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Introduction:

 
Activity-based costing (ABC) unlike other traditional costing is based on the concept of assigning costs based on the activities that drive costs rather than the volume or number of units produced. It involves analyzing all activities to identify what drive costs, that is, what cause costs to be incurred.

Examples of costs drivers includes like production set ups, packing, engineering, receiving in addition to machine or labour hours

Hence ABC basically calculates the costs of individual activities and assigns costs to cost objects such as products and services on the basis of the activities undertaken to produce each product or service.

The benefits of or advantages of implementing activity based costing  system(abc) can felt in the  following conditions:

• When production overheads are high relative to total cost,
• When significant amount of overheads are allocated using only one or two cost pools,
• When there is a great diversity of product range where the products make diverse demands on resources because of differences in volume, process steps, batch size, or complexity,
• When there is considerable diversity of overhead resource input to the products,
• When consumption of overhead is not driven primarily by volume.
• Products that a company is well-suited to  make and sell show small profits while products for which a company is less suited show large profits,
• Complex products appear to be very profitable and simple products appear to be losing money,
• Operations staff have significant disagreements with the accounting staff about the costs of manufacturing and marketing products and services.

ABC systems commonly use a four-part cost hierarchy to identify cost-allocation bases.

• A cost hierarchy is a categorization of costs into different cost pools on the basis of the different types of cost drivers (cost-allocation bases) or different degrees of difficulty in determining cause-and-effect relationships.

The four-part cost hierarchy to identify cost-allocation bases:

1.       Output Unit-Level Costs:

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