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Compare and Contrast Activity-Based Costing and Functional-Based Costing Systems

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Compare and Contrast Activity-Based Costing and Functional-Based Costing Systems

Activity-based costing (ABC) involves two steps; one is services or products consume activities, and activities consume the resources. This method of costing accounting differs from the traditional costing with the model that activities consume resources and processes drive activities. The model of ABC allows for more accurate cost calculation in direct and indirect costs. An activity-based costing system attempts to allocate a company’s cost is acceptable for efforts to implement full cost accounting efforts within a company. Allocation does not require a new type of accounting framework once the cost has been identified. Engineers use the data to evaluate different factory layouts, reduce waste in manufacturing and improve product. Better cost allocation will reveal the true costs of products (Schempf, n.d.). In comparison, both ABC and functional costing are complements to cost management efforts. Both relate the way business is conducted to the way costs are generated in the organization. The information is important for effective cost management (The Stanton Group, n.d.).

Functional based costs are assigned to products such as direct materials, direct labor, and overhead costs. The advantage of traditional cost system (functional-based) is the simplicity. This cost system provides little information beyond material and direct labor to assist management to control costs at the product level or below. This costing provides no guidance to the manager on the effect of sales, marketing, distribution, and customer costs on product or product line profitability (Tarr, n.d.).

In contrast functional based costing assigns responsibility to individuals in charge of an organizational unit such as a department, division, or plant and responsibility is defined in financial terms. ABC responsibility is assigned to teams or processes such as product development. Functional based costs establish performance measures using standard costing and attainable standards. Activity based cost performance measures are process oriented and focus on continual improvement and increasing customer value (Garcia, n.d.). ABC systems have the flexibility to provide reports to assist management decisions regarding the costs of activities undertaken to design, produce, sell, and deliver a company's products or services. The ABC system focus on accumulating costs via key activities, whereas traditional cost allocation focuses on accumulating costs via organizational units. ABC systems provide superior cost allocation information. Functional based cost system will continue to be used to satisfy conventional financial reporting requirements (Reference for Business, n.d.).

Decision Making

In the decision-making process, all costs should be considered product costs. Management can find the ability to influence cost patterns over an extended period once the structure of the cost is understood. The application of ABC assists managers in identifying unused resources and capacity. Decisions can then be made to optimize use of a resource, reduce costs or eliminate it. The ABC’s model would be best for Huge Company because it brings detailed information from the processes up to assess costs and manage capacity on many levels whereas the Traditional-based system model

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