Activity Based Costing: A better way to analyze profits

What is Activity Based Costing?

Activity-based costing is an accounting method that identifies and assigns costs to overhead activities and then assigns those costs to products. An activity-based costing system recognizes the relationship between costs, overhead activities, and manufactured products, and through this relationship, it assigns indirect costs to products less arbitrarily than traditional costing.

Companies implement activity-based costing to: Identify specific products that are unprofitable, Improve production process efficiency, Price products appropriately, with the help of accurate product cost information and reveal unnecessary costs that become targets for elimination.

Activity-based costing provides a more accurate method of product/service costing, leading to more accurate pricing decisions. ABC will use many cost drivers instead of just one cost driver such as machine hours to allocate a manufacturer's indirect costs. This is relevant to all the manufacturing companies which have a vast product and customer range. It also enables improved product and customer profitability analysis.