Compare and Contrast Traditional and

Activity-Based Costing Systems

Calculating an accurate manufacturing cost for each product is a vital piece of information for a
company’s decision-making. For example, knowing the cost to produce a unit of product affects
not only how a business budgets to manufacture that product, but it is often the starting point in
determining the sales price.

An important component in determining the total production costs of a product or job is the
proper allocation of overhead. For some companies, the often less-complicated traditional
method does an excellent job of allocating overhead. However, for many products, the allocation
of overhead is a more complex issue, and an activity-based costing (ABC) system is more
appropriate.

Another factor to consider in determining which of the two major overhead allocation methods to
use is the cost associated with collecting and analyzing information. When making their decision
regarding which method to use, the company must consider these costs, both in time and
money. (Figure) compares overhead in the two systems. In many cases, the ABC method is more
expensive in terms of time and other costs.

The difference between the traditional method (using one cost driver) and the ABC method
(using multiple cost drivers) is more complex than simply the number of cost drivers. When
direct labor is a large portion of the product cost, the overhead costs tend to be consistently
driven by one cost driver, which is typically direct labor or machine hours; the traditional method
appropriately allocates those costs. When technology is a large portion of the product cost, the
overhead costs tend to be driven by multiple drivers, so using multiple cost drivers in the ABC
method allows for a more precise allocation of overhead.

Overhead in Traditional versus ABC Costing

  Traditional ABC

Overhead
Single cost driver Multiple cost drivers
assigned

Optimal usage When direct labor is a large portion of When technology is a large portion of
 Overhead in Traditional versus ABC Costing

  Traditional ABC

the product cost the product cost

Orientation Cost driven Process driven

As shown with Musicality’s products, not only are there different costs for each product when
comparing traditional allocation with an activity-based costing, but ABC showed that the Solo
product creates a loss for the company. Activity-based costing is a more accurate method,
because it assigns overhead based on the activities that drive the overhead costs. It can be
concluded, then, that the cost and subsequent gross loss for each unit’s sales provide a more
accurate picture than the overall cost and gross profit under the traditional
method. (Figure) compares the cost per unit using the different cost systems and shows how
different the costs can be depending on the method used.

Advantages and Disadvantages of the Traditional Method of Calculating Overhead

The traditional allocation system assigns manufacturing overhead based on a single

cost driver, such as direct labor hours, direct labor dollars, or machine hours, and is
optimal when there is a relationship between the activity base and overhead. This
most often occurs when direct labor is a large part of the product cost. The theory
 supporting the single cost driver is that the cost driver selected increases as
overhead increases, and further analysis is more costly than it is valuable. Each
method has its advantages and disadvantages. These are advantages of the
traditional method:

 All manufacturing costs are classified as material, labor, or overhead and

assigned to products regardless of whether they drive or are driven by production.
 All manufacturing costs are considered to be part of the product cost,
whereas nonmanufacturing costs are not considered to be production costs and are
not assigned to products, regardless of whether the costs are based on the products.
For example, the machines used to receive and process customer orders are
necessary because product orders must be taken, but their costs are not allocated to
particular products.
 There is only one overhead cost pool and a single measure of activity, such
as direct labor hours, which makes the traditional method simple and less costly to
maintain. The predetermined overhead rate is based on estimated costs at the
budgeted level of activity. Therefore, the overhead rate is consistent across
products, but overhead may be over- or underapplied.

Disadvantages of the traditional method include:

 The use of the single cost driver does not allocate overhead as accurately as
using multiple cost drivers.
 The use of the single cost driver may overallocate overhead to one product
and underallocate overhead to another product, resulting in erroneous total costs
and potentially setting an incorrect sales price.
 Traditional allocation assigns costs as period or product costs, and all
product costs are included in the cost of inventory, which makes this method
acceptable for generally accepted accounting principles (GAAP).

