Activity-Based Costing: What it Is and How it Works

Naturally, small-business owners want to find places in the budget where they can cut expenses while increasing profits. However, it can be a challenge for business owners to keep up with accounting matters and expand their business at the same time. One of the ways that our team of accountants can help is by providing reports using the activity-based costing system, also known as ABC costing, alongside our other services, like invoicing, issuing payments for bills, managing payroll, and assisting business owners with taxes. But what is activity-based costing? Take a look at how this system works and you’ll soon see the many benefits of activity-based costing for a business.

What Is Activity-Based Costing?

Activity-based costing is an accounting method that assigns costs to the different activities involved in making a product in order to allocate a company’s funds in a fair way. This method paints a clearer picture of where a company’s money is going and can help the business to trim expenses or more accurately price its goods.

What’s an Example of Activity-Based Costing?

Let’s say that a furniture manufacturer makes two types of chairs. One chair is a straight-back wooden kitchen chair with a solid yet plain design. The other chair is an overstuffed leather easy chair perfect for a living room. An accountant using the activity-based costing system to evaluate the costs for these two chairs would find that the plush leather chair requires more materials, labor hours, and equipment to manufacture than the straight-back chair. Therefore, a greater amount of funds must be allocated toward making the overstuffed chair than the simple kitchen chair.

 

How Do You Calculate Activity-Based Costing?

ABC costing calculation follows these steps:

1. Identify activities needed to create the product.
2. Create cost pools of activities, and calculate the overhead cost of each.
3. Assign each pool a cost driver.
4. Divide the total overhead of each pool by the total cost drivers to get a cost driver rate.
5. Multiply this rate by the number of cost drivers.

What Are the Benefits of Activity-Based Costing?

There are several advantages of activity-based costing compared to traditional methods of accounting. ABC costing:

1. Allows a business owner to see exactly where money needs to be allocated
2. Paints a clearer picture of the operations of a business
3. Shows places where costs can be cut
4. Illustrates where more resources are needed to increase the quality of a product or speed up the manufacturing process.

Increase Profitability With Professional Accounting

Activity-based costing is a great strategy for helping you to boost your bottom line, and the skilled accountants at Ignite Spot would be glad to assist you. Owners of small- to medium-sized businesses who choose to outsourced their bookkeeping tasks to Ignite Spot can rely on the work of our capable staff of accountants. We use the most effective accounting methods to help businesses increase profits, freeing up business owners to focus on the goals of their business. Contact us today to see how you can save money and time by letting Ignite Spot take charge of your business’s bookkeeping responsibilities!

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Written by Eddy Hood