity-based costing is both timely and effective for firms that produce unique goods.
A low-volume product, for example, may need minimal equipment hours as well as multiple indirect expenses, whereas a high-volume product may necessitate maximum equipment hours with no indirect costs (Hansen & Mowen, 2006). If the overhead costs of both goods are based exclusively on machine-hours, as is typically the case with traditional costing approaches, the overhead costs of the low-volume product will be inaccurate, potentially resulting in significant financial losses for the company.
Conclusion and Recommendations
In summary, for a sound financial decision, there is need for organization to consider which method is best due to the operations and activities of the organization. As seen from this work, the cost per unit of both Vegan and Non-Vegan Meals is substantially greater when using the ABC Approach than when using the old costing system. The disparity stems from the fact that each product's overhead is significantly different. This is a crucial aspect of the activity-based costing system.
The overhead cost per unit of goods charged to products, and hence the overhead cost per unit determined via traditional costing, might be drastically different. Therefore, it is highly recommended that the most appropriate costing system for GoGo Airline is ABC system. In addition, it is more effective as the traditional method of costing was used in the past.
Traditional Costing System was effective decades ago. However, owing to changes and dynamic nature of businesses, Activity Based Costing System is commended for appropriate costing.
Adopting Activity Based Costing could help a business to accurately determine the cost elements of whole products and services. As a result, it will be possible to make informed decisions on whether to identify and eliminate unproductive goods and services. Alternatively, discover and eliminate inefficient manufacturing or service processes, and allocate processing ideas that produce the same output at a higher yield.
Finally, owing to the fact that technology advancement and development that has resulted to various ABC software and systems, ABC is recommended as an instrument for assessing product and customer cost and profitability based on the activity of the company.
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