Comparing traditional vs ABC

Product costs from a traditional absorption system (using only one volume base like machine hours or labour hours) can be less accurate than ABC for several reasons:

1. Not all overheads are driven by volume

• Traditional costing assumes most overheads change with units, labour hours or machine hours.
• In reality, many overheads are driven by activities (set-ups, inspections, order processing, material handling), not just volume. ABC captures this; traditional costing does not.

2. Complex / low-volume products get mis-costed

• A low-volume product that needs many set-ups, design changes, or special handling may use more support resources but not many machine hours.
• Traditional costing will under-cost this product because it looks “cheap” on machine hours. ABC will load more overhead onto it based on its high activity usage.

3. Simple / high-volume products may be over-costed

• A high-volume, standard product may use many machine hours but very few support activities.
• Traditional costing over-costs it by dumping a big share of overhead on it, while ABC charges it less because it consumes fewer activities.

4. Poor decision-making

Because costs are distorted, managers may:

• Set wrong selling prices,
• Drop profitable products (that appear loss-making under traditional costing), or
• Keep unprofitable products (that appear profitable).

ABC gives a clearer link between the cause (activity) and the effect (overhead cost), so product costs are usually more reliable for decisions.