Some accountants use ABC to mean Activity Based Costing. Under this ABC a manufacturer will use many cost drivers to assign overhead costs to products. The objective of Activity Based Costing is to assign the overhead costs based on their root causes rather than merely spreading the costs on the basis of direct labor hours or production machine hours.
A second use of ABC involves categorizing inventory items into “A” items, “B” items, and “C” items. The “A” items are a relatively small number of items which account for the majority of the inventory’s value. For example, the “A” items might be 20% of the items in inventory which account for 70% of the inventory value. At the other extreme the “C” items might be 60% of the items in inventory but they account for only 10% of the inventory value. The “B” items might be 20% of the items accounting for 20% of the inventory value. Under this system, the “A” items will receive the most attention since they account for 70% of the value. This ABC is sometimes referred to as Pareto analysis or Pareto’s rule and it can be applied to more than inventory. For example, 20% of a company’s customers might account for 70% of the company’s sales.
