In this paper we are going to prepare the income statement on traditional based costing and activity based costing. After that the report tells about the differences in the product line profitability. The report will reveal the contrasting views on the tow approaches of allocating with respect to E Lab and also discuss the benefits that will come up using activity based costing. Traditional costing: The traditional absorption costing used in typically manufacturing company is still allocated overhead into products using direct labor or machine hour as the driver.
They are often allocated largest overhead cost based on smallest direct labor. (www. theacagroup. com/activitybasedcosting. htm) Activity Based Costing: ABC is a system of accounting that focuses on activities as the fundamental cost objects and uses the costs of these activities as building blocks for compiling the costs of other cost objects (Such as product or department). ABC seeks not only to allocate over heads to product costs on more realistic basis, than simply production volume, but also attempts to show relationship between overheads costs and activities that cause them It is also called activity-bases costing or activity accounting.
(Charles T. Horngren p150) E Lab only produced a few types and high quantities of products before, traditional costing method which focused on direct costs were much more important than the production overheads, traditional costing would be accurate before While the production structure has changed, the times demand that flexibility and love of change replaced absorption costing method in E Lab The calculation step of ABC E-Labs, Inc. is a pharmaceutical manufacturer in San Juan.
The company has a highly automated processing system that is used to manufacture three patented pharmaceuticals: Adchlor, Badchlor and Cifchlor. Cost drivers are the real factors that decide the cost incurred and the resource consumed. Unlike the traditional method plagued by inaccuracy in manufacturing overheads allocation. ABC need not adopt two-stage cost allocation process to figure out the each target cost, in order to achieve cost information accuracy.
Therefore, ABC adopts multi activities to distribute costs. It demonstrates that choosing proper cost drivers is the most important and key step. In practice the ABC system uses many drivers as allocation bases in the second stage of the cost allocation system whereas the traditional cost systems tend to use, at the most, two second-stage allocation bases. (Colin Drury, 2002, p298)
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