Traditional Costing System and Activity-Based Costing (ABC)

Traditional  Costing System  and Activity-Based Costing (ABC)

According to the traditional costing system, overheads were allocated using a single predetermined rate. For an instant, direct labor cost is assumed to be the relevant activity base for Job order costing. However, this assumption is not always applicable unless direct labor was a major portion of total manufacturing costs. Since there was a tremendous change in manufacturing and service industries and decrease in amount of direct labour usage, need was arisen for more precise and reliable overhead absorption methods. This need was further geared as there is a significant increase in total overhead costs in present time than past. Thus, Activity-Based Costing (ABC) approach had received substantial interest to allocate overhead on the basis of multiple allocation basis of complex manufacturing processes. Basically, in ABC approach, overheads are allocated to activity cost pools, and assign the activity cost pools to products or services by means of cost drivers. As a developing country, implementation of ABC to Sri Lanka could enable to get its advantages. In line with that, the main objective of this article is to identify the importance of applying ABC to Sri Lanka and challenges and barriers of implementation. Further, study has focused on the civil engineering construction industry of Sri Lanka. 

Generally, traditional costing method is considered as a simple method compared to complex ABC method. Also, it is considered as inexpensive, compared with the costly system such as ABC.  Further, there is a belief that ABC system is too complex to understand. As a result, it has become difficult to implement ABC system in the construction industry in Sri Lanka. As this attitude comes up from the top management, getting support from lower level has become difficult. Further, as there is not satisfactory training on ABC system for top and middle management of the firms of construction industry, they tend to continue with the existing traditional costing system. Hence, as a result of lack of persuasion from the government, industrial regulations and top management of the construction companies, ABC has not become more popular in Sri Lankan engineering industry yet.      

Further, as most construction companies give higher priorities to move for other projects rather than practicing new system, implementation of ABC has become difficult in Sri Lanka. As ABC system is bit complicated than traditional costing system and more incorporated with technical aspects, there is a reluctant to apply ABC system by the construction companies. Further, inadequacy of internal resources (e.g. competent human resources who can deal with ABC and other office facilities) has caused to not implement ABC system in construction industry.