Activity-based costing (ABC) is a method of assigning costs to products or services based on the resources that they consume.
1. Identify costs.
E.g. for distribution: advertising, warehousing etc.
2. Identify secondary costs.
Costs incurred to provide services linked to other parts of the company – not directly products or services. Computer services, administration,…
3. Identify primary cost pools.
Costs more closely aligned with production. Separate product lines; research, development, advertising, procurement, distribution channels,…
4. Measure activity drivers.
Collect information about the activity drivers used to allocate the costs in secondary cost pools to primary cost pools. Allocate the costs in primary cost pools to cost objects. Use activity drivers for information which is already being collected.
5. Allocate costs in the secondary pools to primary pools by using activity drivers.
6. Charge costs to cost objects.
Divide total costs in each pool by the total amount of activity in the activity driver to establish costs per unit of activity. Then allocate costs per unit to costs objects based on their use of activity driver
Determine how overhead is used.
Know your product.
Information about activity costs, distribution costs, margins, minimum price etc.