Activity-based costing (ABC) is a methodology for more precisely allocating overhead costs by assigning them to activities. Once costs are assigned to activities, the costs can be assigned to the cost objects that use those activities (Accounting Tools, 2021). ABC Analysis arbitrarily separates inventory into three groups on the basis of annual dollar usage (cost of a unit X annual usage of the item). Typically, 20 percent of items in inventory account for 80 percent of the dollar usage. These are called a items. About 30 percent of items account for about 15 percent of the dollar usage; these are B items. Remaining 50 percent of the items account for about five percent of dollar usage. For better use of inventory resources A items receive the most attention, and C items receive the least amount of attention. ABC analysis ensures that inventory control procedures have the greatest impact on the inventory cost and inventory performance. By adding the non-cost criteria to the dollar usage criterion in ABC analysis, multiple-criteria ABC Analysis can be developed. Lead-time and criticality are examples of non-cost criteria that can be used in multiple-criteria ABC Analysis.

Example

When it comes to stock or inventory management, ABC analysis typically segregates inventory into three categories based on its revenue and control measures required: A is 20% of items with 80% of total revenue and hence asks for tight control; B is 30% items with 15% revenue; whereas C is 50% of the things with least 5% revenue and hence treated as most liberal.

Approach to manage:

1. Flowchart the process, activity, or value stream.

2. Identify costs and collect cost details.

3. Define resource drivers for performing all activities.

4. Map costs to activities.

5. dentify non-value-added activities for possible elimination.

Who all would need to be involved to setup this type of system (establishing an ABC system)?