Activity Based Costing (Accounting) - Explained
What is Activity-Based Costing?
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What is the Activity Based Costing?
The ABC (Activity Based Costing) method of cost accounting pertains to a company's resource-consuming activities that create costs. It uses physical, monetary and non-monetary indicators to measure these costs and assumes a split variation of the total cost model, which imputes and distributes all of the costs among the company's products.
It allocates all of a company's costs of operations to specific activities that the company carries out. In other words, the method assigns costs to services projects, products, acquisition, or tasks based on its activities and its resource consumption.
Back to: ACCOUNTING, TAX, & REPORTING
How does Activity Based Costing Work?
ABC applies to a company's main activities -- which are integral to the company's purpose -- and secondary activities -- which generate added value for consumers but are subcontracted because they're too costly for the company to assume. This lets you know the amount and cost of each activity's resources. Specifically, ABC:
- Pays special attention to product planning and design costs
- Measures factors such as quality, delivery times, flexibility, innovation and after-sales service and contrasts these measures to traditional cost system operations
- Provides a more detailed and big-picture analysis of the cost-basis of activities than traditional systems.
After the company defines the tasks it performs, ABC determines how costs are distributed among the activities by analyzing inductors, which are factors influencing how much time, money and resources the activities consume. There are three such inductors:
- Transaction inductors, which consider how often an activity is repeated to calculate its average cost
- Inductors of duration, which tell how long it takes to perform each activity
- Inductors of intensity, which measure resource consumption every time an activity is performed.
ABC is superior to traditional cost quantification systems that focus on materials because it emphasizes activity costs and the added value activities bring to company products.