Activity-Based Costing (ABC)
A manufacturing company is uniquely positioned to benefit from activity-based costing. Activity-based Costing is a costing model that aids a company in determining the costs of certain activities involved in producing a product/service and distributing that product/service to a customer. The key steps include:
- Identifying all essential activities necessary for production and distribution
- Assigning a cost to each activity
This approach differs from traditional accounting in that the traditional approach simply calculates costs based on the number of hours a machine is used. This basic method denotes a per-hours-of-use cost for a machine. Total production is calculated by spreading the rest of the (non machine costs) into a category called overhead.
As overhead costs have grown over the years, more and expenses have escaped true scrutiny Company decision-making is enhanced using activity-based costing. Unlike the generalized approach, the more accurate information uncovered through activity based costing can guide decisions on:
- Manufacturing Procedures
In most cases a company already has a baseline from which to start. It probably has an outline of its current manufacturing procedures. The natural first step is to calculate the cost of each step.
The process demands the inclusion of all essential procedural steps so that a cost might be attributed to each and the baseline benefits of each might be established. The following exercise illustrates the utility and advantages of activity-based costing.