A B C

Definition of 'Activity-Based Costing - ABC'

Activity-Based Costing (ABC) is a method of allocating costs to activities rather than product and services . It is generally used as a tool for planning and control. It was developed as an approach to address problems associated with traditional cost management systems, that tend to have the inability to accurately determine actual production and service costs, or provide useful information for operating decisions

 In the words of Cooper and Kaplan ABC systems calculate the costs of individual activities and assign costs to cost objects such as product and services on the basis of activities undertaken to produce each product or service.

Why is new cost management system needed? To determine the true cost for a cost object (product, job, service or customer).
Why is the knowledge of the true cost of a product so

important?
-To identify money makers/ money losers. -To find an economic break- even point. -To discover opportunities for cost improvement. -To improve strategic decision making.

Characteristics of ABC Analysis Traditional distinction made between fixed cost and variable cost are not enough to provide quality information to design a cost system. It helps to identify inefficient products, departments and activities. It helps to allocate more resources on profitable product, departments and activities. It helps to control the costs at an individual level and on a departmental level. It helps to find unnecessary costs. It helps fixing the price of a product or service scientifically.

BASICS OF ABC
Cost of a product is the sum of the costs of all activities required to manufacture and deliver the product. Products do not consume costs directly Money is spent on activities Activities are consumed by product/services ABC assigns Costs to Products by tracing expenses to activities. Each Product is charged based on the extent to which it used an activity. The primary objective of ABC is to assign costs that reflect/mirror the physical dynamics of the business. Provides ways of assigning the costs of indirect support resources to activities, business processes, customers, products.

STEPS IN ACTIVITY BASE

Identification of the main activities. Creation of cost pool. Determination of the activity cost drivers. Calculation of the activity cost driver rate. Charging the costs of activities to products.

Ways to determine object cost Institution Educated Guessing Traditional Cost Accounting(TCA) Activity Based Costing(ABC)
When is ABC Most Useful? High amounts of overhead cost Multiple products Complex production system Significant variation in volume between high and low volume products

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