Definition and Explanation of
Activity Based Costing System:
costing (ABC) is a costing method that is
designed to provide managers with cost information
for strategic and other decisions that potentially
affect capacity and therefore "fixed cost".
costing system is used to determine product costs
for special management reports. This system is
ordinarily used as a supplement to the company's
usual costing system. Most organizations that use
ABC system have two costing systems - the official
costing system that is used for preparing external
financial reports and the activity based costing
system that is used for internal decision making and
for managing activities.
In traditional cost
accounting systems, the objective is to value
inventories and cost of goods sold for external
financial reports in accordance with the generally
accepted accounting principles (GAAP). In activity
based costing (ABC) system the objective is to
understand overhead and the profitability of
products and customers and to manage overhead. As a
consequence of these differences in objectives,
"best practice" activity based costing system
differs in a number of ways from traditional cost
In activity based
Non-manufacturing as well as manufacturing costs
may be assigned to products.
manufacturing costs may be excluded from product
A number of
overhead cost pools are used, each of which is
allocated to products and other costing objects
using its own unique measure of activity.
bases often differ from those used in
traditional costing system.
rates or activity rates may be based on the
level of activity at capacity rather than on the
budgeted level of activity.
from traditional cost accounting systems can
dramatically impact the apparent costs of products
and the profitability of products and customers.