What Is Activity-Based Costing?
Activity-based costing is a method of cost accounting that identifies the activities that cause costs to be incurred, and then assigns all of the costs associated with those activities to products and services.
Activity-based costing is used to assign overhead costs to products and services, which allows these costs to be separated from direct labor or raw materials costs. Activity-based costing can also help companies understand how their processes affect the overall cost of producing their goods or services.
Companies use activity-based costing in order to improve their financial performance by focusing on their most profitable customers as well as their most profitable products and services. Activity-based costing can also help companies identify areas where they can reduce expenses without affecting customer satisfaction or product quality.
Why Is Activity-Based Costing Important?
Activity-based costing is important because it gives companies the ability to gauge their true costs and identify where they can make improvements.
In a traditional cost accounting system, a company may have a general idea of how much it costs them to manufacture one unit of product, but they do not have a clear picture of what factors led to those costs. These factors include employee wages and benefits, raw materials costs, overhead expenses, etc. Activity-based costing allows companies to see exactly what caused these costs so that they can make decisions based on accurate information instead of guesswork.
How Do I Implement Activity-Based Costing in My Business?
If you are looking to implement activity-based costing in your business, there are a few steps you will need to take.
First of all, you will need to identify the activities that are taking place in your company. These are the activities that cause costs to be incurred — for example, ordering raw materials or paying for labor. Once you have identified these activities, you can start assigning costs to them based on their value.
For example, if ordering raw materials is an activity that causes costs to be incurred in your business, then assigning their cost will depend on how much stock is used in each order and how much it costs per unit. So rather than just treating each order as a single cost item (which would give an average cost per unit), you could divide the total cost of an order by the number of units ordered (which would give a more accurate cost per unit). This means that if one order uses more stock than another order, it will have a higher average cost per unit.