Weaknesses of traditional costing

3. Implications for the decision makers

Modern production patterns have changed significantly during the last decades, more machinery and computerized manufacturing systems are used, the batch sizes are becoming smaller to address particular market niches, and there is less use of direct labour as well. In such economic environment, application of the traditional costing method may have the following consequences:

  • Indirect overheads are categorized together in one figure, which is not informative;
  • Because management doesn’t know what components indirect expenses include they cannot implement proper cost control;
  • Direct labour is becoming a smaller proportion of the production costs and may not fairly reflect the relationship between the products and the direct overheads;
  • Because costs are inappropriately or inaccurately shared between products it means that total production costs can be wrong, which may lead to poor pricing or production decisions;
  • Marginally profitable product lines may be closed.

The case study above had showed inaccuracy of traditional costing method for the decision making purposes in the situation when overheads are dependent on various cost drivers rather than on time of machinery processing. If the traditional costing method is applied by the management for product profitability assessment, the company could have withdrawn production of the marginally profitable Luxury Model speakers.

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