Activity Based Costing

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Activity Based Costing allocates manufacturing overhead costs in a much more logical and precise manner than the traditional approach. Activity Based Costing assigns costs to activities that are the real cause of the overhead. It then assigns the cost of activities only to the products that are actually demanding the activities.
Activity Based Costing recognizes that any special engineering, special testing, machine setups and others activities that are the root causes of costs. They cause the company to consume resources. Under ABC, the company will calculate the cost of the resources used in each of these activities. Next, the cost of each of these activities will be assigned only to the products that demanded the activities.  
The significance of Activity Based Costing has grown in the recent years due to the fact that if some products in the company consume special resources and if some do not, then it is a highly possible that the cost of the resources will be put under the products which are not consuming those special resources, thereby increasing the cost of production.
With the implementation of ABC, the management gains a thorough understanding of its business processes and cost behavior during the ABC analysis process. The management applies the insights gained during ABC fact gathering and analysis to improve decision making at both operating and strategic levels. The ABC implementation and analysis helps in the identification of services which do not add any value to the product. These wasteful activities can be identified easily there by reducing irrelevant costs in the manufacture.

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