Terms & Glossaries of Shipping and Trading

ABC (Activity-Based Costing)

Activity-based costing (ABC) is a costing method that assigns overhead and indirect costs to related products and services.

Activity-Based Costing (ABC): Changing the Game of Cost Management

Activity-Based Costing (ABC) is a management accounting method that helps businesses better understand the true costs of their products and services by more accurately allocating indirect costs and making more informed decisions. ABC, first proposed by American accountants Robert S. Kaplan and William J. Bruns in the 1980s, has gradually gained widespread adoption globally. This article will provide a detailed introduction to ABC, including its definition, principles, applications, and advantages and disadvantages.

1. Definition of ABC

ABC is a cost accounting method that differs from traditional methods such as job costing by allocating costs to activities and then allocating activity costs to products or services. ABC recognizes that the costs of products or services come not only from direct and indirect costs but also from the activities that cause these costs. Therefore, by identifying, measuring, and allocating these activities, ABC more accurately reflects the true costs of products or services.

2. Principles of ABC

ABC is based on the following principles:

(1) Cost Drivers of Activities

ABC suggests that the costs of a business are driven by activities. Activities refer to a series of operations or tasks undertaken to produce products or provide services, such as setups, processing, inspections, etc. Each activity incurs costs, and the costs of products or services depend on the resources required to complete these activities.

(2) Cost Drivers

ABC divides costs into fixed costs and variable costs and associates these costs with the drivers of activities. For example, the cost of a production activity may be related to the number of production batches or the types of products. By associating costs with their drivers, ABC can more accurately determine the costs of products or services.

(3) Resource Consumption Analysis

ABC emphasizes the assessment of actual resource consumption rather than allocating costs based on resource usage. This means that even if some resources are not directly used in production, if they are associated with activities, they should still be considered.

3. Applications of ABC

ABC has widespread applications in the following areas:

(1) Product Pricing

By accurately calculating product costs, businesses can more effectively determine product prices, ensuring that prices cover all relevant costs and generate reasonable profits.

(2) Performance Evaluation

ABC helps businesses evaluate the efficiency and costs of various activities, enabling them to formulate improvement plans to enhance production efficiency and product quality.

(3) Cost Control

By identifying the primary activities causing costs and understanding their drivers, businesses can control costs effectively and avoid wastage of resources and unnecessary expenditures.

(4) Product Mix Decisions

ABC enables businesses to have a clearer understanding of the resource demands of different products or services, thus making more informed choices in product mix decisions and optimizing resource allocation.

4. Advantages and Disadvantages of ABC

(1) Advantages:

● More accurate cost calculation: ABC can more accurately reflect the true costs of products or services, avoiding cost misallocation issues seen in traditional methods.

● Improved decision quality: Accurate cost information helps businesses make more informed decisions, thereby enhancing competitiveness.

● Promotes resource optimization: By understanding the cost drivers of activities, businesses can manage and utilize resources more effectively.

(2) Disadvantages:

● High implementation complexity: Implementing ABC requires in-depth analysis and evaluation of the activities and costs of a business, which may be complex and time-consuming.

● High cost: Implementing ABC may require substantial investment of time and resources, including staff training, software purchase, etc., making it costly for some small and medium-sized enterprises.

● High data requirements: ABC requires a large amount of data support, and incomplete or inaccurate data may affect the accuracy of cost accounting.

Activity-Based Costing (ABC) is an effective management accounting method that helps businesses better understand and manage costs, optimize resource allocation, and enhance competitiveness. Despite facing some challenges in implementation, ABC remains a method worth considering for businesses looking to improve cost management practices and decision-making capabilities.