Chapter 3 Discussion

As discussed in the textbook, Activity-Based Costing (ABC) is a "technique that attempts to assign overhead costs more accurately to products than the simpler methods discussed thus far" (Brewer, Garrison, & Noreen, 2012). There are pros and cons with this type of activity costing, as with many different methods of determining overhead. A benefit regarding accuracy would be that by dividing the company into departmental pools, there is a better or more accurate number per that department than if it was determined from just one number. Another benefit is that activity-based costing can link costs to direct activities which allows managers to determine areas where improvements or reform need to be made (Brewer, et al, 2012). Along with the pros, there are also some mentionable cons to activity-based costing. Creating a system or changing over from a more traditional method may be costly with both resources and time. The assumptions or numbers for activity-based costing may be inaccurate or skewed based on the strictly proportional activity measure (Brewer, et al, 2012). In an online search, a comparison of Traditional Costing to Activity-Based Costing revealed only slight difference than the examples provided by the textbook. There are pros and cons to both methods and determining which method is a better value for each company is important. Traditional costing is less expensive than Activity-Based Costing but Traditional also has more errors (Johnson, 2014). Determining how important accuracy for a business is will help determine if the additional costs will be worth the effort to change the determining model. Another example is that Traditional costing conforms to GAAP but uses direct labor-hours as a cost-driver and relies on outdated systems (Johnson, 2014). After reading about the different methods of determining overhead, it makes me feel that there are a lot of complex factors to consider when making a decision as to which strategy to use. An example of activity-based costing could be a fence factory. There are many components to different types of fences. A business in Belle Fourche makes chain link fences and costs need to be based on accessories needed, coated or non-coated, height, post size, equipment required, and materials. By determining all these factors using an Activity-Based system it would give a much more accurate overhead rather than just using direct-labor hours. Each order will vary significantly and where products vary, a constant factor (like labor-hours) would be inaccurate.

References: Brewer, P.C., Garrison, R.H., Noreen, E.W. (2012). Introduction to Managerial Accounting with Connect Plus (6th ed.). McGraw-Hill/Irwin. Johnson, Rose. (2014). Traditional Costing vs. Activity-Based Costing. Retrieved February 4, 2014 from http://smallbusiness.chron.com/traditional-costing-vs-activitybased-costing-33724.html