Commonly Used Terms

Activity-Based Costing (ABC) is a managerial accounting method that assigns certain indirect costs to the products incurring the bulk of those costs. Many large businesses, especially in the manufacturing sector, use this kind of costing system to accurately price their product. But, even Small businesses could greatly benefit from this. 

Actovity Based Costing Calculation

Here is the ABC calculation:
1. List all the tasks necessary to produce the product.
2. Group the activities into cost pools, which incorporate each activity's unique costs (such as manufacturing's). Determine the overall cost of each cost pool.
3. Assign the cost drivers for each activity in the cost pool, such as hours or units.
4. To determine the cost driver rate, divide all overhead for each cost pool by all cost drivers.
5. To get the cost driver rate, divide each cost pool's total overhead by all of the cost drivers.
6. Multiply the number of cost drivers by the cost driver rate.

Advantages and Disadvantages of Activity-based Costing:

Advantages: ABC for small businesses is a great way to calculate overhead decisions and pricing products. ABC system helps you understand how Overhead is used, which helps you determine whether activities that are costing more than they should be substituted or cut off.  You can assign costs to each activity in the production process, allowing you to set a price more accurately.

Disadvantages: Many companies forgo ABC because an improper implementation can exceed the cost of implementing it more than the benefits gained from using it.