ABC Method and Financial Statements

There are pros and cons to both the traditional and the ABC system. One advantage
of the ABC system is that it provides more accurate information on the costs to
manufacture products, but it does not show up on the financial statements. Explain
how this costing information has value if it does not appear on the financial
statements.
 Advantages and Disadvantages of Creating an Activity-Based Costing System for Allocating
Overhead

While ABC systems more accurately allocate the costs based on the various
resources used to make the product, they cost more to use and, therefore, are not
always the best method. Management needs to consider each system and how it
will work within its own organization. Some advantages of activity-based costing
include:

 There are multiple overhead cost pools, and each has its own unique
measure of activity. This provides more accurate rates for applying overhead, but it
takes more time to implement and results in a higher cost.
 The allocation bases (i.e., measures of activity) often differ from those used
in traditional allocation. Multiple cost pools allow management to group costs
being influenced by similar drivers and to consider cost drivers beyond the typical
labor or machine hour. This results in a more accurate overhead application rate.
 The activity rates may consider the level of activity at capacity instead of the
budgeted level of activity.
 Both nonmanufacturing costs and manufacturing costs may be assigned to
products. The main rationale in assigning costs is the relationship between the cost
and the product. If the cost increases as the volume of the product increases, it is
considered part of overhead.

There are disadvantages to using ABC costing that management needs to consider
when determining which method to use. Those disadvantages include:

 Some manufacturing costs may be excluded from product costs. For

example, the cost to heat the factory may be excluded as a product cost because,
while it is necessary for production, it does not fit into one of the activity-driven
cost pools.
 It is more expensive, as there is a cost to collect and analyze cost driver
information as well as to allocate overhead on the basis of multiple cost drivers.
 An ABC system takes much more to implement and operate, as information
on cost drivers must be collected in an objective manner.
 The advantages and disadvantages of both methods are as previously listed, but
what is the practical impact on the product cost? There are several items to
consider at the product costs level:

 Adopting an ABC overhead allocation system can allow a company to shift

manufacturing overhead costs between products based on their volume.
 Using an ABC method to better assign unit-level, batch-level, product-level,
and factory-level costs can increase the per-unit costs of the low-volume products
and decrease the per-unit costs of the high-volume products.
 The effects are not symmetrical; there is usually a larger change in the per-
unit costs of the low-volume products.
 The cost of the products may include some period costs but not some of the
product costs, so it is not considered GAAP compliant. The information is
supplemental and very helpful to management, but the company still needs to
compute the product’s cost under the traditional method for financial reporting.

Changing from the traditional allocation method to ABC costing is not as simple as
having management dictate that employees follow the new system. There are often
challenges that begin with convincing employees that it will provide benefits and
that they should buy into the new system. See this 1995 article, Tapping the Full
Potential of ABC, illustrating some of Chrysler’s challenges to learn more.

Key Concepts and Summary

 Traditional allocation assigns overhead based on a single overhead rate,

while ABC assigns overhead based on several cost pools and the activities that
drive costs.
 Traditional allocation is optimal when the manufacturing process is labor
driven and overhead increases based on traditional activity bases, such as direct
labor hours, direct labor dollars, or machine hours.
 ABC costing is optimal when the manufacturing process is technology
driven and overhead increases based on various activities that differ for each
product.

(Figure)Which statement is correct?

A. Activity-based cost systems are less costly than traditional cost systems.
B. Activity-based cost systems are easier to implement than traditional cost
systems.
C. Activity-based cost systems are more accurate than traditional cost systems.
D. Activity-based cost systems provide the same data as traditional cost
systems.

