What is setup cost?

Setup cost is the cost incurred to get equipment ready to process a different batch of goods. Hence, setup cost is regarded as a batch-level cost in activity based costing.

Setup costs include the costs of changing the tools or dies on the equipment, moving materials or components, and testing the initial output to be certain it meets the specifications. In addition to the out-of-pocket costs, such as the labor cost of setting up the equipment, there is a much greater cost. The greater cost of setup is the lost opportunity of manufacturing profitable output while the machine is idled during the setup time.

Setup cost is viewed as a non-value-added cost that should be minimized.