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Activity-Based Costing (ABC)

Activity-based costing (ABC) is a method that assigns both direct and indirect expenses to products based on their use of activities and resources. This provides a more accurate cost than simply allocating overhead evenly. ABC recognizes that different products require different levels of activities like testing. It calculates a cost driver rate for each activity based on its overhead costs, and uses this to assign the appropriate amount of overhead costs to each product.

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60 views2 pages

Activity-Based Costing (ABC)

Activity-based costing (ABC) is a method that assigns both direct and indirect expenses to products based on their use of activities and resources. This provides a more accurate cost than simply allocating overhead evenly. ABC recognizes that different products require different levels of activities like testing. It calculates a cost driver rate for each activity based on its overhead costs, and uses this to assign the appropriate amount of overhead costs to each product.

Uploaded by

ramniwas sharma
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Activity-Based Costing (ABC)

The activity-based costing (ABC) system is a method of accounting


you can use to find the total cost of activities necessary to make a
product. The ABC system assigns costs to each activity that goes
into production, such as workers testing a product.

Many businesses use the cost of goods sold (COGS) to determine


how much it costs to create a product. But COGS focus on direct
costs and does not include indirect expenses like overhead.

Some businesses take their overhead expenses and allocate them


evenly among all products. But because some products use more
overhead expenses than others, the cost of making each product is
inaccurate under this method.

With activity-based costing, you take into consideration both the


direct and overhead costs of creating each product. You recognize
that different products require different indirect expenses. By
assigning both direct and overhead expenses to each product, you
can more accurately set prices. And, the activity-based costing
process shows you which overhead costs you might be able to cut
back on.

For example, you make soap. Soap A requires more overhead, like
testing, than Soap B. Using activity-based costing, you assign the
right overhead costs to the appropriate products. That way, your
overhead is higher for Soap A than B.

ABC is used to get a better grasp on costs, allowing companies to


form a more appropriate pricing strategy. 

This costing system is used in target costing, product


costing, product line profitability analysis, customer profitability
analysis, and service pricing. Activity-based costing is used to get a
better grasp on costs, allowing companies to form a more
appropriate pricing strategy. 

The formula for activity-based costing is the cost pool total divided
by cost driver, which yields the cost driver rate. The cost driver rate
is used in activity-based costing to calculate the amount of overhead
and indirect costs related to a particular activity. 

The ABC calculation is as follows:  

1. Identify all the activities required to create the product. 


2. Divide the activities into cost pools, which includes all the
individual costs related to an activity—such as manufacturing.
Calculate the total overhead of each cost pool.
3. Assign each cost pool activity cost drivers, such as hours or
units. 
4. Calculate the cost driver rate by dividing the total overhead in
each cost pool by the total cost drivers. 
5. Divide the total overhead of each cost pool by the total cost
drivers to get the cost driver rate. 
6. Multiply the cost driver rate by the number of cost drivers. 

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