(Figure)Activity-based costing systems:

A. use a single predetermined overhead rate based on machine hours instead of

on direct labor
B. frequently increase the overhead allocation to at least one product while
decreasing the overhead allocation to at least one other product
C. limit the number of cost pools
D. always result in an increase of at least one product’s selling price

B
(Figure)Activity-based costing is preferable in a system:

A. when multiple products have similar product volumes and costs

B. with a large direct labor cost as a percentage of the total product cost
C. with multiple, diverse products
D. where management needs to support an increase in sales price

(Figure)In production, what has changed to allow ABC costing to become

valuable?
(Figure)Why is it important to know the true cost for a product or service?
The traditional method of applying overhead does not allocate overhead as
precisely as with the ABC method. Management relies on the costing information
when setting selling prices and bidding on service jobs. If the costing method is not
accurate, some products may be considered profitable under traditional allocation,
when those products are actually operating at a loss.
(Figure)Tri-bikes manufactures two different levels of bicycles: the Standard and
the Extreme. The total overhead of $300,000 has traditionally been allocated by
direct labor hours, with 150,000 hours for the Standard and 50,000 hours for the
Extreme. After analyzing and assigning costs to two cost pools, it was determined
that machine hours is estimated to have $200,000 of overhead, with 4,000 hours
used on the Standard product and 1,000 hours used on the Extreme product. It was
 also estimated that the setup cost pool would have $100,000 of overhead, with
1,000 hours for the Standard and 1,500 hours for the Extreme. What is the
overhead rate per product, under traditional and under ABC costing?
(Figure)Stacks manufactures two different levels of hockey sticks: the Standard
and the Slap Shot. The total overhead of $600,000 has traditionally been allocated
by direct labor hours, with 400,000 hours for the Standard and 200,000 hours for
the Slap Shot. After analyzing and assigning costs to two cost pools, it was
determined that machine hours is estimated to have $450,000 of overhead, with
30,000 hours used on the Standard product and 15,000 hours used on the Slap Shot
product. It was also estimated that the inspection cost pool would have $150,000 of
overhead, with 25,000 hours for the Standard and 5,000 hours for the Slap Shot.
What is the overhead rate per product, under traditional and under ABC costing?
(Figure)A company has traditionally allocated its overhead based on machine
hours but had collected this information to change to activity-based costing:

A. How much overhead would be allocated to each unit under the traditional
allocation method?
B. How much overhead would be allocated to each unit under activity-based
costing?

(Figure)Carlton’s Kitchens makes two types of pasta makers: Strands and Shapes.
The company expects to manufacture 70,000 units of Strands, which has a per-unit
direct material cost of $10 and a per-unit direct labor cost of $60. It also expects to
manufacture 30,000 units of Shapes, which has a per-unit material cost of $15 and
a per-unit direct labor cost of $40. It is estimated that Strands will use 140,000
machine hours and Shapes will require 60,000 machine hours. Historically, the
 company has used the traditional allocation method and applied overhead at a rate
of $21 per machine hour. It was determined that there were three cost pools, and
the overhead for each cost pool is shown:

The cost driver for each cost pool and its expected activity is shown:

A. What is the per-unit cost for each product under the traditional allocation
method?
B. What is the per-unit cost for each product under ABC costing?
C. Compared to ABC costing, was each product’s overhead under- or
overapplied?
D. How much was overhead under- or overapplied for each product?

(Figure)Carlton’s Kitchen’s three cost pools and overhead estimates are as follows:
 Compare the overhead allocation using:

A. The traditional allocation method

B. The activity-based costing method

(Hint: the traditional method uses machine hours as the allocation base.)
(Figure)Lampierre makes brass and gold frames. The company computed this
information to decide whether to switch from the traditional allocation method to
ABC:

The estimated overhead for the material cost pool is estimated as $12,500, and the
estimate for the machine setup pool is $35,000. Calculate the allocation rate per
unit of brass and per unit of gold using:

A. The traditional allocation method

B. The activity-based costing method

(Figure)Portable Seats makes two chairs: folding and wooden. This information
was obtained to review the decision to consider ABC:
 Compute the overhead assigned to each product under:

A. The traditional allocation method

B. The activity-based costing method

(Figure)A company has traditionally allocated its overhead based on machine

hours but collected this information to change to activity-based costing:

