Calculating Activity Based Costing

Getting Started

Activity based costing (ABC) attempts to create the big picture—crystal-clear, full, and accurate—by painting assorted little pictures.

• ABC identifies the relationship between a business activity and all the resources needed to conduct it by assigning costs to each of those resources, thus presenting the true total expense of the entire activity.

• ABC can account for so-called “soft” or indirect operating costs, and thus produce a more revealing, and perhaps startlingly different, financial picture than other accounting methodologies such as standard costing might offer.

• Used properly, ABC helps management better to distinguish operations that add value from those that do not, permitting more informed decisions about such matters as pricing, product mix, capital investments, and organizational change.

• In turn, ABC’s advocates praise it as a more effective tool to identify and control costs, improve productivity, and increase profits.

FAQs

When did ABC start?

ABC came of age in the 1980s amid manufacturers’ furious efforts to raise the quality of their products while simultaneously eliminating every unnecessary cost from their operations. The dramatic improvements realized by manufacturers have led to ABC becoming a widely used tool, especially in the manufacturing industry.

What are the basic steps of ABC?

There are five:

• identify the product or service to be studied;

• determine all the resources and processes that are required to create the product or deliver the service, and their respective costs;

• determine the “cost drivers” for each resource: the cost of labor as well as raw materials;

• collect cost and other data, such as time taken, for each process and resource;

• use the data to calculate the overall cost of the product or service.