ABC and Traditional Product Costing Methods
Activity Base Costing hereafter referred to as ABC and Traditional Product Costing Methods are used for the sole purpose of utilizing cost information to make strategic decisions that affect fixed and variable. Even though ABC is used by manager for making strategic decisions, it is not used independently. It is utilized to supplement official costing systems that are used for preparing external financial reports. (Garrison, Noreen, & Brewer, 2010) In the Traditional Product Costing Method emphasis is put on absorption cost used by manufacturing companies to calculate unit cost for the purpose of valuing inventories and determining cost of goods sold for external financial reports. (Garrison, Noreen, & Brewer, 2010) Traditional Product Costing determines cost of goods sold by combining direct material, direct labor and manufacturing overhead. Having the accurate cost information assist manager in numerous ways to plan, control, and evaluate decisions. With the right information as a part of the planning process companies can determine whether it can or should compete in certain markets. Using the information to control operations a company can analyze relationship between production levels and costs determining whether to increase or decrease production levels of certain products. Furthermore this control data can help with future operations plans because it can determine if the increased costs of additional production would less than the revenue that would be derived from sales of the products. Finally the evaluation process allows the company can compare actual cost against budgeted cost and identify both progress and problems for subsequent management action. (Albrecht, Stice, Stice, & Skousen, 2002) Cycle Time is also a product of accurate product cost. It allows a company to identify and eliminate costly complicated processes. Therefore higher quality, lower priced products, and services can be delivered to customers in increasingly shorter cycle time. (Albrecht, Stice, Stice, & Skousen, 2002)
Although this tool is essential to managers there is a difficulty in determining accurate product costs. There are three elements as stated combined that affect product cost. These elements are direct materials, direct labor, and manufacturing overhead.
Direct material are raw materials directly associated with the product to be manufactured and kept in inventory until used. Direct labor includes payroll for assembly line workers but it does not include cost such as wages for factory janitorial services which is not directly related to the product being made..Miscellaneous materials thaat are used in completing the product are classified as manufacturing overhead. They can include anything from nail to glue or wages for supervisors. (Albrecht, Stice, Stice, & Skousen, 2002)
It is easy to assign cost related to direct labor and direct material for a specific product because of the even flow of those...