A lot of financial advisors has been searching for the best practice of allocation for many years: they didn’t consider “traditional full costing” as a scientific method, so something new had to be made up.
The approach called Activity Based Costing considers business as the sum of many activities: unlike traditional full costing, business is considered in horizontal manner because every activity adds a piece of value on to the product.
At first, the controller must choice a number of activities that represent the utilization of inputs, the consumption of which has accounted for the indirect costs.
Secondly, controller’s choice directs overheads to every activity: the best distributive key must be chosen.
Finally, controller must choose the so called cost drivers, because the total of costs referred to each activity needs to be allocated to each product.
Everybody can see that managers enforce this method with using much discretionary power as it was when they used traditional methods.
No difference for using discretionary power, and no difference for necessary carefulness – what’s the best method?
After having used both methods, nobody has demonstrated a relevant gap between traditional full costing and ABC, because each one could be accurate or inaccurate, easy or complicated, fast or slow, cheap or expensive: it all depends on the accuracy used by controller who decides the amount of money and time that has to be spent chance by chance.