Activity Based Costing ( ABC ) is an accounting methodology that assigns costs to activities based on their use of resources, rather than products or services. This enables resources and other associated costs to be more accurately attributed to the products and the services which they use.
It doesn’t change or eliminate any costs, it provides detailed information about how costs are consumed.
As ABC directly assigns costs to activities, it can be an extremely useful tool for anyone involved in process improvement and cost reduction programmes.
Using ABC means that all the individual activities that are part of a process can be accurately costed. For example in financial services organisations it will be possible to accurately determine the cost of each activity involved in processing a loan application from inputting information onto an application form to final approval of the application. In this way it will be easy to identify the most and least expensive parts of the process.
Process improvement activity could then focus on the most expensive parts of the process. A model could then be constructed showing a comparison between the existing process costs and the redesigned process and its associated costs.
Likewise, when assessing the costs of products and services, ABC can illustrate the costs of them and help in establishing the profitability of the individual products and services. This can be particularly useful in modern economies where companies are increasingly trying to differentiate and personalise both products and services and tailor them to individual needs and requirements.
The main advantages of ABC are: