Final answer:
A traditional cost system assigns costs related to unused or idle capacity to products, potentially leading to inaccurate product costing.
Step-by-step explanation:
A traditional cost system assigns costs of unused or idle capacity to products. This reflects an approach in cost accounting where overhead expenses are spread uniformly across all products, regardless of the actual consumption of resources.
Under this system, idle capacity costs – such as the depreciation of machinery, rent, or insurance not tied directly to production – are allocated to products as part of the overhead. This method may lead to inaccurate product costing because it fails to acknowledge that some products may utilize more or less of this capacity.
To avoid such distortions, some firms use activity-based costing (ABC), which assigns costs based on actual resource consumption. This contrasts with the traditional approach, as ABC does not allocate the costs of unused capacity to products, instead, these costs are treated as period expenses in the time they are incurred. Recognizing idle capacity costs separately allows a firm to make better decisions about pricing, product mix, and process improvements.
In a free enterprise system, accurate cost information is critical for firms to maintain competitiveness and to ensure allocative efficiency. By using the right costing system, a firm can better understand how to scale production, manage resources under conditions of scarcity, and make economic choices that optimize opportunity cost.