Activity Based Costing (ABC) is a managerial accounting system which determines the cost of activities without distortion and provides management with relevant and timely information. It does not represent just a new set of overhead allocation rules or techniques to value inventory. ABC represents a way to look at operating costs and provides methods to dissect the underlying activities, which cause costs to exist. Activity based costing first assigns costs to the activities that are the real cause of the overhead. It then assigns the cost of those activities only to the products that are actually demanding the activities.
• Identifying the most and least profitable customers, products and channels.
• Determine the true contributions to and detractors from financial performance.
• Accurately predict costs, profits and resource requirements associated with changes in production volumes, organizational structure and resource costs.
• Easily identify the root causes of poor financial performance.
• Track costs of activities and work processes.
• Facilitate better Marketing Mix.
• Achieve better positioning of products
History of ABC
First, it may be advantageous to understand the historical origins of ABC. In the early 1960's, General Electric's (GE) finance and accounting people attempted to improve the usefulness of accounting information in controlling ever-increasing indirect costs. The GE staff noted that indirect costs are often the result of "upstream" decisions that are made long before the costs are actually incurred.
For example, engineering design and change orders often resulted in significant increases in parts ordering, machine changeovers, retooling and parts stocking. In addition, the engineering department was never informed of the consequences their actions had on the other parts of... [continues]
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