Activity based costing

Activity based costing (ABC) is a type of costing in which the manufacturing overhead costs are assigned  to products in a more logical manner than the traditional approach of simply allocating costs on the basis of machine hours. ABC enables to assign costs to the activities that are the real cause of the overhead. ABC assigns the cost of activities only to the products that are actually demanding the activities.

Activity based costing is a model that identifies activities in an organization and assigns the cost of each activity resource to all products and services according to the actual consumption by each. It assigns more indirect costs or overhead costs into direct costs. Therefore an organization can precisely estimate the cost of individual products and services so they can identify and eliminate those that are unprofitable and lower the prices of those that are overpriced. 

The ABC model assigns an organization's resource costs through activities to the products and services provided to its customers. It is used to understand product and customer cost and profitability. It is a managerial accounting technique which attempts to allocate all or most of all the firm’s costs are well suited to efforts to implement full cost accounting efforts within a firm, as once the costs that have been identified. The allocation of the costs under this method does not require a new type of accounting framework.      

The activity based costing (ABC) method was developed to provide accurate product costs. It is accomplished by tracing costs to activities. Under this method the activities consume resources and products consume activities. The ABC method assigns costs to products including engineering, marketing, distribution and administrative costs, although some facility related costs may not be assigned. The activity based costing method adopts a lot of cost drivers to predict different costs.

Questions

• What is activity based costing?
• How is activity based costing model used in businesses?