A cost accounting system is a framework used by firms to estimate the cost of their products for profitability analysis, inventory valuation and cost control. Its goal is to advise the management on the most appropriate course of action based on the cost efficiency and capability. Cost accounting provides the detailed cost information that management needs to control current operations and plan for the future.
Costing is essential for every organization, as every manufacturing and other department has to be assigned accurate budget for proper operation (Hansen, Mowen and Guan, 2006). The costing system provides information that is useful to managers for minimizing wastage and allocating resources to different departments.
The traditional costing system is a costing system which calculates a single overhead rate and applies it to each job or department. This system has several flaws which make it outdated and ineffective in today’s business environment. One of the most important drawbacks of the traditional costing system is that it tends to over-emphasize on meeting standards such as price and efficiency without considering other important factors like quality, on-time delivery, and customer satisfaction because of which the products of other companies form better alternatives and pose a tough competition to the organization. It also stunts any scope for improvement or innovation as it is too focused on sticking to the set benchmarks. This often leads to poor overall performance of the organization in the long run which in turn affects the going concern of the business.
Secondly, it utilizes a single, volume-based cost driver which leads to the distortion of the cost of products. It traces overheads to products or services using small number of allocation bases. In most cases this type of costing system assigns the overhead costs to products on the basis of their relative usage of direct labour whereas in reality, most manufacturing companies now use machines and computerized systems for production. This creates a loophole in the system increasing the possibilities of overproduction and unnecessary build-up of stock. Also, for this reason traditional cost systems often report inaccurate product costs as direct labour hours become an ineffective cost driver when the level of technology applied in the production processes of the firm is high.
Furthermore, a traditional costing system often focuses on the direct costs of manufacturing a product and completely avoids significant non-manufacturing costs such as marketing and distribution which are directly responsible for making a product available for consumption. This cannot be considered an appropriate procedure of determining costs as it can become the basis of adverse management decisions regarding issues like product emphasis, make or buy, pricing etc. which in turn affect the profitability of the company. Moreover, the Traditional Costing System can result in the under or over-costing of...