Traditional pricing method has been based upon absorption costing principles and the treatment of overhead usually followed a set procedure.
Cost centres are identified and overhead recovery rates are established usually based on direct labour hours or machine hours and then overhead is absorbed to products or services rendered.
Advantage:
Easy implementation for companies that provide one product also is a plus.
Disadvantage:
Traditional costing is an outdated costing system in many companies because those manufacturing companies now use machines and computers for much of their production rather than labour.
Activity Based Costing
Activity Based Costing or ABC offers a workable and more effective insight into overhead accounting.
“Cost attribution to cost units on the basis of benefits received from indirect activities – for example: ordering, setting up and assuring quality”
Advantage:
Greater costing accuracy is the primary benefit of activity-based costing.
The ability to enable benchmarking and a greater understanding of overhead costs.
Dis Advantage:
Implementing an activity-based costing system within a company requires substantial resources. This can prove a disadvantage for companies with limited funds. Another disadvantage of using activity-based costing is that it is easily misinterpreted by some users.
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