Activity-Based Costing (ABC)

• Lesson
• Exercise
• Answer

A manufacturing company is uniquely positioned to benefit from activity-based costing. Activity-based Costing is a costing model that aids a company in determining the costs of certain activities involved in producing a product/service and distributing that product/service to a customer. The key steps include:

The process demands the inclusion of all essential procedural steps so that a cost might be attributed to each and the baseline benefits of each might be established. The following exercise illustrates the utility and advantages of activity-based costing.

• Identifying all essential activities necessary for production and distribution
• Assigning a cost to each activity

This approach differs from traditional accounting in that the traditional approach simply calculates costs based on the number of hours a machine is used. This basic method denotes a per-hours-of-use cost for a machine. Total production is calculated by spreading the rest of the (non machine costs) into a category called overhead.

As overhead costs have grown over the years, more and expenses have escaped true scrutiny Company decision-making is enhanced using activity-based costing. Unlike the generalized approach, the more accurate information uncovered through activity based costing can guide decisions on:

• Pricing
• Sub-contracting
• Manufacturing Procedures

In most cases a company already has a baseline from which to start. It probably has an outline of its current manufacturing procedures. The natural first step is to calculate the cost of each step.