Guide to Activity-Based Costing

Activity-Based Costing (ABC) is a method of assigning costs to products or services based on the resources that they consume. It works by assigning costs to activities, and then to goods and services based on how much each offering makes use of those activities.

Why it's important: ABC offers more precise cost information than traditional costing methods. It helps to understand the actual costs associated with each product or service, allowing businesses to identify and eliminate non-profitable items and lower the prices of overpriced goods or services. It helps in strategic decision making concerning pricing, outsourcing, identifying process improvements, and measuring profitability.

How it works: 1. Identify the activities that incur costs 2. Assign costs to these activities 3. Identify the cost drivers associated with each activity 4. Assign costs to products or services based on the extent to which each product or service uses the activities.

Exam Tips: Answering Questions on Activity-Based Costing Understand the concept: You should understand how ABC works and why it is used Be sure to define it clearly: Do not skip defining ABC; it shows your basic understanding Calculations: If your exam includes numerical questions, be ready to calculate costs assigned to activities and then to products Application: Some questions might want you to apply ABC to a real-life scenario. Be prepared to demonstrate its practical applications Advantages and limitations: Understand the benefits and drawbacks of ABC, as it can often come up.