Activity Based Costing
A methodology that measures the cost and performance of cost objects, activities and resources. Cost objects consume activities and activities consume resources. Resource costs are assigned to activities based on their use of those resources, and activity costs are reassigned to cost objects (outputs) based on the cost objects proportional use of those activities. Activity-based costing incorporates causal relationships between cost objects and activities and between activities and resources. ABC links activities to a particular product so that the cost impact of that product is more readily visible. ABC combines financial data with nonfinancial data (activity costs) to report the actual per-unit cost of outputs. ABC is a refined form of absorption accounting that replaces misleading overhead cost allocations with cause-and-effect driver relationships that do a better job of segmenting and tracing the diversity and variation of the outputs of the processes. For example, an ABC approach might measure the cost incurred by the accounts receivable department in handling calls for billing errors, whereas the traditional accounting approach ignores the activity and measures the cost of the accounts receivable department as a percentage of revenue.