Imagine you have a small take-out joint selling burgers and lemonades. This month you sell

100 burgers and 100 lemonades for a total of 200 items. What if… at the end of the

month, you have an electric power bill of $200?

How will you divide the electric bill between the burgers and the lemonades?

Easy! The $200 divided by 200 items equals $1 in electric power for each burger or lemonade

sold. But what if… you use 3 kilowatt hours of

electric power to make one burger, but only 1 kilowatt hour of electric power to make

a glass of lemonade?

Is it still fair to write down $1 of electric power for one burger and $1 of electric power

for one lemonade? We should write down a bigger electric power

cost for the burger, right? This is where Activity Based Costing is different

from traditional costing. traditional costing is easy because if often

just divides some types of costs equally between different items.

These are usually costs which are a bit difficult to divide or allocate between products, such

as electricity, telephone bills, internet usage, rent, salaries, and others. However,

Activity Based Costing finds ways to divide or allocate these costs more proportionally

or fairly

These are usually costs which are a bit difficult to divide or allocate between products, such

as electricity, telephone bills, internet usage, rent, salaries, and others so that

we can write down a higher cost for items or products which use more of the stuff related

to costs. In our case we now know that we should write

down a higher electric power cost for burgers than for lemonades.

As a result, this might cause us to sell our burgers at a higher price than the lemonades,

and the lemonades at a lower price than the burgers.

Of course, electric power is not the only cost in making burgers and lemonades. Therefore,

we have to think about other costs as well before making our final pricing decisions.

See? The basic concept of Activity Based Costing isn’t so difficult, is it?

Would you like to learn how to easily calculate product cost using Activity Based Costing?

Check out my free video at MBAbullshit.com See ya there!