Activity Based vs Traditional Costing: Difference and Comparison

Costing is used in accounting. It helps the company and the business in the long run. It comes under the commerce stream. Account people used this method and implemented it based on the kind of product.

Activity-based costing and traditional costing are two such methods used for accounting. 

Key Takeaways

  1. Activity-based costing allocates overhead costs based on specific activities, while traditional costing allocates overhead costs using a predetermined rate.
  2. Activity-based costing is more accurate and better suited for complex production processes, while traditional costing is simpler and more applicable to businesses with uniform products.
  3. Activity-based costing helps identify non-value-added activities, enabling cost reduction, whereas traditional costing doesn’t offer the same level of detail.

Activity Based Costing vs Traditional Costing

The difference between Activity-based costing and traditional costing is the factors that are considered when assigning the price for overhead products. Traditional costing uses a predetermined method to calculate the overhead product rate. It would be good if you use activity-based costing for correct accuracy. 

Activity Based Costing vs Traditional Costing

Activity-based costing is to determine the overhead costs for different methods. The method will not be specific. Here the cost driver will be applied differently based on what kind of product we use.

It is considered the most expensive one as it is very difficult to implement them, and the process will be tedious to understand. 

The traditional costing method is to allocate the overhead products of the factory. It is one of the easiest costing methods as the process will be simple and easier to implement. It is used under accounting. The single cost driver is based on various methods. 

Comparison Table

Parameters of ComparisonActivity Based CostingTraditional Costing
DefinitionThis is used for finding the indirect costs.This method is for finding the cost for the products in advance.
AdvantagesIt gives the profit of the product accurately.Workers will be more productive to do the work.
DisadvantagesThe benefits will be limited.It is not helpful when we determine the overhead costs for general purposes.
Activity TypesUnit level and Facility level.Unit level, facility level, product level, and batch level.
Costing MethodLess expensive costing method.More expensive costing method

What is Activity Based Costing?

This method is used for maintaining overhead and indirect costs. It is related to products and services. This kind of costing method is used in Manufacturing Industry.

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The reason behind this is it is used for enhancing the cost data reliability. This, in turn, will produce reliable costs, which are used for the better production of the company. It is based on activities and specific goals. 

This will help us to get a better grip on costs. So, more companies will be able to follow some strategies for appropriate pricing.

Activity-based costing is mainly used in target costing, product costing, product line profitability analysis, customer profitability analysis, and service pricing. There are some steps to be followed for activity-based costing. 

The first thing we have to do is to identify the cost of the objects we are going to invest in. The second step is to identify the direct costs of those products. The third step is to allocate the indirect costs to these products.

The fourth step is to identify the indirect costs which we have allocated to these products. The fifth step is to compare the price per unit. The sixth step is computing those indirect costs.

The seventh step is computing the total cost of all those products. Their main purpose is to provide more accurate costing services. 

activity based costing

What is Traditional Costing?

Traditional Costing is to identify the cost of the products that are needed to make a profit to the products of the organization. This method is done by allocating overhead manufacturing costs.

So, the predetermined overhead method is calculated in order to apply the rates. The costs that are incurred in traditional costing are Managing the expenses, Packaging, Machine Hours, Machine Setups, Quantity of Materials Required, and Cleaning and maintaining the materials.

In order to follow the traditional costing method, we have to follow some predetermined steps. The first step is to identify the cost overhead. The next step is cost estimation. The overhead costs for some time period will be estimated in this step. The third step is Calculation.

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In this step, we have to choose the cost driver. Because traditional costing is based on the cost-driving method. The fourth step is estimating the amount that is required for the cost-driving method. The fifth step is to calculate the overhead rate, which is predetermined. 