A. How much overhead would be assigned to each unit under the traditional
allocation method?
B. How much overhead would be assigned to each unit under activity-based
costing?
 (Figure)Casey’s Kitchens makes two types of food smokers: Gas and Electric. The
company expects to manufacture 20,000 units of Gas smokers, which have a per-
unit direct material cost of $15 and a per-unit direct labor cost of $25. It also
expects to manufacture 50,000 units of Electric smokers, which have a per-unit
material cost of $20 and a per-unit direct labor cost of $45. Historically, it has used
the traditional allocation method and applied overhead at a rate of $125 per
machine hour. It was determined that there were three cost pools, and the overhead
for each cost pool is as follows:

The cost driver for each cost pool and its expected activity is as follows:

A. What is the per-unit cost for each product under the traditional allocation
method?
B. What is the per-unit cost for each product under ABC costing?

(Figure)Casey’s Kitchens’ three cost pools and overhead estimates are as follows:
 Compare the overhead allocation using:

A. The traditional allocation method

B. The activity-based costing method

(Hint: the traditional method uses machine hours as the allocation base.)
(Figure)Lampierre makes silver and gold candlesticks. The company computed
this information to decide whether to switch from the traditional allocation method
to ABC.

The estimated overhead for the material cost pool is estimated as $45,000, and the
estimate for the machine setup pool is $55,000. Calculate the allocation rate per
unit of silver and per unit of gold using:

A. The traditional allocation method

B. The activity-based costing method

(Figure)Portable Seats makes two chairs: folding and wooden. This information
was obtained to review the decision to consider ABC:
 Compute the overhead assigned to each product under:

A. The traditional allocation method

B. The activity-based costing method

(Figure)Cape Cod Adventures makes foam noodles with sales of 3,000,000 units
per year and retractable boat oars with sales of 50,000 pairs per year. What
information would Cape Cod Adventures need in order to change from traditional
to ABC costing? What are the limitations to activity-based costing?
Difference between activity based costing
and traditional costing
Posted By Terms Compared Staff | Jul 3, 2019 | Accounting |     
Definitions and meanings:
Activity based costing:
Activity based costing is a method of cost allocation of overhead costs such that, for each
different activity, a different cost driver is applied which is best suited for that activity. The cost
driver is specifically selected for each activity.

Traditional Costing:
Traditional costing is a costing method used to allocate overhead costs based on a single cost
driver according to the consumption of a volume of production resources. This single cost driver
can be based on machine hours, labor hours etc. and is used for all the different activities.
 Example:
Julian Co. manufactures fizzy drinks and plans the production of 20,000 drinks for the month of
July. The direct labor hours estimated for the month of July are 900, direct machine hours are
600 and the estimated overheads are $6,000. These overheads can be segregated into three
categories; $1,000 for direct supervision for 350 machine hours, $3,500 for logistics for 540
direct labor hours and $1,500 for 30 production set-ups. By applying traditional costing, the cost
driver for the production of drinks would be based on a single activity level, either labor hours or
machine hours, so:

 Predetermined overhead rate (labor hours) = $6,000/900 = $6.7 per direct labor hour

 Predetermined overhead rate (machine hours) = $6,000/600 = $10 per machine hour

Therefore, for every labor hour spent, a cost of $6.7 or for every machine hour spent a cost of
$10 would be added to the cost of drink.

If we apply activity based costing, this technique will segregate and identify the most suitable
cost driver for the incurred overheads:

Activity Cost Driver

Direct Supervision 350 Machine Hours

Logistics 540 Labor Hours

Production Set-ups 30 Set-ups

 Predetermined overhead rate (direct supervision) = $1,000/350 = $2.9/hour

 Predetermined overhead rate (logistics) = $3,500/540 = $6.5/hour

 Predetermined overhead rate (production set-ups) = $1,500/30 = $50/hour

So, the overheads will be allocated at a rate of $2.9 per machine hour spent, $6.5 per labor hour
and $50 per production set up.

