Activity-Based Costing

Activity-based costing, often shortened to ABC, is an accounting method that lets a business trace its operating costs to the specific activities that cause them, such as planning, engineering or manufacturing, and then link those activities to the products or services that use them. It emerged in the 1980s as a response to traditional cost accounting, which measured mainly direct labor and materials and spread overhead somewhat arbitrarily, a practice that distorted results as automation and support services made overhead a larger share of total cost. Harvard Business School professor Robert S. Kaplan was among the first to argue for a more precise system. With ABC, managers can see which products, services and resources add to profit and which drive losses, build better budgets, and decide whether costly activities should be outsourced, cut back or eliminated. It works best over a long period and needs commitment from senior management.