Activity-Based Costing System | Steps

A method which is based on activities rather than units, products, or departments. An extension of ABC.

Activity-based Costing (ABC) is a refined methodology for costing products than the traditional costing method (TCM). It involves the following steps:

  • The cost object is the start of the ABC process. The cost object can be a product, service, end consumer or region. Remember that ABC is and has been used in many different industries and sectors; therefore, the cost object will fit the needs of the information required by the individual organization. A cost object is something for which a separate cost measurement is required.
  • Once the cost object is identified the organization needs to create a workflow for the cost object. The workflow will identify all the processes and support activities that are used to produce the cost objects. In other words, the entire value chain needs to be analyzed. In the process of identifying activities, workflow maps are very useful, as they prevent activities being missed. Work-flow maps are diagrams which represent the processes involved within an organization.
  • Once the activities are established the organization will then engage in a process which identifies how activities consume resources. This can be a complicated process which includes lengthy surveys or interview processes. Identifying how the resources are consumed by the activities is known as identifying the resource drivers.
  • Once the resources are traced to the activities then the resources can be allocated to the activity pools, identified in the previous stage, through the use of the resource drivers. In many cases, time is used to allocate the costs based upon the surveys used.
  • The final stage is to collect data which relates to the cost drivers. The cost drivers connect the activity pools and the cost objects. The cost drivers represent how the cost objects consume resources from within the activity pools. There is a causal relationship between activity pools and cost objects, and this relationship is represented through the cost driver.

Table 1 summarizes the design process for an ABC system.

Table 1: Stages in the design process of an ABC system

Cost object Identify your cost object, e.g. product, service, consumer, region This will be determined by the type of industry you are in
Activities From the cost objects, a workflow must be identified to trace all activities, including support activities Work-flow mapping and payroll can help in this stage to ensure all activities and employees are included.
Resources Activities must be examined in terms of how they consume resources, establishing the resource drivers Work surveys are usually used to determine how the resources are consumed by the activities. Detailed surveys and interviews with key members of staff can help to determine how much resource each activity uses
Allocating resources to activities The resources are allocated to the activities The resource drivers are used as a means of allocating the resources to the activities. When the activities have resources attached to them they are known as activity pools
Cost drivers The activities must be examined in terms of what drives the costs within the activity pools Cost drivers are the driving force which connect the activities to the cost objects. Clear and easy to measures cost drivers must be allocated to each activity