Activity based costing (ABC) involves the identification of the factors which cause the costs of an organization's major activities. Support overheads are charged to products on the basis of their usage of the factor causing the overheads. The major ideas behind activity based costing are as follows,
a) Activities cause costs, Activities include ordering, Material handling, Machining, Assembly, Production scheduling and Dispatching.
b) Producing products creates demand for the activities.
c) Costs are assigned to a product on the basis of the product’s consumption of the activities.
An ABC system operates as follows:
Step 1 Identify an organization’s major activities.
Step 2 Identify the factors which determine the size of the costs of an activity/cause the costs of an activity. These are known as cost drivers.
Step 3 Collect the costs associated with each cost driver into what are known as cost pools.
Step 4 Determine “ABC rate = Cost pool / Cost Driver”.
Step 5 Charge costs to products on the basis of their usage of the activity.
Outline of Activity Based Costing (ABC)
