Activity-based costing (ABC) is an accounting technique used in business to determine the overhead costs incurred. In any business, there is a correlation between costs, overhead operations and the manufactured goods and this technique assign the overhead costs incurred to products or services to avoid indirect expenses on the part of the business.
It is a common accounting technique in the manufacturing industry since it enables companies to streamline the production process by enhancing reliability on cost data which means that the business can determine the true costs incurred in the production process. Many activities take place in a company during the manufacturing or production process such as the setting up of machines, maintenance of technical equipment, designing of products to the final distribution of the finished product to the consumer. All these operational activities incur overhead costs, and it is important to take this into account during the product costing or profitability analysis.
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All the financial resources used in the production process need to be factored in when during the cost valuation process. For instance, at Unilever, the manufacturing of detergents incurs overhead costs such as costs incurred by indirect materials and the consequent indirect labor. The company intends to produce a new detergent which requires testing and standardization. This means that such costs need to be factored in the final price and as such the new product may be more expensive than other products offered by the same company. These may be indirect expenses since the business does not directly incur them, but they have to pay for by someone. To ensure that the company sets accurate prices, these costs need to be included in the final price of the product so that the company does not incur losses.
