Understanding Activity-Based Costing (ABC) for Accurate Cost Measurement

activity based costing

a method of allocating overhead based on each product’s use of activities in making the product

Activity-based costing (ABC) is a cost accounting technique that assigns indirect costs to an organization’s products or services based on the activities involved in the production or delivery process. The objective of ABC is to provide a more accurate measure of the actual cost of producing a specific product or offering a particular service.

Traditionally, organizations have used cost accounting methods based on direct labor hours or machine hours. However, with the increase in complexity of modern production processes, these traditional methods have become less relevant. ABC, on the other hand, recognizes that indirect costs are driven by activities rather than by direct labor or machine hours.

ABC involves breaking down each step in the production or delivery process into discrete activities, measuring the cost of each activity, and allocating those costs to the products or services that benefit from those activities. By using this approach, organizations can gain a better understanding of the true cost of each of their products or services, and make more informed decisions regarding pricing, profitability and resource allocation.

One of the main benefits of ABC is that it provides a more accurate reflection of the true cost of a product or service, enabling organizations to make better decisions. This can result in more efficient use of resources, increased profitability, and greater customer satisfaction. However, implementing ABC can be complex and time-consuming, and may require significant changes to an organization’s accounting systems and processes.

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