What is Activity-Based Costing (ABC) ?

Activity Based Costing (ABC ) is a systematic approach for categorising and understanding the cost of your product, in a way that helps you to make better, clearer decisions, leading to cost improvement, correct pricing and money-saving.

Most companies use the traditional method of costing which keeps the data and the numbers simple but produces only approximated accounting. Companies that use activity-based costing will have a more accurate picture of their numbers and be better able to identify cost savings.

Below I will show you how and why taking an Activity-Based Costing approach to manufacturing will help you understand which cost drivers could make the difference. Better-priced products lead to content customers, stronger sales and happy management.

The Traditional Method of Costing

In manufacturing, Traditional accounting methods of costing look to gather all the costs of the company. Costs are often grouped together into three areas - materials, processes and overheads.

There is a lot of focus on understanding the material costs, as these are generally easy to identify against the product. For the processes and overheads, this takes more time to clearly identify what cost belongs where, so different processes get placed into cost pools together and spread over the number of products that use them.

This makes accounting simpler and is sometimes done this way because the primary goal is accounting compliance, rather than understanding the cost per unit and data in detail.

How Is Activity-Based Costing Different to the Traditional Method?

Activity Based Costing is a detailed approach that looks to understand what is inside the costs that are traditionally grouped together in a cost pool.

Rather than just spread the cost over several products, ABC seeks to understand how much each product uses and get to grips with all overhead costs and cost drivers.

For each product, the machines or resources that are assigned or used on the manufacture of the product, there should be a clear definition of the costs that are incurred, and then how much of this machine or resource is to be allocated to the specific product.

Who Uses Activity-Based Costing?

Automotive manufacturing is one of the main industries that extensively use Activity-Based Costing to understand and control their product costs.

This Industry is fiercely competitive, and so to maintain profit margins, they must understand and control their costs in fine detail. With this level of understanding, they can focus on maximising product cost savings.

Other large industries such as Aerospace, Rail and Power generation now also make use of this activity-based costing.

FURTHER READING: Why Everyone Needs To Understand Manufacturing Costs.

What Benefits Do Companies Get From Using Activity-Based Costing?

By using Activity Based Costing and understanding their costs in this level of detail, companies are then able to budget, monitor, adjust and deliver their product in line with a profitable plan.

Having a better vision of the costs, means that they have much more clarity about the profit margin that they are achieving.

Costs are were hidden, grouped, amortised, or just never considered, are now in focus, and so can be analysed to consider the best and most cost-efficient way to manufacture a product.

Why You Should Learn About Activity-Based Costing

When you learn about the ABC approach, you switch your thinking to understanding and analysing cost from a point of improvement, rather than just allocating a cost driver for accounting purposes.

This approach encourages you to know a lot about your products, and details of manufacturing, in order to know where you have to collect the information that you will need.

When you have this direction and intensity of focus, you naturally see opportunities to improve the cost of products that were not clear before.

With extensive use of ABC not only will the cost improvement opportunities become more visible, but you will also improve the accuracy of the initial budgeting of your products.

You will be able to price products more competitively with confidence, enabling you to win more business.

Where Can You Learn About Activity-Based Costing?

In the Pivotal Value Training Course on Product Cost Awareness, you can learn in detail about Activity-Based Costing.

In this course, you are introduced to cost structures and learn about the traditional costing method vs. Activity-Based Costing.

Using example parts, you are taken through exercises to complete supplier quotation breakdowns, which shows how the detail of ABC is used to build up and explain the cost.

TAKE A LOOK AT THE PRODUCT AWARENESS COURSE