Activity Based Costing

Activity Based Costing Vs. Functional Based Costing

Activity based costing is an alternative to the traditional way of accounting. Traditionally it is believed that high volume customers are profitable customers, a loyal customer is also a profitable one, and profits will follow a happy customer. (www.valuebasedmanagement.net)Studies on customer profitability have unveiled that Huge Company would benefit from activity based costing opposed to functional based costing, and as a result, activity based costing can support Huge Company's managers to see how to maximize shareholder value and improve corporate performance. (www.valuebasedmanagement.net) Traditional information systems like functional based costing, report costs by functions (e.g. administration, manufacturing, and marketing). Functional based costing systems focus on specific functions of an organization while activity based costing operates on the premise that activities incur costs through the consumption of resources, while customer demand for products and services causes activities to be performed.

There are four steps that are used to determing the cost of goods and services using the activity based costing method. The first step is to identify and classify the activities that a company performs. People identify the activities that a company performs to produce a product to prepare an activity dictionary. (Hilton, Maher, & Selto, p.190)

The second step is to estimate the costs aassociated with these activities. The third step is to calculate a cost-driver rate for each of these activities, and the fourth and final step is to assign activity costs to products. (Hilton, Maher, & Selto, p.190) By using a transaction-level data structure such as activity-based costing, Huge Company can receive, process, allocate and report on activities by customer, contract, order, product, task or other user-defined criteria. (Hilton, Maher, & Selto,