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Activity-Based Costing Defined and Explained

Define and explain activity based costing. Also use some real-life examples of how companies implement this management tool. Offer some comparisons and contrasts and pros and cons from different view points on this topic.

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Before we can start thinking about activity based costing, we need to first understand the difference between direct versus indirect costs (or sometimes prefers to as overhead costs). In business settings (mostly manufacturing environment), there are some costs that can be directly traced to a specific product or service, for instance the cost of four tires can be traced to the car that they are attached to. Those kind of costs are called the direct costs. On the contrary, there are other manufacturing costs that are expensed in the manufacturing environment, but cannot be traced directly to a single unit. Take for example the maintenance costs of a piece of machinery. It is indeed a manufacturing costs, but we have hard time to allocate this cost to a single unit. Ignoring those costs will result in underestimation of the unit costs and therefore inaccurate pricing information.

The first solution that people think of is using an estimation method (or sometimes refers to as the traditional costing ...

Solution Summary

Activity based costing is defined. Real-life examples of how companies implement this management tool are given.