Question

Understand the basic approach in activity-based costing and how it differs from conventional costing.

Answer 1

Activity-based costing is a technique for allocating overhead expenses in which the most appropriate cost driver is used for each individual activity.

While,

Traditional costing is a costing method that divides overhead expenses based on a single cost driver and the amount of production resources that are consumed.

Basic Differences Between them:

1. Main focus: The allocation of overhead expenses to the production activities is the main emphasis of traditional costing. Though it uses a distinct methodology, activity-based costing is also utilised for cost allocation.
2. Application: The constant and variable overheads in the traditional costing approach are easily separated into fixed and variable costs, and there is just one cost driver set for all activities. The implementation of activity-based costing is challenging because it requires selecting an appropriate basis for absorbing overheads, which is a challenging and time-consuming process.

Long-term business process improvement comes from activity-based costing. This is due to the fact that management of a company must thoroughly evaluate manufacturing operations and associated expenditures. This emphasises the causes of some expenditures, which can ultimately aid in managing and controlling them. It is challenging for management to collect additional data on production activities since traditional costing does not force management to search for various cost centres.

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