When Costing is not as easy as ABC

Costs are expensive. But what is even more expensive and unnecessary is the inability to accurately measure and represent your costs. The misrepresentation of actual cost is greatly influenced by the allocation of overhead. When an organization finds it very expensive or impossible to convert overheads to direct cost. They may be forced to make a decision between the traditional costing methods (TCM)and activity-based costing (ABC) methods of cost allocation.

According to Kaplan, The use of TCM would be more practical with the organizations that were running decades ago, where companies manufactured a narrow range of products, so their cost's were easily traceable and a grossly misrepresented overhead had very little impact on the final, total cost of operations .  As today's organization have expanded, the proportion of indirect cost far exceeded direct costs therefore, it is no longer justifiable to use TCM as a method of allocating overheads , especially as the cost of information technology has decreased and the global market competitiveness has intensified.

The first and vital step to enforcing an effective ABC system is accuracy. While very similar to TCM, ABC endeavors to allocate overheads more proportionally to cost objects, based on activities required, cost drivers for these activities and resources demands for each cost object. ABC is however difficult to implement and not effective in large-scale operations or operations with many resources of equal per unit cost as the cost of implementation usually by far exceeds the reward. In such a scenario, it would be usually more effective to implement traditional costing methods.