Traditional costing system vs activity-based costing system / Musliha Musman and Dr Salwa Muda

The business environment has changed dramatically over the last two decades as the result of intense global competition. Businesses that had previously used the traditional costing system were forced to switch to the activity-based costing (ABC) system, a more recent cost system. ABC and traditional costing are two competing approaches for allocating overhead costs to products and services. The ABC technique was developed in the 1980s for assisting firms to improve their cost management and competitive positioning, and it has since become extensively used due to its broad industry applicability (Quesado et.al., 2021; Mahesha, 2022). Both approaches estimate overhead costs related to production and then assign these costs to products based on a cost-driver rate. The traditional costing system uses a single cost driver, whereas the ABC system uses numerous cost drivers, making it more complex than the traditional approach (Quesado, 2021). The traditional allocation system assigns manufacturing overhead based on a single cost driver, such as direct labour hours, direct labour cost, or machine hours, and is optimal when there is a relationship between the activity base and overhead. There is only one overhead cost pool and a single measure of activity, such as direct labour hours, which makes the traditional method simple and less costly to maintain (Mahesha, 2022). The predetermined overhead rate is based on estimated costs at the budgeted level of activity. Therefore, the overhead rate is consistent across products, but overhead may be over or under applied.