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What is Activity-Based Costing?

Activity-Based Costing (ABC) is an accounting method that assigns costs to products, services, or business activities based on their consumed resources. Unlike traditional costing methods that allocate overhead costs based on a single driver (e.g., direct labor or machine hours), ABC identifies various cost drivers related to specific activities. This offers a more accurate reflection of the true costs of production or service delivery.

Why is it important or used in Accounting?

Activity-Based Costing is used in accounting for several reasons:

Advantages of Activity-Based Costing:

Disadvantages of Activity-Based Costing:

Example of Activity-Based Costing for a Wholesaler or Retailer Business:

Consider a wholesaler that distributes electronics to retailers. The wholesaler identifies key activities and their associated costs:

  1. Order Processing Activity:
  1. Inventory Management Activity:
  1. Delivery Activity:

Using ABC, the wholesaler allocates costs to products based on the specific activities that impact those products. For example, if a particular product requires more order processing or incurs higher delivery costs, its total cost under ABC would reflect these specific activities more accurately compared to a traditional costing method. This enables the wholesaler to make more informed decisions about pricing, product mix, and resource allocation based on a better understanding of the true cost drivers within its operations.

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