The classical scenario we see here is trying to work out the cost of producing products.

So, basically, using resources, spending money and costing final outputs. With ABC, you assign costs to each activity in the production process, giving you a more complete picture of the actual costs.Īctivity Based Costing is defined by CIMA as '.an approach to the costing and monitoring of activities, which involves tracing resource consumption and costing final outputs'.

ABC gives us a much more detailed look at the manufacturing part of a business if we're talking about a manufacturing organisation.Īnd rather than thinking about things at a departmental level, which we often do with absorption costing, ABC offers a much more detailed approach of breaking a business down into its different activities. In defining ABC, first of all, what we would say is it is a more complex system of cost accounting than absorption costing. However, what it absolutely does do is overcome the limitations of some of the more traditional approaches to deal with overheads such as absorption costing. However, what some organisations have found is that even though there are theoretical benefits, it's a complex process, and ABC brings with it some problems. All of these things are indirect costs that can’t be directly related to products being produced.ĪBC as an approach was initially put forward by the Consortium for Advanced Management International, and was then developed by academics in the 1970s and 1980s. Typical examples of this would be things like factory rent rates, supervisors' salaries, and also costs to do with things like procuring materials, setting up equipment etc. In other words, indirect costs are things that can't be specifically related to a product which has been produced. So, if we're talking about a manufacturing business, the indirect costs would be all the costs that aren't things like direct materials or direct labour hours.

The overheads of the business are often referred to as indirect costs. Activity Based Costing: Some ContextĪctivity Based Costing or ABC, as it is often abbreviated to, is the method of assigning overhead costs to the products and services of a business.

Activity based costing