traditional costing system


traditional costing system
Any of the systematic costing methods that prevailed before the rise of activity-based costing in the 1990s. Because they rely on an essentially arbitrary allocation of indirect costs, such systems do not give managers accurate product cost information, which means that accurate calculation of product profitability is not possible. The overhead rate in a traditional costing system would typically be calculated using direct labour hours, machine hours, or units. This could lead to accurate product costs when direct costs were high and indirect costs were low, as was usually the case 50 years ago; however, modern organizations typically have low direct costs and higher indirect costs. The strengths of traditional costing systems are:
• simplicity - the calculation of overhead rates is relatively straightforward;
• they are widely understood in the business;
• they are not expensive to operate;
• until the late 1980s they were seen as fairly accurate;
• they are still being used after many decades. The weaknesses of traditional costing systems are:
• their reliance on arbitrary rather than cause-and-effect allocation of overheads;
• their inability to give accurate product costs in multiproduct companies;
• their failure to analyse non-manufacturing costs.

Big dictionary of business and management. 2014.

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