Proration of common overheads cost over products and

proration of common overheads cost over products and services on direct labour hours,
machine hours, prime cost, units or any other relevant basis. This approach did not
allocate the cost accurately and fairly as it was devoid of realistic resource utilization by a
product during its manufacturing. Thus the product costs were distorted from one to the
other specifically where multiple product lines were simultaneously being manufactured.
The determination of product or customer profitability was thus not reliable in the
backdrop of cost proration under the aforesaid traditional costing system.
With the advancement in information technology and globalization of business, the
methodology of costing systems have also improved where by many of the enterprises
have engaged professional managerial accountants for installation of an activity based
costing procedures so as to ensure accurate and reliable costing system in the
organization. The said professionals reviewed the cost structure and determined some
cost pools from the cost centers and combined relevant homogeneous cost pools and
activity drivers to compute activity rates for each cost pool. These activity rates were
used to allocate the overheads cost over products and services on the basis of resources
utilized while manufacturing particular products or rendering services to the specific
clients. Such costing systems provide better cost information for strategic management
decisions and attracted widespread successful implementation for accurate and reliable
product customer margin information.
The product/customer profitability analysis, controlling production resources to improve
value and enhance margins is a process of activity based management to which every
management would like to focus for accomplishment of business functions to the
growing benefits of owners.
The costs of products or services computed under activity based costing system are
usually quite different from the costs calculated under the traditional costing system.
Thus the activity based costing system facilitates the management for fixation of selling
prices with flexible behavior to attract large volume customers offering them special
discounted package prices to prevail in the competitive market for growth in profitability.
8.15 Theoretical Questions
1. Describe the system of traditional costing for product cost computation usually
applied in a manufacturing organization.
2. Discuss in detail the basis generally used for common overheads cost proration
over products or services under traditional costing approach.
3. State the extent to which product cost varies under traditional costing system to the
activity based costing procedure.

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4. Explain the factors which compelled the management for departure from the
traditional costing system to the activity based costing system.