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How Activity-Based Costing Can Help Monitor Production Expenses

Activity-based costing (ABC) is a costing model that helps companies determine the costs of activities involved in production and distribution by identifying each activity and assigning it a cost, unlike traditional accounting that simply calculates machine-use costs and spreads other costs as overhead. ABC provides more accurate information that can guide pricing, outsourcing, and manufacturing procedure decisions. The first step is calculating the cost of each current manufacturing procedure step to establish a cost baseline.

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46 views1 page

How Activity-Based Costing Can Help Monitor Production Expenses

Activity-based costing (ABC) is a costing model that helps companies determine the costs of activities involved in production and distribution by identifying each activity and assigning it a cost, unlike traditional accounting that simply calculates machine-use costs and spreads other costs as overhead. ABC provides more accurate information that can guide pricing, outsourcing, and manufacturing procedure decisions. The first step is calculating the cost of each current manufacturing procedure step to establish a cost baseline.

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Activity-Based Costing (ABC)

How Activity-based Costing Can Help Monitor Production Expenses

Ron Thomas, Thomas Enterprises, Indianapolis.

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:

 Pricing
 Sub-contracting
 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.

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