Differences between activity based costing and traditional

costing:
The main points of difference between activity based costing and traditional costing are
given below:
1. Primary Focus:
The primary focus of traditional costing is the apportionment of overhead costs to the activities
of production. Irrespective of the specific allocation of resources, traditional costing sets a single
metric for every activity involved in production and allocates costs based on the consumption of
that metric. Although, activity based costing is also used for cost allocation but it adopts a
different approach. Under activity based costing, appropriate cost drivers are determined for
every different activity and cost is then allocated according to these cost drivers.

2. Application:
Traditional costing method is easy to implement as a single cost driver is set for all activities and
overheads are simply divided into fixed and variable overheads. Activity based costing is
difficult to implement because it involves choosing a suitable basis of absorption and absorbing
overheads on that same basis is a complicated and time-consuming exercise. Additionally, in
some cases it becomes difficult to determine a proper basis for the allocation of an activity.

3. Scope:
Traditional costing can only be used for the absorption of manufacturing overheads but activity
based costing can effectively be used to allocate manufacturing as well as non-manufacturing
overheads like selling, administration etc. This is because activity based costing considers the
actual center of cost for the period cost and then allocates it.
4. Management use:
The figures extracted by traditional costings can be included into cost figure of statement
of profit or loss because it only inculcates product costs but activity based costing can only be
used for management purposes. The main reason being activity based costing is based on the
subjectivity of the user and two users may not find a cost metric suitable for the same activity.
However, activity based costing can be actively used by the management of a company to make
better cost pools and allocate costs more accurately.
5. Effectiveness of operations:
Activity based costing improves business processes in long term. This is because management of
a company needs to investigate deeply into production activities and related costs. This
highlights the reasons for certain costs being incurred, which can ultimately help control and
manage these costs. Traditional costing does not compel management to look for different cost
centers and so it becomes difficult for management to gather incremental data about production
activities.

Activity based costing vs traditional costing – tabular

comparison
A tabular comparison of activity based costing and traditional costing is given below:

ACTIVITY BASED COSTING VS TRADITIONAL COSTING

Primary Focus

Uses multiple cost drivers for multiple activities. Uses identical cost driver for different activities.

Application

Is difficult to implement and requires time and effort. Is straightforward and easy to implement.

Scope

Cover product cost only. Can cover both product as well as period costs.

Management Use
 The values can be used in external financial statements. The values cannot be used in reports of external repor

Effectiveness of operations

Enhances management knowledge about activities related to Does not provide opportunity to identify any specific re
production process. for costs incurred.

Conclusion – activity based costing vs traditional costing:

Traditional costing is a conventional method of costing and is an easily understandable method
by the management of a company. Its use is suitable for companies that have low overhead cost.
In medium to large size companies where overheads are relatively high, the use of activity based
costing may be preferred.

Managers may resist the use of activity based costing because not only it increases the amount of
work required to identify all overhead operations but also it needs specialist management costing
knowledge and experience.
Activity-based costing or ABC is a costing approach for optimizing cost and time.
Besides measuring the performance of an activity, this cost accounting technique helps to
identify all the costs related to every unique activity. The activity can be placed anywhere
within an organizational structure, comprising of a project or process.
In Activity-based costing, resource costs are assigned to activities that consume
resources, and activity costs are assigned to the cost objects like services, products, and
customers. ABC thus recognizes the relationship between the activities and cost drivers.

Need of Activity-Based Costing

The manufacturing industry has seen a 360-degree shift in its processes over the years.
Technological innovation is at its peak, bringing in automation and many other
advancements. This has also given rise to competition worldwide.
This shift has decreased the amount of direct labor required in the industry. The overhead
costs are on the rise due to factors such as depreciation, maintenance, and repair works of
the equipment, etc.

Since no correlation is seen between direct labor and overhead costs incurred,
predetermined overhead rates based on direct labor are used, which is inappropriate. This
would lead to a significant cost deviation.

