Activity–based costing (ABC) is a costing methodology that identifies activities in an organization and assigns the cost of each activity with resources to all products and services according to the actual consumption by each.
Advantages of activity based costing:
- ABC is flexible enough to trace cost to processes, customer’s areas of managerial responsibility as well as product cost
- ABC focuses on real nature of cost behaviour and help in reducing costs and identifying activities which do not add value to the product;
- It also provides reliable indication of long run variable product cost which is relevant to decision-making;
- more realistic product costs are provided especially in advanced manufacturing system;
- More overhead can be traced to the product;
- In ABC costing system poor decisions due to inadequate cost information are less likely to occur.
- ABC may facilitate cost control through the identification and management of cost generating activities. For example in order to reduce set up costs, production planning could be used to eliminate short term production runs and hence reduce number of set up costs.