Traditional Costing & Accounting
Written by Eddy Hood
There are several different methods that accountants and bookkeepers use to manage the financial aspects of businesses. One of these methods is known as the traditional costing system. The traditional costing system is an accounting method that is used to predict profits. This method uses cause-and-effect techniques and takes into account direct and indirect costs and expenses in a business.
Direct and Indirect Costs
Direct costs include matters such as the costs of materials used in the manufacturing process and the cost of labor to create products. Indirect expenses include expenses that are more difficult to accurately predict. They include matters such as overhead costs and more unpredictable direct labor costs. Together, these costs allows businesses to estimate the total cost of manufacturing a product. When the total cost is predicted, the company is able to determine how much profit they can expect to see. This is done in traditional costing by dividing total cost of products by the amount of direct labor costs that will be required to produce the finished product.
Potential for Inaccuracies
The problem with this method is that there are often unexpected expenses incurred within the manufacturing process. Because of this, estimations for profit are affected. Companies often lose money, because the total cost to manufacture a product ends up being much more than originally expected. When the total cost increases unexpectedly, the amount of profit that a company receives is diminished. Despite the potential for inaccuracies, the traditional costing method is frequently used because it is much simpler than other methods.
Another popular method used by accountants is known as activity-based costing, also known as ABC. The ABC method was created to solve inaccuracy problems found in the traditional costing method. In activity-based costing, each activity has an assigned cost. These costs are calculated first to ensure that every portion of manufacturing and production are accounted for before the company assigns a total cost to a product. This method is most popular in the field of manufacturing.
Activity-Based Costing vs. Traditional Costing
When it comes to activity-based costing vs. traditional costing, there are a lot of factors to consider. Activity-based costing was developed from traditional costing accounting methods, so there are similarities between the two methods. They are both used as a way of tracking expenses, for instance. However, while both activity-based costing and traditional costing methods are used frequently in the accounting field, there are many differences between the two methods. Activity-based costing is much more complex and time-consuming than traditional costing, so it is often more expensive for companies and accountants to use the ABC method. Although the ABC method allows a total cost to be assigned more accurately to ensure profit, its accuracy is generally best suited to those businesses that manufacture products rather than those that offer services. Companies that do not manufacture a product may find that they have more success with traditional costing or other accounting methods. Whether a traditional costing system or an activity-based costing method is desired, at Ignite Spot, we have a firm of accounting and bookkeeping professionals that are experienced with each method. Contact us online to instantly download a pricing guide or by phone to learn more about our outsourced accounting services for small business owners.
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