Activity-based costing can help avoid this aberration. This method allocates overhead
costs by adopting multiple bases. It helps to prevent extra costs.

Applications of Activity-Based Costing

1. Activity-based costing can develop and refine the cost of a particular value stream.
2. ABC serves as a decision-making tool for degerming the profitability of a product or service.
3. Activity-based costing provides comparative standards to perform benchmarking and
reengineering.
4. A selective and focused approach towards the important activities can be adopted due to
ABC.

Process for Activity-Based Costing

Process for
Activity-Based Costing

1. Identify Activities
For ABC, major activities involved have to be identified.

It can be divided into the following subcategories:

a. Unit-level or Primary Activities
The cost of the basic materials required is based on the volume of the output to be
delivered.

b. Batch-level Activities
The manufacturing support activities such as ordering materials and its inspection
constitute the batch level activities.

c. Product-Level Activities
Product level activities include keeping activities up to date, advertising of a product, etc.

d. Facility-level Activities
Facility-level activities include security, maintenance, salaries, etc.

2. Assign Costs to Activity Cost Pools

The total costs incurred for a group of activities is known as a cost pool. Costs must be
assigned to the cost pools for a specified time period.

3. Identify Factors influencing the Cost of Activities

Identify the functional area cost drivers. The functional areas include materials
management, quality control, R&D, marketing, etc.

Example:

Materials management consists of issuing purchase orders and inspection of materials.

The number of purchase orders placed is the cost driver for these activities.

4. Assign the Cost of Activities to the Product

The demand for each activity is different. Assign the costs accordingly. The overhead
costs come into the picture in this step.
Benefits of Activity-Based Costing
1. ABC provides accurate information as compared to the traditional costing method. It puts
forth a different perspective of the cost structure.
2. Activity-based costing enhances control of overhead costs as overheads are not driven by the
volume of work.
3. This technique identifies the non-value-adding activities. Thus, reducing the cost.
4. Managers can make better decisions.

Limitations of Activity-Based Costing

1. There is a risk of spending too much time and effort over gathering and sorting the data.
2. The level of complexity is high. The managers find it frustrating.
3. Activity-based costing can be expensive.

FAQs
 What is Activity-based costing?

Activity-based costing is a cost accounting technique that identifies all the costs related to
every unique activity.

 Why is Activity-based costing important?

ABC is an accurate costing method which leads to better pricing decisions. This method
eliminates excess overhead costs.

 What are the benefits of Activity-based costing?

Adopting ABC leads to better control over the cost of each activity, and the non-value-
adding activities are identified. This also helps with the decision-making processes of the
project.
What is cluster sampling?
Cluster sampling is a probability sampling technique where researchers divide
the population into multiple groups (clusters) for research. Researchers then
select random groups with a simple random or systematic random sampling
technique for data collection and data analysis.
 Select your respondents

Example: A researcher wants to conduct a study to judge the performance of

sophomore’s in business education across the U.S. It is impossible to conduct
a research study that involves a student in every university. Instead, by using
cluster sampling, the researcher can club the universities from each city into
one cluster. These clusters then define all the sophomore student population
in the U.S. Next, either using simple random sampling or systematic random
sampling and randomly pick clusters for the research study. Subsequently, by
using simple or systematic sampling, the sophomore’s from each of these
selected clusters can be chosen on whom to conduct the research study.

In this sampling technique, researchers analyze a sample that consists of

multiple sample parameters such as demographics, habits, background – or
any other population attribute, which may be the focus of conducted research.
This method is usually conducted when groups that are similar yet internally
diverse form a statistical population. Instead of selecting the entire population,
cluster sampling allows the researchers to collect data by bifurcating the data
into small, more productive groups.

Cluster sampling definition

Cluster sampling is defined as a sampling method where the researcher
creates multiple clusters of people from a population where they are indicative
of homogeneous characteristics and have an equal chance of being a part of
the sample.

