The facts discussed above give rise to the importance of employing an accounting method which takes into account the full costs of operation. Consequently, full cost accounting allows managers to give an appropriate cost to the companys products and services to include a fair share of overheads to each unit produced.
This paper will take a look at the presently used costing methods in business organizations namely traditional and activity based costing. The next section will discuss how cost accounting was traditionally conducted. Next, it will focus on the recently recognized activity based costing and how it is utilized. Lastly, this report will compare the two methods and apply them to real world examples to asses their relative efficiency.
Traditionally, all costs were orinally fixed. In fact, cost comes from a Latin word which means “to stand.” However, developments were made as managers recognized the efficiency of categorizing costs into either fixed or variable. As we now know, fixed costs refer to administrative expenses which remain “fixed” in either busy or slack seasons. On the other hand, variable costs are those which significantly varies with the number of output produced and are dependent on business productivity. Variable costs are those which naturally “rise” or “fall” with business activity (Cost Accounting 2006).
Traditional costing is one of the simplest way of costing products and services. In this system, it is assumed that costs are directly associated with the volume of production as a single cost is given to all products and services. Hence, this costing method presupposes that as the level of production goes up, so does cost. Traditional costing essentially uses unit-based costing which alloates manufacturing overhead based on the unit of products manufactured (ABC Concepts 2000).
Accordingly, the traditional approach to