Activity-Based Costing in Manufacturing
Activity-based costing (ABC) has become one of today’s most popular methods of
costing by using activities to allocate indirect costs, such as overhead. Versions of
ABC originated as early as the 1920’s; however, advancements have been adopted in
modern business. Activity-based costing is an essential aspect of accurate, more
reliable cost information to produce true costs in representing financial data.
Applications, implementation procedures, and changes in ABC are illustrated as a
guide to better understanding ABC in manufacturing.
Knowing the strategy behind activity-based costing is the first essential facet of this
guide to better understanding costs. An organization can create a better strategy and
corporate focus if the costs are better understood. Activity-based costing refines a
costing system by focusing on individual activities as the fundamental cost objects.
An activity is an “event, task, or unit of work with a specified purpose; for example,
designing products, setting up machines, operating machines, and distributing
products” (4, p. 141). Put simply, ABC is a systematic, cause and effect method of
assigning the cost of activities to products, services, customers, or any cost object (7).
Disregarding the definition of the method, ABC is an accounting tool that has
established a breakthrough role in the world of costing – applicable in retail or
manufacturing from sole proprietorships to large corporations.
The entire idea of this method being activity-based has created a different perspective
in costing, one that produces more of a true cost. Many accountants and managers
believe that inventory cost figures give accurate product costs, which is not usually
the case (5). The true cost of a product is better calculated by tracing other costs, such
as overhead, to the manufacturing of the specific product, and it identifies any non-
value added activities. Understanding the true cost of providing products and services
to customers is one of the key elements of survival in a competitive environment (8).
Most companies need to be better informed of general costing to ensure a unified
approach to operations. From the implementation of ABC, Chrysler was convinced