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  Limitations of Traditional Costing System

Limitations of Traditional Costing System

The following are the limitations of traditional costing system.

  • In a conventional costing system, overheads that are indirect costs are allocated, apportioned and at last absorbed in the cost units. There can be alteration in computing costs because of the basis that are selected for absorption. The following instance will clarify the condition.

Suppose a manufacturing company is making two products, X and Y. The direct material cost for the products is Rs.1,00,000 and Rs.2,00,000 correspondingly. The sum overheads are Rs.1,50,000 and the company accepts direct material cost as the basis for absorption. The absorption % of overheads will be 50% of the direct material. [1,50,000/3,00,000 X 100 = 50%] So the overheads absorbed in the product X will be Rs. 50,000 and for Y, they will be Rs.1,00,000 [50% of the overheads] Product Y has a larger share of the overhead costs like the material costs are higher than that of X. Though, actually product Y might be requiring lesser efforts in the indirect activities than X, but only since it has a higher material costs, it will be charged along with larger amount of overheads. So there is a distortion in the total cost. This distortion in costs might lead to incorrect decisions in various areas such as make or buy, pricing decisions, acceptance of export offer etc.

  • Other limitation of traditional costing system is the division among fixed and variable might not be realistic because there are many complications because of the complexity of the modern business.

 There should be linkage among the activities and the costs. Likewise the information should be presented concurrently that means that information should be made presented when the activities are going on. Information presented after the activity is over will not be of very much use. As described above, the Activity Based Costing system is developed because of the limitations of the traditional costing system.

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