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Activity-based costing (ABC) assigns costs to specific activities in manufacturing, rather than based on machine hours. Steps include identifying activities, relating expenses to each activity, and allocating expenses to multiple activities. ABC is increasingly used due to rising manufacturing costs and the need to manage them effectively.
Activity-based costing (ABC) is a strategy that seeks to provide a more accurate means of allocating overhead costs in a manufacturing environment. The general idea is to identify each activity associated with the manufacturing process and assign a cost to that activity. This approach is sometimes favored over the more traditional process of assigning costs based on the number of machine hours generated during the production day. To determine the steps for activity-based costing for a given activity, it is necessary to identify all the expenses associated with that activity, then assign those expenses to specific cost objects.
One of the key steps in activity-based costing focuses on identifying the specific activities associated with a given project or process. This is important, as doing so will provide the starting point for understanding the costs associated with the project in general and each activity in particular. In some cases, organizing activities in chronological order can help ensure that all activities are identified and accounted for before attempting to move to any type of cost allocation.
With the range of activities identified, the steps for activity-based costing involve relating project expenses to each of those activities. Many of the costs will be unique to a particular activity within the general group of activities related to the project. The task of allocating those costs is fairly straightforward, since the expenses relate to only a single activity.
Other expenses may have to do with more than one activity, so it is necessary to allocate a portion of those expenses to multiple activities. This will involve assessing how much spending should be allocated to each individual activity, typically by dividing the costs into percentages that may be related to each relevant activity. Doing so helps increase the effectiveness of activity-based costing, since the amount of expenses assigned to each activity is more accurate.
Although basing cost allocation on machine hours is still common, the use of steps for activity-based costing has increased over time. This is because increases in overall manufacturing costs have increased, making it even more important to manage those costs effectively. Additionally, many companies tend to produce multiple product lines being produced simultaneously, making the process of allocating expenses to specific production lines a bit more important than ever before. The various steps for activity-based costing are also useful when batches are run of different products, and some products are produced in large batches while others are produced in smaller batches.
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