Activity Based Costing
Activity based costing (ABC) is an approach to the costing of products and processes that is configured to provide a more detailed analysis of the costs associated with products, services and activities. It is an approach which seeks to capture the costs of the activities that are associated with the production, sale and provision of goods and services. The ABC approach attempts to identify all of the activities that are associated with a product or process, and to make sure that the true costs of each of these activities are accurately captured in the final cost assigned to each unit of product output or service.
The origins of activity based costing come from a very traditional Manufacturing cost accounting approach. It has remained popular because it provides a way to assign production costs more accurately to the product outputs of an organization. It is based on the principle that the right cost should be associated with each of the products and services produced by any organization. This principle is used to support strategic management decision-making, providing comprehensive and accurate cost information that reflects the activity levels of the organization.
ABC works by assigning costs to various activities through an activity pool. The cost assigned to each activity is referred to as an activity cost driver. This activity cost driver is used to allocate a portion of costs to each part of the activity. The amount of cost allocated to each part of an activity is determined by the amount of time, resources or materials used for that particular part of the activity.
In order to implement ABC accurately, organizations are required to break down their activities into a detailed list of tasks and associated costs. This includes developing an accurate cost analysis model, which should include costs associated with labor and material inputs, as well as overhead costs and other factors such as waste and storage.
ABC is complicated and difficult to implement, and as such, it is often thought of as an inefficient way to manage costs. However, it is important to recognize the potential benefits of ABC; it can help organizations to better understand the costs associated with their activities, and the impact each activity has on the overall cost structure of their operations.
ABC can be used to reduce costs in a number of ways, including streamlining internal processes, eliminating waste and duplication of effort, and identifying possible cost savings opportunities. The implementation of ABC can also allow organizations to create accurate pricing strategies and make more informed decisions about where to allocate resources. By using ABC as part of their overall accounting practices, organizations can better understand and control their operational costs, allowing them to increase their profitability.
