What Is Activity-Based Costing in Accounting?

Tracking expenses is an essential part of accounting. You’ll need to know how much money your business spends on various goods and services so that you can deduct them from your taxes. Rather than grouping all of your businesses together, though, you may want to use activity-based costing. Activity-based costing will provide deeper insight into your business’s expenses by allowing you to assign them to activities.

The Basics of Activity-Based Costing

Activity-based costing is the process of assigning expense costs – specifically overhead-related expenses – to activities. It’s commonly used in the manufacturing industry. Manufacturing companies in the United States and abroad often prefer activity-based costing. With activity-based costing, they can assign their overhead expenses to activities. As a result, they can closely track their expenses.

How Activity-Based Costing Works

Activity-based costing revolves around activities. What are activities exactly? In accounting, an activity is any action for which your business incurs an expense. Purchasing new equipment can be considered an activity. Fulfilling a customer’s purchase order can also be considered an activity.

Benefits of Activity-Based Costing

It may sound confusing, but activity-based costing is relatively simple; you just need to assign expenses to activities. Some expenses may have a single activity, whereas others may have multiple activities Activity-based costing involves the assignment of expenses to activities.

You can use activity-based costing to improve your business’s cash flow. If your business operates in the manufacturing industry, it may suffer from a poor cash flow if it produces a surplus of products. If your business produces more products than what it sells, for example, its cash flow will suffer. Activity-based costing can help you improve your business’s cash flow by revealing the activities associated with your business’s production process.

With activity-based costing, you can break down your business’s expenses into the following categories: fixed expenses, variable expenses and overhead expenses.

Another benefit of activity-based costing is product pricing. You’ll have an easier time setting the right price points for your business’s products if you use activity-based costing. You can evaluate the activities associated with your business’s production process. With this information, you can create the perfect price points that allow for maximum profitability while keeping your business’s expenses in check.

Not all businesses use activity-based costing. Nonetheless, it offers several benefits. Activity-based costing is simple, can improve your business’s cash flow, provides insight into expenses and can help with product pricing.

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