Activity-based costing

Definition

Activity-Based Costing (ABC) is a costing method that assigns overhead and indirect costs to related products and services. It identifies specific activities within an organization and assigns the cost of each activity to all products and services according to the actual consumption by each.

5 Must Know Facts For Your Next Test

1. ABC provides more accurate cost information by tracing expenses directly to activities.
2. It helps in identifying non-value-added activities, enabling managers to improve efficiency.
3. ABC requires detailed data collection which can be time-consuming and expensive.
4. This method is particularly useful in complex environments with diverse products or services.
5. Predetermined overhead rates are calculated based on estimated costs of activities divided by their respective cost drivers.

Review Questions

• How does Activity-Based Costing improve accuracy in product costing?
• What are some potential drawbacks of implementing ABC?
• Why is it important to identify cost drivers in the ABC method?

Related terms

Traditional Allocation Method: A costing method that allocates overhead using a single predetermined rate.

Variable Costing: A costing method that includes only variable manufacturing costs—direct materials, direct labor, and variable manufacturing overhead—in unit product costs.

Absorption Costing: A costing method where all manufacturing costs, both fixed and variable, are assigned to units of product.