Activity Based Costing (ABC)

Activity based costing - ToolsHero

This article explains Activity based costing (ABC) by Robert Kaplan in a practical way. After reading you will understand the basics of this powerful financial management tool.
What is Activity Based Costing?
Activity Based Costing (ABC) is a system that goes beyond traditional cost price models with respect to indirect cost calculation models.

This method was developed in the United States. Robert Kaplan is regarded as the founder of the theoretical principles of activity based costing within the cost management knowledge area.

In the 1970s the activity based costing method was introduced in the manufacturing industry to solve the problems of traditional cost price calculation. In the 1980s, the authors Robin Cooper and Robert Kaplan wrote numerous articles about this.

In traditional cost price systems such as the cost centre and surcharge methods, indirect costs are allocated based on volumes of products, for instance hours of labour and machine hours. The costs are not allocated to the cost drivers and there is no causal relationship. This makes it hard to determine the costs of the production factors and overheads as a result of which a distorted picture may be presented in terms of costs.

Unlike traditional cost price systems, activity based costing does establish a causal link between the cost drivers and indirect costs. By passing on this insight to the responsible cost drivers, a transparent and cost-conscious conduct is stimulated.

The implementation of Activity Based Costing can help employees to understand the different cost categories and to analyse activities that add value. This is also a way to find out what activities do not add value and should therefore be eliminated.

In this manner improvements can be realized that can lead to higher performance results. It also contributes to strategic developments within cost price calculations. More accurate cost information can help an organization respond to competitive advantage and certain decisions in the Ansoff Matrix (PMM).

ABC identifies cost groups of activity centres in organizations and allocates costs to products and services based on a number of events or transactions that are absolutely necessary in a process to deliver the product or service.

Benefits and drawbacks of activity based costing

With the introduction of activity based costing the integral cost price of products can be calculated more accurately.
Though simulation it is easier to calcula...

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