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 of resources. This costing method helps in understanding the true cost of producing a product or providing a service by allocating indirect costs based on the activities that drive those costs.
For example, let’s consider a company that manufactures two types of products – Product A and Product B. Product A requires more machine setup time compared to Product B. Using traditional costing methods, the company might allocate the machine setup costs equally to both products. However, with ABC, the company can allocate more setup costs to Product A, which accurately reflects the resource consumption.
By using ABC, companies can make more informed decisions about pricing, product mix, and process improvements. It provides a more accurate picture of the costs involved in producing goods or services, leading to better cost control and profitability.
Benefits of Activity-based costing:
- Accurate cost allocation
- Identification of cost drivers
- Better decision-making
- Improved cost control
Overall, Activity-based costing is a valuable tool for organizations looking to understand and manage their costs more effectively.
Learn more about Activity-based costing on Wikipedia