Activity Based Costing vs.Traditional Approach (Sober Plc) Essay

Activity Based Costing vs.Traditional Approach (Sober Plc) - Essay Example Financial information forms the basis for much of the decision-making for organizations, and the need for more accurate information continues to grow. Ignorance of the manufacturing realities may put an organization at risk of losing its competitive edge, which inevitably results in loss of profitability and crippling losses. Traditional volume based costing techniques present numerous challenges to organizations, especially in the modern manufacturing environments, where the overhead costs continue to rise. In addition, introduction of new technological advancements in the production processes invalidates traditional cost allocation mechanisms and articulates the need for organizations to switch to new and more market aware costing systems. This paper discusses traditional versus activity based costing with regard to a case on a global motorcycle company currently in a managerial stalemate over the most appropriate costing method. Introduction Traditional costing techniques can be h ighly misleading in their estimation costs of particular products, markets, or organization activities. Traditional approach to allocation of overheads is blind to the factors that drive costs, which are known as cost centres in activity based costing (Luehfing, 2005). ... Background to the Case The senior management staff at Sober Limited engages in a heated ideological standoff because of different viewpoints regarding the appropriate accounting policy for the company. The finance manager proposes adoption of a new costing system, which is activity based costing (ABC), and highlights the fact that the method can prove that the production of one of the company’s primary products, Fireball motorcycle, is no longer profitable, and in fact eats into the company’s profits from other segments. The chairman, critical of activity based costing and favourably predisposed towards traditional costing methodology, expresses his confidence in existing costing methodology, which shows that the production of Fireball is still a viable and profitable option. In addition, the chair claims that the use of activity based costing will only result in unnecessary cost overruns for the company. Analysis of labour hours and ABC in the context of Sober Public L imited Company Sober uses traditional volume based absorption costing to allocate overheads. The company allocates overheads according to the number of labour hours, although sweeping technological changes have put serious credibility as to the relevance of the use of labour hours to allocate costs. The company has had to reduce the size of the workforce due to the introduction of new manufacturing technology. New and more fitting cost drivers than labour hours are now available, and they include deliveries to retailers, set-up costs, and purchase orders. The company seriously considering and questioning the appropriateness of traditional cost allocation methods for overheads in the fundamentally altered manufacturing and market environments. The company sells the motorcycles globally, and the