Activity-Based Costing: Pros, Cons, and Examples

abc costing example

For example, in a factory, the number of hours a machine runs determines how much electricity is used and how much will have to be spent on maintenance. In this example, the number of machine hours is the cost driver that controls how much electricity is used and the cost of maintenance. The fewer the number of machine hours, the less the cost of electricity and maintenance; whereas, the higher the number of machine hours, the more the cost of electricity and maintenance. The number of machine hours is a typical cost driver used in traditional costing systems, as is direct labor hours.

Activity based costing (ABC) assigns manufacturing overhead costs to products in a more logical manner than the traditional approach of simply allocating costs on the basis of machine hours. Activity based costing first assigns costs to the activities that are the real cause of the overhead. It then assigns the cost of those activities only to the products that are actually demanding the activities. As an activity-based costing example, consider Company ABC that has a $50,000 per year electricity bill. For the year, there were 2,500 labor hours worked, which in this example is the cost driver. Calculating the cost driver rate is done by dividing the $50,000 a year electric bill by the 2,500 hours, yielding a cost driver rate of $20.

A Guide to Activity Based Costing in Healthcare

One of the hardest things for manufacturing organizations is coming up with pricing that keeps their products competitive and profitable. The problem is that traditional costing methods can generate waste and keep companies from earning the profits they desire. Given the service-line/service-center abc costing example relationship, an accurate costing methodology must track and account for resource consumption throughout the care journey. Cost-accounting solutions need the ability to record all specific costs incurred, no matter the department or area of the hospital.

  • Activity-based costing (ABC) is a costing method that assigns overhead and indirect costs to related products and services.
  • By understanding which activities drive the most costs, you can identify areas to improve efficiency and reduce waste.
  • If you want to implement an ABC system but don’t know where to start, you’re in the right place.
  • Using the same expenses and information from Example 1, Rio Group LLC has asked you to allocate its overhead to each product using activity-based costing.
  • The costing of the two products can be continued by adding in fixed overhead costs to obtain the total absorption cost for each of the products.
  • With more accurate costs developed via TDC, hospitals and health systems are also making more informed decisions in determining their financial plan and moving toward new budgeting processes like rolling forecasting.

It encourages management to evaluate the efficiency and cost-effectiveness of program activities. Let’s define all the individual terms you need to understand the ABC accounting method. You first need to work out the kilowatt hours (kWh) consumed for that period. And if that’s not an option, try not to overfill the clothes dryer as this can slow down the drying process and lead to greater energy usage. The best clothes dryer is the sun and it costs nothing to run, so dry your clothes on a washing line whenever you can. The Department of Energy says washing clothes with cold water “can save up to 10 times more energy” than a warm wash.

Product Costing

Organizations across the country are beginning to adopt the time-driven costing methodology to advance the accuracy of their costing. At Montefiore Medical Center in New York, leaders used Time-Driven Costing to create more accurate staffing models. “We could start creating staffing models that are much more responsive, precise, and fine-tuned,” says director of decision support Jason Oliveira. While the revised approach encourages more efficiency by virtue of no longer surveying staff on where and how they spend their time, it is by no means a perfect solution to complicated costs. The objective of Kaplan’s time-driven activity-based costing is to be close to the actual number, rather than identifying it.

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