Implementing Activity-Based Costing (ABC) involves the following five steps:
Identify Activities: The first step is to identify all the activities that occur within
the organization. These activities can be related to production, administrative
tasks, or any other function that consumes resources.
Allocate Activity Costs to Cost Objects: In this step, the costs assigned to
activities are allocated to specific cost objects, such as products, services, or
projects. This allocation is based on how much each cost object consumes
Calculate Cost Driver Rates: Cost drivers are the factors that cause costs to be
incurred in activities. Common cost drivers include machine hours, labor
hours, or the number of setups. Cost driver rates are calculated to determine
how much each cost object should be charged for the activities it consumes.
Assign Costs to Cost Objects: Finally, costs are assigned to cost objects based
on the cost driver rates calculated in the previous step. This provides a more
accurate and detailed picture of the cost associated with each cost object.
Advantages of ABC:
Accurate Cost Allocation: ABC provides a more accurate and detailed
understanding of the costs associated with each product, service, or project,
leading to better cost allocation.
Improved Decision-Making: ABC helps in making informed decisions about
pricing, product mix, and resource allocation by highlighting the true costs
and profitability of different activities and products.
Resource Efficiency: It identifies inefficient or non-value-added activities,
allowing organizations to streamline processes and reduce costs.
Enhanced Cost Control: ABC enables better cost control by pinpointing areas
where costs can be reduced or eliminated, leading to improved profitability.
Customer Profitability Analysis: Organizations can determine which
customers or market segments are the most and least profitable, helping in
targeted marketing and customer management.
Disadvantages of ABC: