Activity-Based Costing (ABC)

Managers measure the cost of producing goods and services so they can be sure they are selling those products for more than the cost to produce them. Traditional methods of costing assign costs to various departments or functions, such as purchasing, manufacturing, human resources, and so on. With a shift to more horizontal, flexible organizations has come a new approach called activity-based costing (ABC), which allocates costs across business processes. ABC attempts to identify all the various activities needed to product a product or service and allocate costs accordingly.

For example, an activity-based costing system might list the costs associated with processing orders for a particular product, scheduling production for that product, producing it, shipping it, and resolving problems with it. Because ABC allocates costs across business processes, it provides a more accurate picture of the cost of various products and services. In addition, it  enables managers to evaluate whether more costs go to activities that add value (meeting customer deadlines, achieving high quality) or to activities that do not add value (such as processing internal paperwork). They can then focus on reducing costs associated with non-value-added activities.

Reference: New Era of Management