activity based costing

Fin, Gen Mgt

a method of calculating the cost of a business by focusing on the actual cost of activities, thereby producing an estimate of the cost of individual products or services.

Abbr. ABC

EXAMPLE

An ABC cost-accounting system requires three preliminary steps: converting to an accrual method of accounting; defining cost centers and cost allocation; and determining process and procedure costs.

     Businesses have traditionally relied on the cash basis of accounting, which recognizes income when received and expenses when paid. ABC’s foundation is the accrual-basis income statement. The numbers this statement presents are assigned to the various procedures performed during a given period. Cost centers are a company’s identifiable products and services, but also include specific and detailed tasks within these broader activities. Defining cost centers will of course vary by business and method of operation. What is critical to ABC is the inclusion of all activities and all resources.

     Once cost centers are identified, management teams can begin studying the activities each one engages in and allocating the expenses each one incurs, including the cost of employee services.

     The most appropriate method is developed from time studies and direct expense allocation. Management teams who choose this method will need to devote several months to data collection in order to generate sufficient information to establish the personnel components of each activity’s total cost.

     Time studies establish the average amount of time required to complete each task, plus bestand worst-case performances. Only those resources actually used are factored into the cost computation; unused resources are reported separately. These studies can also advise management teams how best to monitor and allocate expenses which might otherwise be expressed as part of general overheads, or go undetected altogether.