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Why is an activity-based costing system more accurate for product cost than traditional systems?

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Quick Answer

The activity-based costing system is far more accurate in determining the cost of a product due to the inclusion of all needed equipment and labor necessary for producing the product. While the traditional accounting system is often used, it has significant weaknesses when figuring total costs.

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Why is an activity-based costing system more accurate for product cost than traditional systems?
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Full Answer

When using the activity-based method of costing, a manufacturer has a more accurate picture of what it costs to make each product. This allows an easier interpretation for internal management to base decisions on. Activity-based cost systems also provide a better understanding of the overhead costs involved in making the product.

Traditional costing methods don't include the manufacturing costs involved in producing the product, therefore not giving an accurate cost guide. However, the traditional method is used most often. External financial statements utilize the traditional method to provide a value of the cost of goods. However, using only the traditional cost method can lead to detrimental management decisions since it excludes the full cost of manufacturing the product. Good business standards entail use of both methods, so financial management can see the exact cost of producing each item the plant manufactures, including labor, utilities and all other costs involved. Activity-based costing methods improve the overhead costs associated with both the cost and cause, making it a much more flexible accounting option.

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