Define and discuss Activity Based Costing, including its impact on profitability

Answer 1

Traditional cost accounting is well suited to situations where an output and an allocation process are highly correlated. On the other hand, traditional cost accounting is not very effective in situations where the output is not correlated with the allocations base. This is the more likely scenario in logistics. This is where we can see the effectiveness of activity-based costing (ABC), which can be defined as, "A methodology that measures the cost and performance of activities, resources, and cost objects. Resources are assigned to activities, then activities are assigned to cost objects based on their use. ABC recognizes the causal relationships of cost drivers to activities.". ABC assigns resources to an activity (for example, labor cost for picking product), identifies the cost drivers (for example, labor cost for picking a pallet versus picking an inner-pack), and then allocates those costs to products, customers, markets, or business units. ABC more accurately reflects the actual cost of performing an activity than does traditional cost accounting.