The traditional costing system implies the usage of manufacturing overhead based on cost driver volumes that are required for an item’s production (Warren et al., 2018). This kind of costing method is beneficial for various reasons. First of all, it helps in the assignment of all direct costs associated with the manufactured product. This costing model also implies effective conduct of cost management and measurement of the cost for the newly manufactured product line. Thus, it improves the cost-related decision-making of the firm.
Nevertheless, the method has several critical drawbacks. For example, during the absorption of indirect costs machine hour rate, labor hour rate, and other overhead recovery rates are used which has no impact on the decision-making process. The business growth with the implementation of the traditional costing model may lead to inaccurate calculations because of the division of PF costs into variable and fixed. In addition, the method of allocation of indirect costs at this business stage is done arbitrarily.
On the other hand, Activity-Based costing (ABC) is a model which assigns overhead to multiple activity cost pools which are allocated to products and services using cost drivers (Warren et al., 2018). The advantage of such a method is that it can add value to the continuous growth of the business. It also helps to identify the unnecessary costs and wasteful products. Thus, helping to improve the production effectiveness. Its potential blossoms in businesses that are specialized in the production of customized products and services.
Nevertheless, this costing model can increase the burden on financial resources and be time-consuming for the firm. Some activity-based costs might be irrelevant to the company’s decision-making. Moreover, transition to the new model will require training of the employees to which they might demonstrate reluctance by essentially resisting the change. Thus, it is evident that the ABC method has its own set of disadvantages.
The implementation of the ABC model in a small manufacturing business would depend on the growth potential of the company. However, I would still implement the system as the drawbacks are not as critical in comparison to the traditional model. Moreover, the company has multiple product lines and traditional costing will not be able to estimate the costs as accurately. Therefore, to preserve optimal growth of the company ABC method would be the most beneficial.
Warren, C. S., Reeve, J. M., & Duchac, J. E. (2018). Financial and managerial accounting. Cengage Learning.