Activity Based Costing

Activity Based Costing

Activity based costing

Definition and concept

'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 utilise cost drivers to attach activity costs to outputs.'

Activity–based costing (ABC) is a costing methodology that identifies activities in an organization and assigns the cost of each activity with resources 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 Official Terminology, 2005

A development of the principles of ... Show more content on Helpwriting.net ...Activity analysis is the process of identifying appropriate output measures of activities and resources (cost drivers) and their effects on the costs of making a product or providing a service.

ABC systems have the flexibility to provide special reports so that management can take decisions about the costs of designing, selling and delivering a product or service. The key aspect is that ABC focuses on accumulating costs via activities, whereas traditional cost allocation focuses on accumulating costs within functional areas.

The main advantage of ABC is that it minimises or avoids distortions on product costs that might occur from arbitrary allocation of overhead costs.

Steps in development of an ABC System

ABC uses cost drivers to assign the costs of resources to activities and unit cost as a way of measuring an output.

There are four steps to implementing ABC.

1. Identify activities

The organisation needs to undertake an in–depth analysis of the operating processes of each responsibility centre. Each process might consist of one or more activities required to produce an output.

2. Assign resource costs to activities

This involves tracing costs to cost objects to determine why the cost occurred. Costs can be categorised in three ways:

i. Direct – costs that can be traced directly to one output. For example, the wood and paint that it takes to make a chair. ii. Indirect – costs that cannot be

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