The sixth and final step is to apply the rate which we have calculated from the estimation to the overhead product. This type of costing is mostly used by manufacturing industries. Because their main purpose is to predetermine the amount for the products they are going to make.

traditional costing

Main Differences Between Activity Based Costing and Traditional Costing

  1. Activity-based costing is used to cover only the product cost. On the other hand, traditional costing is used to cover both the product and the period costs.
  2. Activity-based costing is very difficult to learn and understand, and at the same time, the implementation process becomes very difficult, while traditional costing is easy to understand, and the implementation process is simple.
  3. Activity-based costing is used in external finance, while traditional costing is used in external reporting statements.
  4. Activity-based costing uses multiple drivers for its operational requirements, while traditional costing uses an identical cost driver for its operational requirements.
  5. Activity-based costing uses only two activities, but traditional costing uses four activities.
Difference Between X and Y 2023 05 05T181640.056
References
  1. https://onlinelibrary.wiley.com/doi/abs/10.1111/1475-679X.00031
  2. https://link.springer.com/content/pdf/10.1007/s12351-009-0049-3.pdf

Last Updated : 14 July, 2023

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23 thoughts on “Activity Based vs Traditional Costing: Difference and Comparison”

  1. The real-world examples and applications mentioned for activity-based costing and traditional costing shed light on their practical relevance and implications in business settings.

    Reply
    • Absolutely, Qpowell. The real-world applications provide a clear context for understanding the implementation of activity-based costing and traditional costing in business operations.

      Reply
    • I agree, Qpowell. The inclusion of practical examples enhances the article’s value by demonstrating the actual use of these costing methods in different scenarios.

      Reply
  2. The explanations provided for the concepts of activity-based costing and traditional costing are highly informative and serve as a great resource for individuals seeking detailed knowledge in this area.

    Reply
    • Absolutely, Noah. The clarity in explanations helps in developing a deeper understanding of activity-based costing and traditional costing for accounting purposes.

      Reply
    • I wholeheartedly agree, Noah. The article offers valuable insights and explanations, making it easier to comprehend the complexities of costing methods.

      Reply
  3. The article does an excellent job of outlining the specific steps involved in activity-based costing and traditional costing. This insight is beneficial for those looking to understand the practical implementation of these methods.

    Reply
    • I couldn’t agree more, Wayne. The detailed steps provided for both costing methods offer valuable guidance for their application in different business contexts.

      Reply
  4. The article provides a well-rounded perspective on the use of activity-based costing and traditional costing, making it an insightful read for anyone interested in the field of accounting and finance.

    Reply
  5. This article provides a clear explanation of the differences between activity-based costing and traditional costing methods, as well as their advantages and disadvantages.

    Reply
    • I completely agree, Freddie. The article’s in-depth analysis is beneficial for understanding both costing methods and their implementation in real-world scenarios.

      Reply
  6. The article’s emphasis on the benefits and limitations of both costing methods offers a balanced viewpoint, aiding in decision-making for businesses looking to optimize their cost allocation processes.

    Reply
    • I completely agree, Mowen. The detailed exploration of pros and cons serves as a valuable guide for businesses evaluating the most suitable costing method for their operations.

      Reply
  7. The article’s focus on the advantages and disadvantages of activity-based costing and traditional costing provides a comprehensive view of their respective benefits and limitations.

    Reply
    • Absolutely, Russell. Understanding the pros and cons helps in making informed decisions about the most suitable costing methods for specific business needs.

      Reply
  8. The comprehensive coverage of activity-based costing and traditional costing methods makes this article a valuable resource for those wishing to gain an in-depth understanding of cost allocation practices in accounting and finance.

    Reply
    • Indeed, Joel Ross. The detailed coverage of the costing methods offers a deep dive into their intricacies, making it a must-read for professionals in the field of finance and accounting.

      Reply
  9. The comparison table provides a concise overview of the parameters of comparison between activity-based costing and traditional costing. It helps in better understanding their differences and use cases.

    Reply
    • You’re absolutely right, Aiden04. The detailed comparison table makes it easier to grasp the key distinctions between the two costing methods.

      Reply
    • I agree, Aiden04. The information presented helps in understanding the nuances of each method and their applicability in various business scenarios.

      Reply
  10. The practical insights provided for activity-based costing and traditional costing methods offer valuable knowledge for individuals seeking to enhance their understanding of how these methods are applied in practice.

    Reply
    • Absolutely, Lily34. The practical guidance provided in the article offers critical insights into the real-world application of activity-based costing and traditional costing.

      Reply
    • I couldn’t agree more, Lily34. The practical insights serve as a valuable resource for professionals looking to implement these costing methods effectively.

      Reply

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