Activity Based Costing (ABC) Definition Process – Calculation with Example

Activity based costing can be defined as a system which the businesses uses to track the cost of a system which is primarily focused on the activities which are used for producing any product. In activity based costing, the costs are first traced to the products from the activities which are related to the production of the products. The costing system consists of all the activities which are responsible for the involvement of the cost along with the entire products which are produced based on their demands.

The costing of the products is charged depending on the uses of a product for an individual activity. In the conventional costing system of product, the costs of each product are first traced for an organizational unit and not for the activities for instance the plant, department which are later traced to the products. The activity based costing has one fundamental difference from the traditional costing system which is the determination of cost.

When it comes to activity based costing, the cost is decided based upon the core principle of the consumed activity resources. The objects which consumed by the activities are the services and products. The is a principle which is varies from the TCS, also known as the traditional costing system, which implies that the services or the products consumes the resources directly and the costs of activity which are left uncalculated.


Flow of Cash in the Activity Based Costing:


The two major stages in the activity based costing are the tracing costs for the activities and the tracing costs for the products. So primarily, there are two stages of activities based costing which are

Step one

Identifying the primary activities of the organizations which include purchasing, materials handling, dispatch, receipt, assembly, machining and much more.

Step two

The main part of step two is two ascertain the factors which will help to determine all the entire costs of the activities which are known as the cost drivers such as amount of orders that have been delivered, the amount that has been ordered, the amount of purchase orders along with the amount of set-ups and much more.

Step three

The step three consists of costs for each of the activities which are known as the costs pools which are in a straight line equal to the primary cost centres.

Step four

The step four consist of all the overhead charge supports such as the products which are based on the usage of the activities such as the cost of the chosen driver. For instance, if you have bought product that is $1000 and you will need to pay $100 as the cost for the chosen driver, then it sums up to as the cost of the each product is around $10. So, if there is a batch which is generating around five purchase orders, then the total would round out at three multiplied by ten dollars each which is thirty dollars for purchasing each of the overheads.

Methodology of ABC:

Activity Based Costing pursues a two-arrange cost task methodology and doles out asset costs, for example, production line overhead expenses to action cost focuses or cost pools and after that to cost items to decide the measure of asset costs for every one of the cost articles. That is, assets (costs) are doled out to exercises. Action cost is then doled out cost objects.

Assets are what associations spend their cash on—the classes of costs that are recorded. Asset is characterized as a monetary or cash component that is connected or utilized in the perfor­mance of exercises. Compensations and materials, for precedents, are assets utilized in the presentation of exercises. Extra instances of assets incorporate fix, review, lease, devaluation, utilities, protection, and supplies. Most Activity Based Costing frameworks as of now bar costs like personal charges and intrigue cost that are not utilized in the presentation of exercises.

Asset drivers are the reason for following assets to exercises. Asset driver is characterized as a proportion of the amount of asset devoured by a movement. A case of an asset driver is the level of all out square feet of room involved by a movement. This factor is utilized to follow a bit of the expense of working the offices to the action.

Exercises speak to work performed in an association. The expense of exercises is controlled by following asset to exercises utilizing the asset drivers. A case of how the compensations of a getting division of an assembling organization may be followed to accepting office exercises is represented. In this precedent, the asset is accepting division pay rates.

The exercises are as per the following get materials, empty trucks, move material, plan receipts, facilitate material, and resolve seller blunders. The asset driver is a level of individuals’ time gave to each accepting office action. While level of individuals’ time was chosen as the asset driver in this precedent, as an option, the head check of individuals alloted to every action or the hours dedicated to every movement could have been utilized as the asset driver.

Expecting that pay rates were the main asset of the getting office, computing the expense of accepting division exercises would be very straightforward. All that is required is to increase the level of individuals’ time by the compensation sum.

What is activity based costing (ABC)? Definition and meaning – Calculation

One of the primary steps to proper management is indirect costs primarily when it comes to outsourcing and downsizing. The departments can be assigned to when there is too much involvement of indirect costs which eventually lead them to appear as non-profit on the documents. An evolution management can choose to halt the operations as well as permanently close down a profitable branch if there is costs have been properly distributed.

And once the profitable branches are closed down for compounding the problems, the only branches that remains opened are the unprofitable branches. If only the profitable branches are closed down, a company may be unable to fix the costs. And it remains the same when it comes to outsourcing as well. If the costs are not allocated properly, outsourcing may turn out to be expensive.