History, Process, and Practicality of Activity-Based Costing (original) (raw)

Until 1985, companies relied on traditional costing methods and simple cost pools, such as direct labor-hours and machine-hours, to allocate overhead costs. As economies and business processes became increasingly complex, a new system for cost allocation was devised, called activity-based costing (ABC). Compared to traditional costing methods, ABC is more accurate in assigning revenues and costs because it assigns different costs to separate cost pools. To implement ABC, managers follow five steps: Determining cost pools and measures, assigning costs to said pools, calculating rates, assigning costs to cost objects, and writing performance reports. As for assigning costs to cost objects, they are assigned by unit, by batch, by product, and by customer; and if costs do not belong to any of these cost objects, they are assigned to costs that sustain businesses. Although ABC was originally intended for use by manufacturing companies, this is more common among service companies. ABC cannot be used by itself; rather, it must be combined with other business techniques such as decision support systems (DSSs). It is also useful for differential analysis and segment reporting. A variant of ABC, time-driven ABC (TDABC) is useful when using time as a cost driver, and provides a more accurate estimate of expenses than does standard ABC.