Activity-Based Costing (ABC) is a detailed accounting framework that assigns manufacturing and non-manufacturing costs to products in a more logical manner than traditional costing methods. By focusing on activities as the fundamental cost drivers, it helps organizations identify inefficient products, departments, and activities. This framework aids in understanding the true cost of producing a product, enabling more informed pricing, budgeting, and strategic decisions. The main benefit of ABC is that it provides a more accurate picture of cost behavior and product profitability.
Identify the activities that are required to produce a product or deliver a service. | Assign costs to these activities based on their consumption of resources. | Determine cost drivers associated with each activity. | Calculate the rate per cost driver. | Assign costs to products or services based on their usage of each cost driver.
Regularly update and review cost drivers and activity data | Ensure accurate and comprehensive data collection | Integrate ABC with other financial systems for holistic management
Provides more accurate product costing | Helps identify and eliminate inefficient processes | Facilitates better decision-making and budgeting
Can be time-consuming and costly to implement | Requires detailed and accurate data collection | May lead to complexity and confusion if not properly managed
Complex production processes with multiple products | When overhead costs are a significant portion of total costs
In small or less complex operations | Where direct costs far outweigh overhead costs