Differences Between Costing Methods

ABC Cost Method

Activity-Based Costing (ABC) method is a calculation technique that was initially developed to enhance the profitability of products and selection of manufactured products optimal mix. This costing method can be defined as a technique that entails allocating manufacturing overhead costs to goods using a more logical approach. In this case, the technique first allocates costs to activities that are the actual causes of overhead. Once this is carried out, the activity-based costing then allocates the cost of those activities only to products that require the activities. The method involves cost allocation and decision making since it was developed to incorporate long-term planning components and forecasts (Dorin & Diaconescu, 2014, p.111).

Activity-Based Costing differs from traditional costing methods because cost allocation involves the use of a more logical approach. In essence, ABC cost entails a more logical means of assigning costs unlike traditional costing methods where costs are assigned depending on machine hours. Secondly, ABC method differs from traditional costing methods in the sense that cost allocation is determined on the basis of activities linked with production whereas traditional costing methods assign costs depending on an average overhead rate.

Given its differences with traditional costing methods, ABC method has several advantages and disadvantages. The disadvantages of this technique include short- and long-term planning benefits, enhanced decision-making capabilities, improved efficiency in cost calculation, and improved accuracy and reliability. On the other hand, the disadvantages of ABC method include limited benefit if overhead costs account for a small portion or volume related, difficulties in assigning all overhead costs to certain activities, difficulties in justifying costs, and complexities in providing stakeholders' explanations.

Traditional Costing Methods

Traditional costing methods are some costing systems that are utilized in determination of a product's cost relative to generated revenue just like ABC method. However, traditional costing methods are defined as costing systems that allocate manufacturing overhead costs depending on the volume of the cost-driver or machine hours. For instance, traditional costing methods can allocate costs based on the labor hours required for the production of a specific item. The use of these factors in assigning costs is because these factors i.e. machine hours have direct impact on costs incurred during production. As a result, traditional costing methods played a crucial role in managerial decisions through offering operational aspects of cost and efficiency (Utku, Cengiz & Ersoy, 2011, p.318).