Editing Activity-based costing (section)

=== Historical development ===
Traditionally, cost [[accountant]]s had arbitrarily added a broad percentage of analysis into the indirect cost. In addition, activities include actions that are performed both by people and machine.

However, as the percentages of indirect or [[overhead cost]]s rose, this technique became increasingly inaccurate, because indirect costs were not caused equally by all products. For example, one product might take more time in one expensive machine than another product—but since the amount of direct labor and materials might be the same, additional cost for use of the machine is not being recognized when the same broad 'on-cost' percentage is added to all products. Consequently, when multiple products share common costs, there is a danger of one product subsidizing another.

ABC is based on George Staubus' Activity Costing and Input-Output Accounting.<ref>Staubus, George J. Activity Costing and Input-Output Accounting (Richard D. Irwin, Inc., 1971).</ref> The concepts of ABC were developed in the [[manufacturing sector]] of the United States during the 1970s and 1980s. During this time, the ''Consortium for Advanced Management-International'', now known simply as ''CAM-I'', provided a formative role for studying and formalizing the principles that have become more formally known as Activity-Based Costing.<ref>[http://www.cam-i.org Consortium for Advanced Manufacturing-International]</ref>

Robin Cooper and [[Robert S. Kaplan]], proponents of the [[Balanced Scorecard]], brought notice to these concepts in a number of articles published in ''Harvard Business Review'' beginning in 1988. Cooper and Kaplan described ABC as an approach to solve the problems of traditional [[cost management|cost management systems]]. These traditional costing systems are often unable to determine accurately the actual costs of [[Factors of production|production]] and of the costs of related services. Consequently, managers were making decisions based on inaccurate data especially where there are multiple products.

Instead of using broad arbitrary percentages to allocate costs, ABC seeks to identify cause and effect relationships to objectively assign costs. Once costs of the activities have been identified, the cost of each activity is attributed to each product to the extent that the product uses the activity.  In this way, ABC often identifies areas of high overhead costs per unit and so directs attention to finding ways to reduce the costs or to charge more for more costly products.

Activity-based costing was first clearly defined in 1987 by [[Robert S. Kaplan]] and [[W. Bruns]] as a chapter in their book ''Accounting and Management: A Field Study Perspective''.<ref>Kaplan, Robert S. and Bruns, W. ''Accounting and Management: A Field Study Perspective'' (Harvard Business School Press, 1987) {{ISBN|0-87584-186-4}}</ref> They initially focused on manufacturing industry where increasing technology and productivity improvements have reduced the relative proportion of the direct costs of labor and materials, but have increased relative proportion of indirect costs. For example, increased automation has reduced labor, which is a direct cost, but has increased depreciation, which is an indirect cost.

Like manufacturing industries, [[financial institution]]s have diverse products and customers, which can cause cross-product, cross-customer subsidies.  Since personnel expenses represent the largest single component of non-interest expense in financial institutions, these costs must also be attributed more accurately to products and customers. Activity based costing, even though originally developed for manufacturing, may even be a more useful tool for doing this.<ref>Sapp, Richard, David Crawford and Steven Rebishcke "Article title?" ''Journal of Bank Cost and Management Accounting'' (Volume 3, Number 2), 1990.</ref><ref>Author(s)? "Article title?" ''Journal of Bank Cost and Management Accounting'' (Volume 4, Number 1), 1991.</ref>

Activity-based costing was later explained in 1999 by [[Peter F. Drucker]] in the book ''Management Challenges of the 21st Century''.<ref>Drucker Peter F.''Management Challenges of the 21st Century''. New York:Harper Business, 1999.</ref> He states that traditional cost accounting focuses on what it costs to ''do something'', for example, to cut a screw thread; activity-based costing also records the cost of ''not doing'', such as the cost of waiting for a needed part. Activity-based costing records the costs that traditional cost accounting does not do.

The overhead costs assigned to each activity comprise an activity cost pool.

From a historical perspective the practices systematized by ABC were first demonstrated by Frederick W. Taylor in Principles of Scientific Management in 1911 (1911. Taylor, Frederick Winslow (1919) [1911]. The Principles of Scientific Management. Harper & Brothers – via Internet Archive (Prelinger Library) Free access icon. LCCN 11-10339; OCLC 233134 (all editions).
The Principles of Scientific Management – via Project Gutenberg Free access icon.).  Those were the basis of the famous time and motion studies ([[Time and motion study]]) that predated the later work by Walter Shewhart ([[Walter A. Shewhart]]) and W Edwards Deming ([[W. Edwards Deming]]).  Kaplan's work tied the earlier work to the modern practice of accounting.