Traditional Costing or ABC Costing Metrics?
Manufacturing companies usually employ traditional costing like an approach to identifying what exactly it costs to produce products. This includes a real cost having a factor in order to determine how you can allocate overhead costs – which is known as cost driver.
The important thing in traditional costing is it is very simple to perform than any other techniques, such as activity based cost methodology, though it can also be much less precise.
Traditional costing begins having a metric. As an example, an organization might take a look at a couple of items. One requires a single hour for making as the other requires a couple of hours.
After that it will take all the indirect or overhead costs and add them up together. As soon as they have established what it pays, this splits the expenses through the quantity of the metric to get the indirect cost hourly it may apply at the item.
For example a business which makes products needs several employees, every employee operating 1,000 hours, and an additional several part time workers, additionally operating 1,000 hours. Along the way of creating products, it usually spends $500,000. The overhead rate is the consequence of dividing $500,000 by 5,000 hours (for example 5 employees working 1,000 hours). That calculates $100 hourly.
A part of developing a traditional costing strategy is choosing cost drivers. In particular, an organization might decide to calculate labor hours, even though calculating machine hours could be a much better metric in some manufacturing facilities.
Some other metrics might range from the kilometers traveled for any transport operations as well as quantity of materials dealt with for any chemical manufacturing business which processes materials.
The issue using traditional costing will be it utilizes one flat rate to be able to designate costs. As an example, if the manufacturing plant creates a couple of products, single line supervisor has the capacity to lower manufacturing expenses, cost benefits might turn out to be designated throughout each items manufactured, misreporting the effect from the supervisor’s achievements.
Activity based cost system or simply ABC Costing system adds extra degrees, making it simpler to be able to better calculate and allocate actvity costs.