Concept of Activity-Based Costing

Activity Based Costing is a Methodology that assigns costs and expenses registered in a company general ledger to activities and processes realized by the organization. In a second stage activities and processes assign cost to cost objects (products, services, customers, distribution channels, regions, etc.)

Activity-Based Costing measures the total resources consumed by a process, product or service, valued in monetary terms (money). Performing a good classification and allocation of costs, provides information on the profitability generated by each product, service or process.

Allocations must reflect real consumption of resources for each activity, process or business segment. There are different methods for measuring costs. The choice depends on the needs and the objective to be achieved with the costing system.

The activity-based costing is a methodology that enables a strategic costing of activities, processes, products, customers, distribution channels, product families, distributors, subsidiaries, sales regions, or any business segment to be measured. The methodology is based on assigning costs to products, channels or customers, by using drivers or cost drivers. Every driver is defined depending on resource consumption and demand for activities that each of the segments has . This costing system is much more accurate and addresses the most important questions of any business such as:

  • What are the most profitable products or services and make them lose money?
  • Which customers add value to the company and which of them destroy it?
  • What is product portfolio to maximize profitability in every distribution channel or sales region?

Strategic costing system generates information that organization can use to take actions such as: cost reduction, accurate costs allocation for pricing, process improvement, profitability analysis by business segment, definition of financial and non financial indicators that allow for improving business management and decision making process. There are also different classifications of costs. Depending on their behavior can be categorized costs into fixed and variable, depending on how much they relate to a product or service, they are classified into direct and indirect. Both direct and indirect costs, fixed or variable of organizations can be reduced.
To reduce costs, the first thing an organization should consider is NOT affect operation. This requires to have an established and proven methodology that leads only to reduce costs, improve process efficiency by making the use of resources to maximize results.