Activity-based costing
Activity-based costing (often abbreviated to the acronym ABC) arose from the recognition that organizational activities cause costs. For example, when an engineering department issues a manufacturing change order to change the design of a product, it triggers parts ordering costs in the purchasing department and tooling costs in the manufacturing department. Traditional costing systems do not adequately handle the fact that costs could be incurred in one part of an organization as the result of decisions made in another part of the organization.
Moreover, traditional process or job costing systems tend to allocate indirect costs on some type of volume-related allocation basis, such as direct labor. But indirect costs do produce and deliver a small-customized order than to fill a large order for a standard product. Thus, traditional volume-based costing systems tend to understate the costs of low-volume products and overstate the costs of high volume products.
The traditional costing system, with its limited number of cost pools and allocation bases, is suited to a simple product and a simple production process-a view, which may be simplistic in the current environment.
Activity-based costing is an attempt to take a less simplistic view of the causes of costs. ABC is based on the premise that it is activities that consume resources. That is, most costs originate from factors other than volume. Instead, costs arise from things like order preparation, equipment setups, materials movement, storage time, waiting time, order changes, and so on. The accountant works with other members of the organization to find the factors that drive costs. These cost drivers become the allocation bases for indirect costs.
The key to ABC is not in the mechanics of computation but in the conceptual perspective it brings to the mechanics of cost assignment are still grounded in the same underlying......
