Activity-Based Costing: Is it right for me?
ABC is as easy as 1-2-3. Put some dollar signs on that, and you have Activity-Based Costing! This method is ideal for businesses that manufacture products or want to find other ways to allocate overhead. Activities can include anything from labor hours, machine hours, units, or other measurements of work. For companies who have mainly direct costs, this may not be the best method for you, but check with your accountant today to see what they recommend!
Transaction Drivers vs Duration Drivers
The ABC method requires a cost driver. This can be an activity or a unit of work and is assigned on a per-driver basis. There are two types of cost drivers: transaction drivers and duration drivers. Transaction drivers are based on counting how many times an activity occurs. In contrast, a duration driver is based on the length of time it takes to complete a task.
The ABC method recognizes 5 levels of activities:
1. Batch-Level Activity
2. Unit-Level Activity
3. Customer-Level Activity
4. Organization-Sustaining Activity
5. Product-Level Activity
Steps to ABC Method
1. Make a list of all activities and parts required to create the product.
2. Create cost pools for each activity, dividing each individual activity and associating it to a cost. For each part, assign a cost to each activity.
3. Assign each cost pool a unit. These are typically dollars or units.
4. Total Overhead Cost Pool / Total Cost Drivers = Cost Driver Rate
5. Cost Driver Rate * Number of Cost Drivers = Total Cost
Example of Activity-Based Costing:
Check out this awesome video for a breakdown of ABC Costing:
For a deeper look to see if ABC costing is right for you, book an appointment with Practical Accounting Solutions today!
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Disclaimer: The views presented in this post are meant as educational resources and should not be taken as direct advice for your personal finances or small business. Should you have questions regarding a post relating to your specific finances, please contact us at firstname.lastname@example.org.
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