INTRODUCTION
- Overhead, in traditional costing system, overhead costs are grouped together under cost center and then absorbed into product costs on one of the basis such as direct labour hours, machine hours, volume etc.
- In certain cases this traditional costing system gives inaccurate cost information. Though, It should not be assumed that all traditional absorption costing systems are not accurate enough to give adequate information for pricing purposes or other long-run management deci- sion purposes.
- Some traditional systems treat overheads in a detailed way and relate them to service cost centres as well as production cost centres. The service centre overheads are then spread over the production cost centres before absorption rates are calculated.
- The main cause of inaccuracy is in the calculation of the overhead rate itself, which is usually based on direct labour hours or machine hours. These rates as- sume that products that take longer to make, generate more overheads and so on.
- Organisations, who do not wish to know how much it costs to make a product with precise accuracy, may be happy with traditional costing system. Others however fix their price on cost and need to be able to determine it with reasonable accuracy.
- The latter organisations have been greatly benefitted from the development of activity based costing (ABC), which is more a modern absorption costing method, and was evolved to give more accurate product costs.
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