Costing based on activities
Costing based on activities, also known as activity-based costing (ABC), is a costing method that identifies activities in an organization and assigns the cost of each activity to all products and services according to the actual consumption by each. This method helps in accurately determining the true cost of a product or service by taking into account the resources used in each activity.
How does activity-based costing work?
Activity-based costing works by first identifying all the activities that are performed in an organization to produce a product or service. These activities can be categorized as unit-level, batch-level, product-level, or facility-level activities. The cost of each activity is then allocated to the products or services based on the resources consumed by each activity.
Example of activity-based costing
For example, let’s consider a company that manufactures two products: Product A and Product B. Product A requires more machine setup time compared to Product B. In a traditional costing system, both products would be assigned the same machine setup cost. However, with activity-based costing, the cost of machine setup would be allocated based on the actual setup time required for each product. This would result in a more accurate cost allocation for each product.
Benefits of activity-based costing
- Accurate cost determination
- Identification of cost drivers
- Improved decision-making
- Enhanced cost control
Overall, activity-based costing provides a more accurate and detailed insight into the cost structure of an organization, enabling better decision-making and cost control.
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