What is Activity Based Costing

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Activity-based costing (ABC) a method used in business to analyze cost consumed by the business’ performance of transverse processes and the contribution of each activity through cost object. And also enables analysis of the indirect costs that make up the products and/or services.

The strategies used by companies to achieve their objectives must be based on production or organizational  processes. The ABC approach enables users to precisely provide a view of these operations on account of a traditional hierarchical organization, but also having a transverse view, facilitating the analysis of how they operate between activities within processes.

The method of defining and identifying performance indicators for each activity, are useful for gauging the overall smooth functioning of the enterprise, and for achieving strategic objectives. It also helps to identify inefficiencies and hidden costs so as to improve profitability and better comprehend the costs consumed by each activity.

It tries to match the overhead of the running processes, through the quantitative use of sub-processes. A complete loss of overhead rates is hardly possible, as a remnant of overhead costs that are not assigned, shall be retained even with the deployment of process cost. The individual costs are not included in the costing, as these can be attributed directly to cost.

The difference between ABC and traditional methods of calculating costs is that the sources are assigned to indicators of resources and not directly to products. In addition, these drivers are resources allocated to activities, thus ultimately inducing production.

The concept of activity is more appropriate to describe how organizational processes are handled, it allows you to precisely identify the causal link between products or services and resources. For the activity based costing, an activity is a set of basic tasks performed by an individual or group. It can provide a product or customer service.

These tasks are performed from a set of resources. Each of these activities do not consume 100% of resources, and production is only affected by the actual cost to manufacture it.

The aim of the process cost is a load-transfer of a company’s overheads, which are not, as is customary in the internal allocation, distributed by a percentage surcharge rates to the individual cost centers, where they will be assigned to cost objects (internal transfer).

The analytical approach is to see how the resources (human, financial, physical, intellectual) are consumed by the activities (actions undertaken by different departments within the company and an integral part of a process).

The functional approach entails breaking down the trade process and the process activities (close process quality). The principle is to analyze the performance of each process and activity, observed deficiencies or faults and improve the flow of processes in order to improve overall business operations.

Computers are really essential in the preparation and analysis of an activity based costing model. Initially, the companies developed their models on spreadsheets, but quickly found the limits of these tools. Today, through software companies work to develop their models and analysis results under the activity based costing and activity based management methods.

 

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