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What Is 'Activity-Based Costing (ABC) '

Activity-based costing (ABC) is an accounting method that identifies overhead activities and assigns their costs to products based on the activities required to produce each product. ABC recognizes the relationship between costs, activities, and products to assign indirect costs less arbitrarily than traditional methods. ABC is mostly used in manufacturing where it improves cost reliability and classification by tracing nearly true production costs. ABC defines activities as any work or task with a specific goal, such as machine setup or product design, which are considered cost objects that consume overhead resources.

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123 views2 pages

What Is 'Activity-Based Costing (ABC) '

Activity-based costing (ABC) is an accounting method that identifies overhead activities and assigns their costs to products based on the activities required to produce each product. ABC recognizes the relationship between costs, activities, and products to assign indirect costs less arbitrarily than traditional methods. ABC is mostly used in manufacturing where it improves cost reliability and classification by tracing nearly true production costs. ABC defines activities as any work or task with a specific goal, such as machine setup or product design, which are considered cost objects that consume overhead resources.

Uploaded by

komal komal
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as DOCX, PDF, TXT or read online on Scribd
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What is 'Activity-Based Costing (ABC)'

Activity-based costing (ABC) is an accounting method that identifies and assigns costs
to overhead activities and then assigns those costs to products. An activity-based
costing (ABC) system recognizes the relationship between costs, overhead activities,
and manufactured products, and through this relationship, it assigns indirect costs to
products less arbitrarily than traditional methods.

Some costs are difficult to assign through this method of cost accounting. Indirect costs,
such as management and office staff salaries, are sometimes difficult to assign to a
product. For this reason, this method has found its niche in the manufacturing sector.

'Activity-Based Costing (ABC)' analysis used


Activity-based costing (ABC) is mostly used in the manufacturing industry since it
enhances the reliability of cost data, hence producing nearly true costs and better
classifying the costs incurred by the company during its production process.

This costing system is used in target costing, product costing, product line profitability
analysis, customer profitability analysis, and service pricing. It is also hugely popular
since organizations can develop a much better corporate focus and strategy if costs are
better grasped.

Definition of Activities in ABC System


The ABC system of cost accounting is based on activities, which is any event, unit of
work, or task with a specific goal, such as setting up machines for production, designing
products, distributing finished goods, or operating machines. Activities consume
overhead resources and are considered cost objects.

Under the ABC system, an activity can also be considered as any transaction or event
that is a cost driver. A cost driver, also known as an activity driver, is used to refer to an
allocation base. Examples of cost drivers include machine setups, maintenance
requests, power consumed, purchase orders, quality inspections, or production orders.

There are two categories of activity measures: transaction drivers, which involves
counting how many times an activity occurs, and duration drivers, which measure how,
long an activity takes to complete.

How ABC System Improves Costing Process


Activity-based costing enhances the costing process in three ways. First, it expands the
number of cost pools that can be used to assemble overhead costs. Instead of
accumulating all costs in one company-wide pool, it pools costs by activity. It also
creates new bases for assigning overhead costs to items such that costs are allocated
based on the activities that generate costs instead of on volume measures, such as
machine hours or direct labor costs. Finally, ABC alters the nature of several indirect
costs, making costs previously considered indirect- such as depreciation, inspection, or
power- traceable to certain activities. Alternatively, ABC transfers overhead costs from
high-volume products to low-volume products, raising the unit cost of low-volume
products

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