Activity based costing vs.

Traditional Costing
Introduction:
Information systems are described as costing procedures. Direct labor hours and units produced are the definite
required information. According to the specific costing system defined methodology, it is key data that product
costs. Same input data could be used in different ways as the results are dependent on costing system. To
minimize the waste, costing system is helpful. It is essential to understand the working of both systems, if anyone
wants to compare them.
Impact of traditional costing:
To assign manufacturing overhead to units produced, most of manufacturing companies used traditional costing
system. Manufacturing overhead cost uses the volume metric, the assumption made by users of the traditional
costing method. Accountants assign manufacturing costs only to products under traditional costing. Costs that are
connected with the production of an item, such as administrative expenses, traditional accounting fails to assign
nonmanufacturing costs. To make external financial reports, firms mostly use traditional accounting as it gives
the worth of goods that are sold.
Alignment with Generally Accepted Accounting Principles or GAAP refers towards the advantages of traditionalbased costing. Manufacturing companies starts to use machines and computers for most of their production as
traditional costing is an outmoded costing system in various companies. It used to calculate direct labor hours as
computers and machines make the system updated. Cost drivers that may contribute to the cost of an item are
neglected by traditional costing. It eliminates certain nonmanufacturing costs refers towards bad management
decisions is another disadvantage of traditional costing system (Johnson, R. 2014).
Impact of activity-based costing technique:
In the last decade of the twentieth century, the activity-based costing technique has been considerably developed
(Cooper, 1990).It describes the shortcomings of traditional absorption costing methods as it utilizes direct labor to
allocate indirect costs (Dugdale, 1990).Assignment of resource costs to products based on activities occurs in
management accounting process called ABC which refers to work and incurring cost as employed by products
and services (Krumwiede and Roth, 1997).
It seems essential to utilize the contingency theory for explaining the use of ABC by the business strategy. The
nature of the environment to which the organization relates is the best way to organize as it is the key notion
presented by Scott (1992: 89).
The Miles & Snows (1978) typology involves four strategic types:
1. Defenders
2. Prospectors
3. Analyzers
4. Reactors
A firm can enhance its profit either by producing the products at lower cost in the market or offer the innovative
products and services as compared to competitors as elaborated by Porters typology.
Description with Various Research Studies
Especially in the Anglo-Saxon countries like the U.S. and the UK, the impact of ABC on organizational
performance has been studied by many authors. The ABC method can eliminate the inexactitude about the cost

distribution and for improving performance as explained by partisans (Ittner et al., 2002). 75% of respondents
said that the use of ABC resulted in improving in financial performance, and only 25% who gave opposing
arguments as the empirical study conducted in the United States (Shields, 1995). McGowan and Klammer (1997)
and Foster and Swenson (1997) afterwards verify these results.
The relevance, the causality, the availability and the meaning of information are improved by using the ABC
system are conformed from empirical study comparing the performance of traditional methods and that of the
ABC method, Mc Gowan (1998). 42% of enterprises used ABC method considers that it makes the performance
of management system efficient whereas 28% is the amount considered for all other firms.
The use of ABC is connected positively and significantly with eliminating costs in the U.S. manufacturers during
the XXI century as described by (Ittner et al., 2002). The utilization of the ABC approach mostly results in
enhancing profitability, competitiveness and shareholder value as given by Pizzini (2006).
In recent times, ABC method has an indirect positive impact on the industrial performance from an empirical
study of 1250 U.S. companies Banker et al, (2008). The utilization of the ABC method results in a better overall
performance for enterprises that are present in Australia as confirmed by Zaman (2009)
ABC Proves Better
ABC method proves more refined judgment for this strategy and cost for development of the strategy, if
manufacturing companies utilizes low cost strategy with the competition with its competitors. Those
manufacturing firms who produce the same types of products must face severe competition; they may use the
same information as used by ABC to enhance their competitiveness. Higher profits which result in improvement
in financial performance refer towards lower cost.(Hoa, T. N. 2010)

References:
Hoa, T. N. 2010. THE IMPACT AND IMPORTANCE OF ACTIVITY BASED COSTING ON FINANCIAL
PERFORMANCE OF MANUFACTURING FIRM. HELP University College
Cooper, R. (1990), Implementing an Activity-Based Costing System, Journal of Costing Management, spring: 3342.
Dugdale, D. (1990), The Uses of Activity-Based Costing, Management Accounting, October: 36-38.
Krumwiede, K.P. and Roth, H.P. (1997), Implementing Information Technology Innovations: The Activity-Based
Costing Example, S.A.M. Advanced Management Journal 62 (4): 4-13.
Scott, W.R. (1992), Organizations: Rational, Natural, and Open Systems. Englewood Cliffs, N.J.: Prentice-Hall.
Ittner, C.D., Lanen W.N. and Larcker D.F. (2002), The association between Activity Based Costing and
manufacturing performance, Journal of Accounting Research 40, (3): 711-726.
Shields, M D. (1995), An Empirical Analysis of Firms: implementation experiences with Activity-Based Costing,
Journal of Management Accounting Research 7: 148-166.
Foster, G. and Swenson, D. W. (1997), Measuring the Success of Activity-Based Cost Management and its
Determinants, Journal of Management Accounting Research, 9: 109-141.
McGowan, A. S. (1998), Perceived benefits of ABCM implementation, Accounting Horizons, 12(1): 3150.
Pizzini, M. J. (2006), The relation between cost-system design, managers evaluations of the relevance and
usefulness of cost data, and financial performance: an
empirical study of US hospitals, Accounting, Organizations and Society 31 (2):179210.

Zaman, M. (2009), The Impact Of Activity Based Costing On Firm Performance: The Australian Experience,
International Review of Business Research Papers 5 (4): 200-208.
Johnson,
R.
2014.
Traditional
costing
Vs.
activity
based
costing.
Available
at :http://smallbusiness.chron.com/traditional-costing-vs-activitybased-costing-33724.html accessed 8 December
2014