Activity Based Costing Definition Essay

Activity-based costing (ABC) is a costing technique where a firm identifies activities within its operations and then assigns the cost of each activity to products and services it produces. These costs are assigned based on the actual resource consumption related to a product or service. This method is based on the assumption that the activities identified by an organization are the real cause of operational overhead. One example of a fun product whose production costs can be estimated using the ABC method is a car. This technique can assist a car manufacturer to determine the direct and overhead costs related to the production of a particular car model. Some of the activities associated with the production of a car include parts buying, special engineering, testing, machine setup, assembly, and others. Each of these activities has a specific amount of resource consumption that contribute to the overall costs. These costs are also tied to transaction-based drivers, such as the number of orders that the company receives. The activities that might raise costs for the car manufacturer include machine setup, testing, assembly and purchasing activities. The cost of these activities is driven overheads, such as labor hours, units, and other cost drivers. Buying costs can also increase costs depending on the procurement process, including whether the organization uses just in time purchasing. It is possible to reduce the cost of these activities to optimal levels through appropriate management techniques. For instance, synchronization of activities from machine setup to testing can prevent delays and idle time, and ensure optimal allocation of labor hours. Overall, effective use of activity-based costing can assist an organization to optimize resource allocation and manage costs.