Activity Based Costing vs. Standard Costing

Attribute	Activity Based Costing	Standard Costing
Focus	Activities and their costs	Standard costs and variances
Cost allocation	Based on activities performed	Based on predetermined rates
Accuracy	More accurate as it considers actual activities	Less accurate as it relies on predetermined rates
Complexity	More complex due to detailed activity analysis	Less complex as it uses standard rates
Flexibility	More flexible in adapting to changes in activities	Less flexible due to reliance on standard rates

Introduction

Activity Based Costing (ABC) and Standard Costing are two popular costing methods used by businesses to allocate costs to products or services. While both methods have their own advantages and disadvantages, understanding the differences between them can help businesses make informed decisions about which method to use.

Definition

Activity Based Costing is a costing method that assigns costs to products based on the activities involved in producing them. This method focuses on identifying and allocating costs to specific activities that drive costs, rather than using broad averages. On the other hand, Standard Costing is a costing method that assigns costs to products based on predetermined standards for materials, labor, and overhead. These standards are set based on historical data and are used as benchmarks for evaluating performance.

Cost Allocation

One of the key differences between ABC and Standard Costing is how costs are allocated to products. In ABC, costs are allocated based on the activities that drive costs, such as machine setup, material handling, or quality control. This method provides a more accurate picture of the true cost of producing a product, as it takes into account the specific activities involved. On the other hand, Standard Costing allocates costs based on predetermined standards, which may not always reflect the actual costs incurred. This can lead to variances between standard costs and actual costs.

Accuracy

Another difference between ABC and Standard Costing is the level of accuracy in cost allocation. ABC is often considered more accurate than Standard Costing, as it takes into account the specific activities that drive costs. This method provides a more detailed and precise view of the costs associated with producing a product. Standard Costing, on the other hand, relies on predetermined standards that may not always reflect the actual costs incurred. This can result in variances between standard costs and actual costs, leading to less accurate cost allocation.

Complexity

ABC is generally more complex and time-consuming to implement compared to Standard Costing. This is because ABC requires businesses to identify and allocate costs to specific activities, which can be a labor-intensive process. However, the detailed information provided by ABC can help businesses make more informed decisions about pricing, product mix, and process improvements. Standard Costing, on the other hand, is simpler and easier to implement, as it relies on predetermined standards for cost allocation. While Standard Costing may be less accurate than ABC, it is often preferred by businesses for its simplicity and ease of use.

Cost Drivers

ABC focuses on identifying and allocating costs to activities that drive costs, known as cost drivers. By understanding the cost drivers of a product, businesses can better manage and control costs. This method provides a more detailed view of the cost structure of a product, allowing businesses to make more informed decisions about pricing and resource allocation. Standard Costing, on the other hand, does not explicitly focus on cost drivers. Instead, costs are allocated based on predetermined standards, which may not always reflect the true cost drivers of a product.

Conclusion

In conclusion, both Activity Based Costing and Standard Costing have their own strengths and weaknesses. ABC provides a more accurate and detailed view of cost allocation, while Standard Costing is simpler and easier to implement. Businesses should consider their specific needs and objectives when choosing between these two costing methods. By understanding the differences between ABC and Standard Costing, businesses can make informed decisions about which method is best suited for their operations.