Example: Consider a scenario where an organization is looking to survey the

performance of smartphones across Germany. They can divide the entire
country’s population into cities (clusters) and select further towns with the
highest population and also filter those using mobile devices.

Types of cluster sampling

There are two ways to classify this sampling technique. The first way is based
on the number of stages followed to obtain the cluster sample, and the second
way is the representation of the groups in the entire cluster. In most cases,
sampling by clusters happens over multiple stages. A stage is considered to
 be the step taken to get to the desired sample. We can divide this technique
into single-stage, two-stage, and multiple stages.

Single-stage cluster sampling: 

As the name suggests, sampling is done just once. An example of single-
stage cluster sampling – An NGO wants to create a sample of girls across five
neighboring towns to provide education. Using single-stage sampling, the
NGO randomly selects towns (clusters) to form a sample and extend help to
the girls deprived of education in those towns.

Two-stage cluster sampling: 

Here, instead of selecting all the elements of a cluster, only a handful of
members are chosen from each group by implementing systematic or simple
random sampling. An example of two-stage cluster sampling – A business
owner wants to explore the performance of his/her plants that are spread
across various parts of the U.S. The owner creates clusters of the plants.
He/she then selects random samples from these clusters to conduct research.

Multiple stage cluster sampling: 

Multiple-stage cluster sampling takes a step or a few steps further than two-
stage sampling.

For conducting effective research across multiple geographies, one needs to

form complicated clusters that can be achieved only using the multiple-stage
sampling technique. An example of Multiple stage sampling by clusters – An
organization intends to survey to analyze the performance of smartphones
across Germany. They can divide the entire country’s population into cities
(clusters) and select cities with the highest population and also filter those
using mobile devices.

Steps to conduct cluster sampling

Here are the steps to perform cluster sampling:

1. Sample: Decide the target audience and also the sample size.

2. Create and evaluate sampling frames: Create a sampling frame by
using either an existing framework or creating a new one for the target
audience. Evaluate frameworks based on coverage and clustering and
make adjustments accordingly. These groups will be varied, considering the
 population, which can be exclusive and comprehensive. Members of a
sample are selected individually.
3. Determine groups: Determine the number of groups by including the
same average members in each group. Make sure each of these groups are
distinct from one another.
4. Select clusters: Choose clusters by applying a random selection.
5. Create sub-types: It is bifurcated into two-stage and multi-stage
subtypes based on the number of steps followed by researchers to form
clusters.

Applications of cluster sampling

This sampling technique is used in an area or geographical cluster sampling
for market research. A broad geographic area can be expensive to survey in
comparison to surveys that are sent to clusters that are divided based on
region. The sample numbers have to be increased to achieve accurate
results, but the cost savings involved make this process of rising clusters
attainable.

Cluster sampling in statistics

The technique is widely used in statistics where the researcher can’t collect
data from the entire population as a whole. It is the most economical and
practical solution for statisticians doing research. Take the example of a
researcher who is looking to understand the smartphone usage in Germany.
In this case, the cities of Germany will form clusters. This sampling method is
also used in situations like wars and natural calamities to draw inferences of a
population, where collecting data from every individual residing in the
population is impossible.

Cluster sampling advantages

There are multiple advantages to using cluster sampling. Here they are:

 Consumes less time and cost: Sampling of geographically divided

groups requires less work, time, and cost. It’s a highly economical method
to observe clusters instead of randomly doing it throughout a particular
region by allocating a limited number of resources to those selected
clusters.
 Convenient access: Researchers can choose large samples with this
sampling technique, and that’ll increase accessibility to various clusters.
 Data accuracy: Since there can be large samples in each cluster, loss
of accuracy in information per individual can be compensated.
 Ease of implementation: Cluster sampling facilitates information from
various areas and groups. Researchers can quickly implement it in practical
situations compared to other probability sampling methods.
In comparison to simple random sampling, tis technique can be useful in
deciding the characteristics of a group such as population, and researchers
can implement it without having a sampling frame for all the elements for the
entire population.