Activity-Based Costing

Activity-based costing (ABC) is a costing method that identifies activities in an organization and assigns the cost of each activity to all products and services according to the actual consumption by each. This model assigns more indirect costs (overhead) into direct costs compared to conventional costing.

CIMA (Chartered Institute of Management Accountants) defines ABC as an approach to the costing and monitoring of activities which involves tracing resource consumption and costing final outputs. Resources are assigned to activities, and activities to cost objects based on consumption estimates. The latter utilize cost drivers to attach activity costs to outputs.

ICMAB (Institute of Cost & Management Accountants of Bangladesh) defines activity-based costing (ABC) as an accounting method that identifies the activities that a firm performs and then assigns indirect costs to cost objects.

With ABC, a company can soundly estimate the cost elements of entire products, activities and services, that may help inform a company's decision to either:

  • Identify and eliminate those products and services that are unprofitable and lower the prices of those that are overpriced (product and service portfolio aim)
  • Or identify and eliminate production or service processes that are ineffective and allocate processing concepts that lead to the very same product at a better yield (process re-engineering aim)

In a business organization, the ABC methodology assigns an organization's resource costs through activities to the products and services provided to its customers. ABC is generally used as a tool for understanding product and customer cost and profitability based on the production or performing processes. As such, ABC has predominantly been used to support strategic decisions such as pricing, outsourcing, identification and measurement of process improvement initiatives.

Tags: Accounting